The Toronto Stock Exchange (TSX) is the top index that tracks the Canadian stock market, and this is the most important market for many Canadian investors. The country’s top exchange covers a range of industries, but as many investors are well aware, this index provides heavy exposure to resource-related stocks and financials. These are sectors that are typically considered to be more value- than growth-focused, which isn’t great during bull markets but tend to perform much better in downturns.
That said, the heavy commodity exposure the TSX provides has meant that Canadian investors who have stuck closer to home haven’t really felt the impact of various geopolitical headwinds in the same way as other global economies.
Following a dip of more than 10% from where the TSX started this year in early April, the TSX has since made back all these losses and then some. Canadian stocks are now more than 3% higher year to date at the time of writing.
Let’s dive into two key red flags (and one green flag) that investors should consider.
Image source: Getty Images
Heavy exposure to the U.S. market
Mark Carney is Canada’s new prime minister and has put forward an aggressive agenda to stem the influence and importance of the U.S. market on Canada’s economy. By diversifying the country’s geopolitical exposure, the new Liberal administration is hoping to move past decades of dependence on the U.S. economy for Canadian goods.
In doing so, there’s hope that opening up other international markets (and intra-provincial trade) could bring future growth and prosperity home. We’ll have to see on this front, given that much of the country’s existing infrastructure has been built to support the steady flow of energy and other goods to the U.S.
As the saying goes, if the U.S. sneezes, Canada catches a cold. While that may be less of an issue moving forward if Carney is able to take action on his pledges, this is a risk investors will continue to face, particularly with such a volatile leader now in place south of the border.
Commodities do carry some cyclical risk
Given Canada’s resource-heavy economy, strong global demand for commodities is key to providing the sort of earnings base for many of these companies to thrive. In serious recessions, demand for all types of goods declines, and that could have a much more significant impact on countries that supply these economic inputs.
There’s some cyclical risk with any company or sector, particularly in the macro sense. And while the Canadian economy has evolved toward becoming more tech and non-resource/housing-reliant, it’s clear that investors will need to monitor the global macro environment more than in other markets.
For some investors, that can be a daunting ask.
The good news
As mentioned, this year’s decline and resurgence for Canadian stocks is noteworthy. The Canadian stock market hasn’t performed as well as many European markets over this time frame for a range of reasons (perhaps most notably the country’s proximity and reliance on the U.S.). However, if these Liberal promises come to fruition, there are a myriad of reasons why Canadian investors can remain bullish on the country’s prospects for the very long term.
I’m of the view that the Canadian economy will continue to be of utmost importance to global growth, and it’s a place worth investing in. That won’t change, and if anything, the recent dip we saw provided some intriguing buying opportunities for undervalued stocks I haven’t seen in some time.
Carry on.
