Why the Canadian stock market is performing so poorly compared to the U.S. market

The Canadian stock market just isn't delivering the kind of returns as the U.S. stock market because it didn't benefit from the Trump effect, and overseas investors aren't attracted to TSX's resource-heavy stocks.

TSX didn't benefit from the Trump bump and overseas investors don't see much opportunity here

Traders work on the floor of the New York Stock Exchange in New York on Jan. 31. (Brendan McDermid/Reuters)

The week's gut wrenching volatility on stock markets tell us two important things. First, that over a year or more, most stocks are still performing incredibly well. Second, that Canada's stock market looks awful when compared to U.S. benchmarks like the Dow Jones or the S&P 500.

Around this time last year, the Dow Jones Industrial Average had just sailed past the 20,000 mark for the first time. Today, even after the plunge on Monday, the Dow is up a respectable 19 per cent over the past 12 months. Same goes for the S&P 500; factor in Monday's sell-off and the index is still sitting on a nearly 12.5 per cent gain.

So, investors may have given some gains back on Monday, but they've seen a solid year of returns. At least that's the case for stocks traded on  U.S. markets. Canada's TSX tells a very different story. Over 12 months, the TSX has fallen 3.1 per cent.

Look at a two-year chart tracking the Dow, the S&P 500 and the TSX. If you're on a mobile device and it's too tiny all you need to know is the TSX is lagging. Badly.

All three indexes stay pretty closely entangled, rising and falling together right up to 2017. By the end of January, the Dow and the S&P start their long climb. The TSX forges off on its own. On that two-year timeline, the Dow and the S&P are up 49 per cent and 43 per cent, respectively. The laggard TSX just 22 per cent.

Use this handy interactive chart from Yahoo Finance. Look at the five-year chart,it's the same story. Scroll out to see how the three indexes have done since the financial crisis in 2008. The TSX just isn't keeping up.

The Trump effect

The date where those three indexes split is no coincidence. The U.S. markets began to climb after Donald Trump was sworn in as president. His promises of tax cuts, deregulation and infrastructure fuelled the market rally.

"As soon as Trump was in office, (stock markets) knew he was going to spend," said Conor Bill, managing director of Mt. Auburn Capital. "His plans for tax cuts were like catnip for the markets. They reacted. They continue to react very strongly."

The U.S. markets began to climb after Donald Trump was sworn in as U.S. president. His promises of tax cuts, deregulation and infrastructure fuelled the market rally.

Bill said Canada's stock market index didn't get any such bump. But more importantly, he said the TSX is lagging mainly because it's composed largely of resource heavy stocks that aren't exactly booming right now.

"The tech weighting is incredibly small in the TSX," he told CBC News. "Whereas it's much larger in the Dow and the S&P., and tech has been far and away the best-performing sector internationally."

Karl Schamotta from Cambridge Global Payments agreed.

"Canada remains a laggard in new-economy activity (the country spends more on real estate commissions and transfer costs than on R&D)," he said in an email.

He said low oil prices, combined with ongoing pipeline delays and a strong dollar mean Canadian oil is trading at an even larger discount than usual.

International investors sour on Canada

But Schamotta said there's a deeper problem that the lagging TSX highlights: that international investors don't see as much opportunity in Canada right now.

"Global markets are increasingly aware that Canadian households are severely indebted — meaning that the consumption growth that has long powered the economy is unlikely to be sustained."

The rapidly falling price of oil dragged down Toronto's stock market on Monday amid lingering worries for the country's economic outlook this year. (Frank Gunn/Canadian Press)

And therein lies the bigger issue. It's one thing if the country's stock market index isn't performing well. You can change the stocks held in that basket or give them a different weighting.

Schamotta said the issue here is that the TSX is actually pretty reflective of our economy and the lagging performance is yet more proof that we need to diversify.

"We as an economy need to become more competitive," he said. 

Canada ranks second last (ahead of only Italy) in the G7 for research and development as a percentage of GDP. For too long we've been a consumer-led economy. If we don't address that, it's not just the stock market that will fade. It's the broader Canadian economy.