TSX gaining favour over S&P 500: Rosenberg Research

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By Marius Jongstra

An interesting divergence is opening up when it comes to our proprietary model’s view on North American equity markets in Canada’s favour, specifically in the outlooks for both the S&P/TSX composite and the S&P 500 indexes.

As little as just four months ago, we held fairly subdued views on both regions. Since then, however, there has been a notable shift in favour of stocks north of the border compared to their peers in the United States.

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In the context of the much more overbought, crowded, overvalued and exuberant conditions as pertains to the S&P 500, there is a path ahead to relative outperformance in Canadian stocks, providing a window to narrow the valuation gap that has opened up in recent years.

A clouded macroeconomic backdrop in Canada is keeping the S&P/TSX composite from overweight territory for now, but the landscape has improved enough to upgrade our views from a previous underweight stance. Updates will continue to be evaluated in the coming months for further signs of improvement.

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Indeed, valuations on the S&P/TSX composite are far from the stretched conditions that U.S. investors face south of the border. A forward P/E ratio of 15.3x is more or less in line with its historical average of 14.7x (dating back to 2010).

For the S&P 500, however, the index trades at a whopping 22x, more than five points above the norm and it registers as a 1.6 standard deviation event relative to its average. The almost seven-point gap between Canadian and U.S. multiples is among the widest readings on record.

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At face value, expected earnings per share (EPS) growth tilts favourably to U.S. equities, which are projected to grow at an 11 per cent annual rate out to 2026. This compares to seven per cent (annualized) for the S&P/TSX composite.

As always, however, change is at the margin. A deeper look beyond headline level growth rates shows clear negative revision momentum to 2024 and 2025 expectations for the S&P 500, having been marked 1.6 per cent lower for the former and by 1.2 per cent for the latter from recent highs, to their lowest levels since January and April, respectively. Projections in Canada are holding up much better comparatively, having shown relative stability of late when benchmarked against the U.S.

That this is occurring at a time when sentiment and positioning data show a pessimistic and uncrowded investor backdrop reveals that these developments have largely gone unnoticed. Our Canadian equity model subcomponent tracking the former is registering at a lowly 35th percentile reading (the most bearish since October 2022) while the latter is flagging the lightest positioning since the turn of the year (33rd percentile). Compare and contrast this with comparable 94th and 90th percentile readings, respectively, in our U.S. equity model.

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This is a constructive development from a contrarian perspective, given the potential this creates for a “positive” surprise relative to expectations.

For example, short interest on the iShares MSCI Canada ETF recently touched seven per cent and compares to a historical median (dating back to 2005) of 3.8 per cent. For the SPDR S&P 500 ETF, this metric is reading at two per cent, which is in line with where it typically resides. No wonder then that the Canadian ETF has had more than US$600 million in net outflows over the past 52 weeks (20th percentile reading), while the American one has taken in a whopping US$48 billion during this period (98th percentile).

We can also add our in-house gauge of analyst sentiment as another example — looking at buy ratings across a number of key stocks in the S&P/TSX composite. This group is now the most bearish since September 2020.

A lot of these developments, of course, trace back to investors’ apparent unwillingness to want commodity exposure at this time. It has been quite clear in our analysis for some time that this asset class is unloved and underowned. Direct exposure to basic materials represents roughly one-third of the S&P/TSX composite via the energy and materials sectors. That our models happen to be constructive on the outlook on many commodities bodes well for the outlook ahead.

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Bottom line: Our models have experienced an improvement in their views on Canadian equities, from the consistent underweight signals back in June. The S&P/TSX composite has gained nearly 12 per cent over this period. A supportive liquidity backdrop from the Bank of Canada and stable-to-improving earnings estimates are occurring alongside still-depressed sentiment and positioning indicators (contrarian positives).

Investors have yet to fully buy into the rally that has brought the S&P/TSX composite to new all-time highs, in stark contrast to the obvious euphoria in market sentiment stateside.

Marius Jongstra is vice-president of market strategy at independent research firm Rosenberg Research & Associates Inc., founded by David Rosenberg. To receive more of David Rosenberg’s insights and analysis, you can sign up for a complimentary, one-month trial on the Rosenberg Research website.

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