Through the decade prior to 2021, investors saw the TSX underperform the S&P500 by -10.9% (annualized). However, the fortunes for the TSX appear to have reversed in 2021 with Canada outperforming the US by roughly 6%. Over the past 55 years, investors have seen that the commodity cycle has helped define periods of TSX outperformance. The chart below summarizes the parallel relationship between commodity prices and relative TSX outperformance.

This outperformance can be attributed in part the sector mix of each index. The Energy and Materials sectors represent 26% of the TSX versus just 6% of the SP500. As commodity prices rise, corporate earnings and cash flows improve for those related companies. As the chart below displays, the year-over-year earnings growth of TSX listed companies grow in tandem with the commodity cycle.   With the broad commodity indices spiking higher in 2021, investors may wonder if a new commodity cycle has started with further TSX outperformance to follow. According to Myles Zyblock, Chief Investment Strategist at Dynamic Funds, the TSX is expected to deliver one of the strongest earnings growth rates in the world this year.

Our team has written in previous blogs about commodities and inflation.  The case for “sticky” high commodity prices hinges on structural supply and demand imbalances. Regardless of where one stands on this debate, investors should look at market valuations to help determine their geographic mix. The TSX is by no means “cheap”, currently trading at ~16.2x forward 12-month consensus earnings estimates. This is a 9.5% premium to the long term historical average of 14.8X since 2001. That being said, the TSX is trading at an approximate 22% discount relative to the S&P 500 on a forward PE basis. This is an extraordinarily deep discount. As the chart below shows, in instances where this discount is >20%, the TSX has outperformed the S&P500 over 1Yr, 3Yr and 5Yr periods.

Within our discretionary PIM portfolio, we have already increased our Canadian weighting by adding to economically sensitive sectors like financials and resources. Although it is too early to declare a secular trend of Canadian equity dominance, a tactical rebalance that respects the relative valuation discount between the TSX and S&P500 is warranted. We recommend investors to review their geographic and sector mix with their investment advisor.