Chart of the Month – January 2020

Why did the S&P 500 outperform the TSX Composite?

We frequently get asked why the U.S. stock market always seems to outperform the Canadian market. This is a good question as one would expect the equity market in the stronger economy to be higher.  Yet even if Canada’s economy outperforms that of the U.S. this often does not seem to be the case. Last year however the U.S. economy grew at roughly 2% while Canada’s grew at approximately 1.5% so one might expect the U.S. stock market to outperform that of Canada’s, which it did.

US & Canada Sector Returns 1 Year 2019

This however is not the whole story as the reality is far more a factor of the sector makeup of each market. The chart to the left below tracks the performance of each industry sector in both markets and it is interesting to note that technology is the highest performing sector in both markets but contrary to most peoples’ expectation, the Canadian technology sector outperformed that of the U.S.           

However if you now look to the sector weight in the index on the right hand chart you will note that the technology sector makes up 21% of the capitalization of the S&P500 versus only 5.7% in the TSX Composite.  So the stronger performance in Canada, has a much smaller impact on the overall index returns.  

The largest sector in the Canadian index is the financials.  As you can see in the chart below, this heavy weight sector contributed 5.4% to the overall index return, which is a larger contribution than the 4.1% contribution of the same sector to the S&P500 – despite the Canadian index having weaker performance than its U.S. counterpart.  It’s heavier weight, more than offsetting its weaker performance.

Similarly, the energy sector in both countries severely underperformed, being the worst sector in the U.S. and second worst in Canada (failing to hit the bottom of the list only due to the implosion of the marijuana stocks), however the overall impact on the indices was different, due to the Canadian sector having three times the weight in the index.

The main lesson to be learned from this is that finding an appropriate portfolio benchmark is not as easy or straightforward as often presented.  Performance of the benchmark is impacted not only by the economic fundamentals of the individual country, but also by the weighting applied to various industries within the benchmark.  It also suggests that individual investors need to stay focused on their own objectives and selecting an appropriate asset allocation to meet those goals, rather than  the performance of arbitrary benchmarks.