5 reasons why Canada’s stock market stinks

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The S&P/TSX composite index was up almost four per cent this year as this column was being written. The S&P 500 was up about 14.7 per cent and the Nasdaq was up 18 per cent. Of all the large developed markets, the Canadian index’s performance is the absolute worst, except for France.

If you are an American investor, the Canadian market looks even worse. In U.S. dollar terms, the S&P/TSX composite is only up 0.7 per cent this year. Investors could have made nearly four times that amount by investing in a guaranteed investment certificate for half a year, with no angst, no risk and no stress.

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Let’s examine a longer period. Looking at annual returns since 2012, the S&P/TSX composite is up a cumulative 68.6 per cent (not including dividends). That sounds decent enough until one looks at the S&P 500’s return over the same period: a blistering 234.5 per cent. The U.S. market has beaten our market by nearly four times during this period. Adding the impact of currency, our market has returned a paltry 27 per cent in U.S. dollar terms in 12 years.

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So, what gives with the Canadian market? Why is it so bad relative to global markets? Here are five reasons.

Economic performance and currency

Of course, one can’t discuss stock markets without discussing economics. Frankly, and to be blunt, the Canadian economy simply sucks compared with the United States. We are less competitive, we have higher taxes (just raised), we are less productive and we spend more money.

The Canadian economy would already be in recession if not for immigration spending. Our inflation rate ticked higher this week, despite the slowdown. Canadian gross domestic product is estimated at about two per cent this year, after narrowly avoiding an official recession in 2023 with 1.1 per cent growth.

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Since our stocks are tied to the economy, a weak economy — and, subsequently, a weak dollar — are keeping foreign investors from loading up on Canadian stocks, and the S&P/TSX composite suffers. Imagine a broker’s sales pitch to a U.S. investor: “Would you like a return of nearly 15 per cent in U.S. stocks or a return of nearly zero in Canadian stocks?”

The index’s make-up is wrong

The S&P/TSX composite is currently 30.7 per cent financials, 18 per cent energy and 14 per cent industrials. Contrast that with the S&P 500 at 32.4 per cent technology, 12.4 per cent financials and 11.8 per cent health care.

Sure, our Canadian banks are an important part of the economy, but to be close to one-third of our index? Come on. If the financials do not perform well, then the index is never going to outperform. And energy? It seems everyone hates carbon producers, yet it is at 18 per cent of our index while just 3.6 per cent of the S&P 500. I think we can all agree that technology is likely to grow faster than banking and energy over the next decade, so why can’t the S&P/TSX composite reflect this?

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Multi-voting shares

The perception in the U.S. is changing somewhat, but Canada has had a preponderance of companies where management dominates control of their company through the use of multi-voting shares. For example, Teck Resources Ltd. has class A shares with 100 votes and class B shares with one vote (note that Teck’s structure is set to change in a few years).

Generally speaking, global investors can’t stand multi-voting share structures, nor should they. A management team with voting control but no equity control makes little sense. Management should be aligned exactly with shareholders: one vote per share. We think these structures have hurt the Canadian market’s attractiveness to international investors.

Canadian companies are too small

Of the current 226 companies in the S&P/TSX composite, only eight have a market capitalization of more than $100 billion. A total of 125 companies, or more than half the index, have market capitalizations of less than $5 billion. Four companies are worth less than $1 billion.

The company with the lowest market cap in the S&P 500 is Invesco Ltd., at US$6.8 billion. There are 36 companies larger than our largest company, Royal Bank of Canada. For any international investor, the Canadian market is really just too small of a playing field.

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Too much inconsistency

The S&P/TSX composite is primarily a capitalization-weighted index. Thus, some stocks that are in the $1-billion range tend to go in and out of the index on a semi-regular basis. If a particular stock does well one year, it gets added. Then it has a weak year and gets removed from the index.

Now, this is not necessarily unique, but it seems some S&P/TSX composite stocks go in and out of the index in a revolving-door-type fashion. For investors, particularly those trying to match an index, this can make tracking very difficult.

Speaking of consistency, we have seen governments do multiple flip-flops with policies. For example, there was the income trust debacle of 2006, as well as this year’s increase in the capital gains inclusion rate, which comes at a bizarre time considering our low growth. None of these items make our market more attractive to international and even domestic investors.

Peter Hodson, CFA, is founder and head of Research at 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals. He is also portfolio manager for the i2i Long/Short U.S. Equity Fund. (5i Research staff do not own Canadian stocks. i2i Long/Short Fund may own non-Canadian stocks mentioned.)

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