While U.S. equity markets have been record-highs this year, the TSX Composite Index has posted rather modest gains by comparison. Michael O’Brien, Managing Director & Head of the Core Canadian Equity Team at TD Asset Management, discusses the difference in performance and the outlook for Canadian stocks.

Transcript

Greg Bonnell - While US markets have been hitting new highs this year, the TSX Composite's modest gains have looked a little sleepy by comparison. Joining us now to discuss all this is Michael O'Brien, managing director and head of the core Canadian equity team with TD Asset Management. Great to have you back on the program.

Michael O’Brien - It's great to be here. It's always fun.

Greg Bonnell - You and I were talking ahead of the show, and all you have to do is pull up a chart, where you look at the S&P 500, the rally it has had into new record territory this year, and then you overlay the TSX Composite Index, and I think the term you used is sleepy. What's going on here?

Michael O’Brien - Well, I mean, I think the first thing to say is the TSX isn't having a bad year. It's having an average year. We're at almost the halfway point, I guess, tomorrow. Total return-- TSX probably up about 5%. That's kind of a normal year. The problem is we're being compared to the superstar next door. It's kind of like I'm the high school quarterback, and everybody looks at me, and they look over in the next field, and there's Tom Brady throwing spirals. It's pretty hard to compete. So the question is almost not what's wrong with Canada. It's holy smokes, everything seems to be going right in the States.

But even there, it's not a wide, broad market. It's just a number of very impressive, very large companies have just captured people's imagination. So that's the first thing is Canada isn't actually having a terrible year. We're having an average year. It's just the comparison is really tough.

In terms of why we aren't doing better, that is a good question because we did get the Bank of Canada as the first G7 central bank to cut rates. One would have hoped that would have lit a bit of a fire under the stocks. Looking at any sort of conventional valuation metrics, it's not an expensive market. Dividend yield is attractive. Most of the more prominent sectors are trading very reasonable valuations. So one would have hoped that there'd be a fire lit under them.

The two things I would point to-- one is simply the sentiment issue, where I think the fascination around the Magnificent Seven, the NASDAQ, AI hype, it's just sucking all the oxygen out of the room. And it's not just Canada. A lot of the other markets, it's just hard to grab attention when everybody's so captivated by this phenomenon.

The other part of it, though, which falls more into the self-help part, is the Canadian economy is in a soft patch here. We shouldn't expect people to be really fired up about Canada if economic growth is subpar, if earnings growth isn't going to be terribly exciting in the short term. And let's be honest, the overall business climate-- investors aren't really wowed by what they're hearing about Canada these days. It's not the most investor-friendly corner of the world at the moment. So I think all of those things are holding us back. We can talk about why some or all of those things will change over time, but I think--

Greg Bonnell - This would be the next step.

Michael O’Brien - ... in the here and now, I think that is the issue. Sentiment here is poor. And the neighbor to the south is kind of sucking all the oxygen out of the room at the moment.

Greg Bonnell - Yeah, because you talk about being outperformed by the Americans-- not having a terrible run here, but overshadowed-- what could lead us to perhaps even outperformance in the years ahead?

Michael O’Brien - Well, in the short-term, valuations don't always-- they're not always your best friend in terms of timing when I should buy or sell a stock or a market. Over the long-term, valuations are almost all that matters. And so, from that perspective, what we've got going for us in Canada, it's the glass-half-full view of this is we've got a market where expectations aren't over exuberant. And so, over time, if the Canadian economy resumes its growth, if the population continues to grow, if the central bank can bring rates down over the next number of years, I think there's reasons for optimism.

But it's just in the here and now, we've got to work through these things. So I think the first step forward has been-- the central bank rate cut I think is very significant. It was only 25 basis points.

Greg Bonnell - Do we need to see more? It's one thing to say we've cut, but why aren't these yields looking more attractive on the big blue chip stocks? It's like, well, it was one cut.

Michael O’Brien - Yep. So going from 5% to 4.75%, that's not going to change the investment decision of a lot of businesses. It's not going to make or break a lot of households in terms of whether they can make that next mortgage payment. What you need is follow through. And so if we get another two, three, four rate cuts over the next, say, the balance of the year or into early 2025, that will go a long way towards at least putting a floor under the economy, if not actually beginning the process of turning us around.

In hand with that, you think of the single biggest group of stocks in the TSX, the Canadian banks. Right now, we're in a period where bank earnings growth is subpar because, largely, we're going through a credit cycle where PCLs, or Provisions for Credit Losses, have been steadily rising quarter after quarter after quarter. The underlying businesses-- there is some cause for optimism this last earnings season. The underlying business trends are improving. However, the loan losses are kind of overwhelming that at the top of the house. We need to see that roll over, which one would expect if the economy begins to stabilize and improve.

And then, beyond that, I think there are a number of pockets of the market, and we can get to these, where I think some self-help is needed, where they need to do some internal repairs. But if they can do that, then there's a good case to be made that over the next three to five years, these will be strong performers.

Greg Bonnell - I think about the commodities complex-- obviously a big part of the market. I mean, you talk about the financials, the heavyweight for the TSX Composite, but then energy, materials rounding out the top three. We keep hearing about the world's going to need more uranium. The world's going to need more oil. They're going to need more metals that go into EVs. And the Canadians will look and say, well, don't we have these things? Why aren't we benefiting?

Well, you know what that is-- look, that is the one bright spot-- or not the one bright spot. That's the single biggest bright spot both for the Canadian economy and for the Canadian market today is the resource economy is very healthy and pretty much pick your commodities. They're either solid or outright strong. Oil is doing well at $80 WTI. Canadian producers do very well. Natural gas hasn't had great price action in the here and now, but everybody can see, with LNG Canada hopefully coming on by year end, much better days ahead for natural gas. So there's a lot of optimism there.

A lot of excitement around metals like copper and what role they will play in electrification, build-out of AI data centers. So there's a lot of positivity towards copper. Gold-- it's pretty hard to be negative on gold when it's $2,300-$2,400 an ounce. So that's a good outlook. You mentioned uranium. Canada-- one of the very top uranium producers. Those are all disproportionately out west too. So I think this is a good time to be a Western Canadian when you think of the resource-based economy.

So that has been the least of our problems. It's actually been a bright spot. So whether you look at the energy names, materials names, they've been solid performers, generally speaking, year to date.

Greg Bonnell - Longer term, how should we think about the Canadian market?

Michael O’Brien - Longer-term, the Canadian market-- look, at the end of the day, the stock market is largely a reflection of the economy and the operating environment for all these companies. If one has faith, as I do, that over time, Canada, broadly speaking, is going to make the right decisions and the companies are going to make the right decisions, I think we've got an excellent starting point. We don't have an expensive market. A lot of the traditional cyclical industries, they're either sort of coming out of a low point or beginning to come around.

I think if we can get a bit better tone around the business climate here, and if we can see some proof of concept that the rate cuts that have begun and hopefully will continue to come will lead to a reacceleration of the economy sometime in 2025, I think the Canadian economy, the Canadian market as a whole looks very solid, particularly when you think some of the big sectors have been punching below their weight for some time. The Canadian banks have not done much for investors over the last four or five years, which is very unusual when you look at history. So I think that's a great example of once we turn the corner, if one has the belief and the faith that we're going to turn the corner, then there are much brighter days ahead.