Playbook for Canadian Stock Market in H2: Is TSX Poised to Outperform S&P 500?

Higher gold and oil prices have helped the S&P/TSX Composite Index emerge from a five-quarter earnings slump in Q1, with expectations that earnings growth will pick up momentum in the subsequent quarters. Typically, the TSX outperforms the S&P 500 when commodity prices are on the rise.

Gold has shined brighter than many other commodities this year, rallying even as the chances for a Fed interest rate decrease. Typically, a strong U.S. dollar would hurt gold, but recent demand for gold has overpowered the historical correlation between the U.S. dollar and real yield movements.

TD Bank has raised its outlook for gold at $2,250 per ounce in 2024, with these pumped-up prices likely to hold steady into 2025. Central banks are increasingly buying gold to counter geopolitical uncertainty, signaling a bullish market outlook. Moreover, market players are betting on the Fed to kick off a cycle of rate cuts. This expectation, paired with a predicted dip in both nominal and real bond yields as the year goes on, suggests that the thirst for gold isn't drying up anytime soon.

Regarding the oil market, the price per barrel of crude has consistently hovered between $75 and $85 since the year's outset. This stability is the result of a mix of influences: on one side, the market has been tight, with less anxiety over a surplus; on the other, there's been concern over OPEC+ unity and an uncertain demand forecast. Weighing these factors, TD predicts that oil prices will stay aloft, averaging around $80 per barrel for 2024. TD also underscores the persistent geopolitical unrest in the Middle East, a factor that retains the potential to spur periodic spikes in oil prices.

Bloomberg's consensus economic projections indicate that while TSX earnings are expected to increase in the coming year, the growth is likely to be modest, thus offering limited potential for index growth. The sluggish economic environment has led the Bank of Canada to cut rates, which may support modest returns as TSX valuations normalize.

Following the initial rate cut of this cycle, Bank of Canada Governor Tiff Macklem, when pressed about the possibility of further rate cuts, chose to highlight the positive implications for an economy that had been grappling with the highest policy rate in two decades, saying, "Let's just enjoy the moment." This optimistic stance seems to mirror the broader global economic climate where inflation is generally subsiding without triggering a widespread recession, marking an ideal scenario for policymakers who have navigated through significant upheavals over the previous four years. For the Bank of Canada, with the process of lowering rates underway, attention is now turning to the pace and extent of the upcoming interest rate decreases.

Recent forecasts from major banks sketch out the anticipated trajectory for interest rate cuts in Canada: Royal Bank, Scotiabank, and CIBC predict a total of four rate cuts in 2024, while TD and Bank of Montreal estimate three cuts by year's end, with interest rates leveled out at 4.25% as the year concludes.

During easing cycles, sectors such as Consumer Staples, Information Technology, Real Estate, Financials, and Materials usually experience advantages. With predictions suggesting an additional 2-3 rate cuts on the horizon, these may be the key sectors worth watching. Additionally, with trillions of dollars sitting in retirement accounts in cash amid a high interest rate environment, the downward trend in interest rates could erode the returns on these cash holdings, compelling investors to seek out other avenues, particularly dividend stocks, which promise more attractive yields.

As noted by Adams, a decrease in labor productivity is negatively impacting the outlook for GDP and the TSX's earnings potential. Echoing this concern, Macklem recently sounded the alarm on Canada’s productivity problem and underscored the pressing need for productivity improvements.

Generative AI technology's swift advancement could significantly boost productivity by easily integrating with everyday tech like computers and smartphones, enhancing professional efficiency. While Canada's thriving AI ecosystem and top-tier expertise position it at the forefront of this digital wave, its companies are adopting AI lag behind their counterparts in the United States. This hesitancy in embracing AI could limit Canada's tech potential and impact TSX's performance.

The 3 key factors outlined by Adams present both prospects and hurdles for the TSX in the latter half of the 24-hour period. Additionally, she points to historical patterns hint at a possible third-quarter (3Q) rebound for the TSX after lagging behind the US S&P 500 by over 5% in the second quarter (2Q), despite typically stronger median equity performance. Since 2013, the TSX has usually recovered in the following quarter after such underperformance, outperforming the S&P 500 by an average of 1.4%, except for the anomaly during the 2019-2020 Covid-19 downturn. This pattern suggests that, following a period of underperformance, the TSX may be poised for a competitive edge in the upcoming 3Q.