The accompanying chart seems simple at first but it contains a wealth of information on the current investment environment and considerable portfolio guidance. In short, current global market trends are positive for Canadian equities and the loonie.
The orange line represents the relative performance of economically sensitive, cyclical stocks relative to defensive equity sectors such as consumer staples, health care, alcohol and tobacco, food and household products.
The trend is measured by dividing the value of the FTSE all world cyclical index by the FTSE all world defensive index.
The orange line has been rising since mid-2016, indicating the outperformance of cyclical sectors. This is all kinds of good news for Canadian investors. The sectors that make up the FTSE cyclicals index are the same ones that dominate the S&P/TSX composite – industrial and precious metals mining, railways, finance and industrials.
The outperformance of cyclical stocks should also help support the value of the Canadian dollar. The relative attractiveness of the TSX's economically sensitive markets will attract foreign capital and boost the loonie.
The chart also shows that the outperformance of cyclical stocks has tracked the increase in the 10-year U.S. Treasury bond yield.
This is important for a number of reasons. For one, the rising 10-year yield has increased the steepness of the yield curve (the difference between the two- and 10-year yields), and bank stocks on both sides of the border have rallied as a result. Banks borrow funds at short term rates, and lend them out at longer term rates so a steeper yield curve means higher profits.
The higher 10-year yields also reflect expectations for higher future economic growth and inflation rates.
The timing of the surge in yields – after the U.S. election – is not a coincidence. Mr. Trump's victory increased the likelihood of fiscal spending initiatives that will boost economic growth.
The U.S. 10-year bond yield will be an important indicator for Canadian investors in the coming months.
Continued higher yields will be a positive sign for the large cyclical components of the domestic equity market. A fall in yields would indicate declining growth expectations and profit forecasts for banks and other lenders.