In the past 12 months, the Citi economic surprise index for Canada has provided an effective leading indicator for the S&P/TSX composite. Digging deeper, the data suggest that domestic energy, materials and industrial stocks have the most to gain, and lose, if domestic growth is significantly above or below current optimistic economist estimates.
The accompanying top chart compares the S&P/TSX composite with the Citi surprise index in the past year. As a reminder, the Citi surprise index is not a measure of nominal Canadian economic activity but a comparison of official economic reports relative to economists' expectations. A reading of zero would indicate that economic data are being reported exactly in line with estimates and a rising (orange) line indicates that economic growth is being reported above expectations.
The chart shows that a decline in the Citi index predicted significant market sell-offs in the period of June to July, 2015, as well as in November, 2015. The surprise index also began a recovery in mid-January, 2016, a week before the equity markets began to rally.
I tested all 10 of the major S&P/TSX industry subindexes to see which market sectors appeared most sensitive to the path of the Citi surprise index. Correlation analysis uncovered that energy, materials and industrial stocks were most affected by changes in direction for the Citi index.
The domestic economy is currently mired in a soft patch that has economists forecasting, on average, a 0.7-per-cent contraction for the second quarter. These same economists, however, expect a quick snap back to strong growth with gross domestic product to expand by 2.9 per cent for the third quarter and 2.2 per cent for the fourth quarter. (The average total year estimates for 2016 GDP growth stand at 1.4 per cent.)
Expectations for Canadian growth are high and the Citi economic surprise index will be very important to watch in the months ahead, as I've written previously. It will provide a daily scorecard allowing investors to gauge whether the rosy forecasts of economists are being met. The second chart strongly implies that investors in energy, materials and industrials stocks should watch the surprise index even more closely – their performance has been closely related.
The surprise index rallied almost 50 per cent on Wednesday after the release of stronger-than-expected retail sales data. This was a welcome development after the index's steady and disquieting 53-per-cent decline from April. Canadian investors can hope that the downward trend has been broken and that economists' optimistic forecasts will be met or exceeded as the third quarter begins.
Follow Scott Barlow on Twitter @SBarlow_ROB.