If the past week is any indication, the second half of the year for Canadian stocks could look much different than the first.
All told, it was a thoroughly unimpressive opening six months for domestic equities, which sat out of a global uptrend and underperformed nearly every other major country index.
A formidable mix of negative influences dragged down Canadian index performance, as the global oil glut made an unwelcome reappearance, foreign investors got spooked by the housing market as well as Canada's deteriorating trade relationship with the United States and declining bond yields raised new doubts over bank profitability.
That script flipped in the final days of the year's first half. Crude oil inventory concerns eased up. Government of Canada five-year bond yields rose to their highest levels since 2014. And even housing bears seemed to take a breather after Warren Buffett's powerful vote of confidence in Home Capital Group Inc.
None of this has succeeded, however, in inspiring the S&P/TSX composite index to break out of its stupor. But Canadian stocks are at least crossing the midway point with some underlying momentum while priced at a steep discount to U.S. equities.
"Better domestic readings and improving global sentiment on Canadian assets should see the TSX outperform in the second half," CIBC economist Nick Exarhos said in a note. "That should help narrow the discount Canadian equities currently face, particularly with respect to financials."
Almost everywhere outside of Canada, it has been a double-digit kind of year. The MSCI all country world index had its best first half in nearly 20 years, having advanced by 10.5 per cent.
Global returns were driven by solid performance in U.S., European, and emerging markets indexes, many of which spent much of the year ringing in new all-time highs.
Of the 24 countries Bloomberg counts as "developed markets," there are just two indexes in the red year to date: Israel's, which was down by 2.5 per cent, and Canada's, down by 0.7 per cent.
Blame certainly does not rest on the Canadian economy. First-quarter real GDP growth of 3.7 per cent annualized was the best of the G7 countries. And first-quarter corporate profit grew by nearly 30 per cent. While much of that was due to the recovery from the oil bust, even after excluding the energy sector S&P/TSX, earnings were up by an impressive 15 per cent over the prior year, according to Thomson Reuters.
The energy sector was again the focus of investor concern, however, as crude oil prices revisited bear market territory in the spring. From February to June, West Texas intermediate declined from about $54.50 (U.S.) a barrel to $42.50, as OPEC's production cuts were overwhelmed by surging U.S. shale production.
Not surprisingly, the oil and gas sector was the dog of the first half, posting a 14.7-per-cent decline. The materials sector was the only other in the S&P/TSX composite index to drop year-to-date, while financials were flat. But considering those three sectors account for two-thirds of the index's market capitalization, there was little chance for the remaining eight sectors to drive the index higher.
"We expect these sectors to do better in the second half of the year," Stéfane Marion, chief economist at National Bank of Canada, said in a note. "The domestic economy remains sound and corporate profits have rebounded."
On Wednesday, Mr. Marion recommended investors increase Canadian equity allocations. Part of that call is based on rising commodity prices and a weak U.S. dollar, both of which have gained momentum in recent days. WTI crude pared back its losses, rising through the $46-a-barrel mark Friday, while the greenback's slide saw the Canadian dollar rise higher than 77 U.S. cents for the first time in more than eight months, also on Friday. "While housing concerns are paramount, what cannot be ignored are encouraging growth trends as the oil price shock moves further into the rearview mirror," Shailesh Kshatriya, director of Canadian strategies at Russell Investments Canada, said in a report.
Decent macro trends should put Canadian stocks in good stead as they start the second half attractively priced compared to U.S. peers, Mr. Marion said. Not since 2004 has the gap between Canadian and U.S. valuations been so wide.