Unbeknownst to many is that with an 18% advance in 2024, the S&P/TSX Composite Index TXCX-I did not fall that far behind the “exceptional” S&P 500 INX-I. The difference is that the Canadian stock market did not need as much heavy lifting from “animal spirits” (aka P/E multiple expansion) as much as from good old-fashioned earnings growth (the consensus for 2025 is pretty much the same as the S&P 500 at nearly 10%… but the potential for multiple expansion is infinitely superior).
Here’s what is catching my eye, and why Americans should pay attention to the investment opportunities here in Canada.
The Exchange Rate
The Canadian dollar CADUSD-FX is at the low end of the historical range, and the U.S. dollar is at the very high end. For equity investors, the lags from the prior Canadian dollar weakness will act as a gift that keeps on giving from an earnings perspective. At the same time, for the here and now (and this is a message to global investors), do you want to buy an asset in an overvalued currency or an asset in an undervalued currency? Consider that a rhetorical question.
Inflation
Both headline and core inflation in Canada are at or below the 2% target. The U.S. is still some ways away from that mark. In some sense, underlying measures of inflation in Canada are measurably below 2%. This is the bright side of a weak economy — what it does to inflation. And inflation and inflation expectations are critical for P/E multiples — and multiples are a far more powerful determinant of stock price movement than earnings on their own.
Monetary Policy
The more pronounced decline in Canadian inflation has allowed the BoC to cut rates by 175 basis points so far in this new policy easing cycle, compared to the 100 basis points stateside. The Fed has signaled a pause for a variety of reasons — much more fiscal largess and Donald Trump policy uncertainty at play. While Canada would be vulnerable to any aggressive U.S. trade action, that would only feed into even lower interest rates north of the border. Every action has an equal and opposite reaction and any further drop in rates would be added fodder for multiple expansion. The BoC, in contrast to the Fed, has signaled that even without the tariff threat, the rate-cutting cycle is far from over (even if the pace of cuts slows down). This is an important tailwind.
Bond Yields
With inflation lower in Canada and the central bank cutting rates more aggressively, yields out the curve north of the border continue to trade at a steep discount — 3.3% for the 10-year yield versus 4.6% in the Treasury market. As inflation and monetary policy continue to diverge, the bond yield discount is likely to widen even further. And this is vital because what it means is that in Canada, unlike the U.S., investors get paid to take on equity risk. How so? Well, the gap between the TSX earnings yield and the 10-year government of Canada bond yield is nearly 350 basis points — the so-called equity risk premium. That is infinitely wider and far more compelling than the negative 10 basis point equity risk premium in the United States. Yet another relative tailwind.
Valuation
Even without taking into account the more benevolent interest rate and bond yield landscape in Canada (it should be added that in addition to lower inflation, the fiscal deficit-to-GDP ratio in Canada at 2% is significantly below the 6% U.S. level — even the Liberals in Canada have been running a tighter ship than their Democratic brethren stateside), the TSX valuation backdrop is far more compelling. The P/E multiple on trailing earnings in Canada is 20x versus 25x in the U.S. The forward multiple at 15x is also far below the comparable near-22x multiple for the S&P 500. No doubt, Canada being more of a “value” than “growth” proposition (since there is not that much Tech or Health Care exposure), generally sees a multiple discount. But historically, the trailing P/E multiple in Canada is 1 point below where it traditionally is in the U.S. — not in the same orbit as the current 6-point gap (which represents a 1.5 standard-deviation event — something that always catches our eye in gaps that have a history of mean reverting).
While on a PEG ratio basis (the price-to-earnings ratio normalized by the three-year expected earnings growth expectation), both the TSX and S&P 500 are close to being on an equal footing at around 2x apiece. What Canada offers is diversification for global investors into the value arena but with a far more attractively-priced currency (as in, dirt cheap).
Dividends
In the midst of a global interest-rate cutting cycle, yield becomes more scarce and, as such, more valuable. In Canada, an investor can garner a 2.8% dividend yield in the TSX compared to 1.3% in the U.S.. Putting that into perspective, an investor can actually get a dividend yield in Canada that comes very close to matching what can be garnered from a coupon across the government of Canada bond curve — but the same definitely cannot be said in the U.S. where 10-year rates are more than 300 basis points above the microscopic 1.3% S&P 500 dividend yield. Much like the P/E valuation gap, the differential in dividend yields between these two markets is off the charts: the current 150 basis point premium is far and away higher than the long-run norm of 50 basis points (and again, classifies as a 1.5 standard deviation event).
The best yielding sectors at the moment can be found in Utilities, Financials, and Real Estate. And when you look at how investors are gravitating to this “yield scarcity” theme, the Dividend Aristocrats index has advanced a very nice +15% in the past year, and with the benefit of having terrific stability characteristics. Getting in on this action for an American investor with the Canadian dollar scaling the bottom of the historical range would seem to be a very wise decision heading into 2025.
David Rosenberg is founder of Rosenberg Research.
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