Canada has spent the past year being thoroughly shamed for its economic flaws.
Ours is an uninspired, anemic economy, mired in a productivity funk, steadily losing ground to peers, with eroding standards of living and declining per capita GDP, etc., etc.
But here’s where the stock market can offer a bit of a palate cleanser. Because for companies listed on the Toronto Stock Exchange, productivity is on the rise.
Since the depths of the COVID-19 pandemic, sales per employee for companies in the S&P/TSX Composite Index are up by about 20 per cent.
This spike in productivity has translated into higher profit margins. Now at around 12.5 per cent across the market’s benchmark index, Canadian margins are on par with those of U.S. blue chips.
This doesn’t absolve Canada of the need to fix its economic problems. But it does put the stock market on firmer footing versus the United States.
And it casts doubt on whether Canadian stocks should be trading at an enormous discount. The average valuation on U.S. stocks is nearly 50 per higher when comparing forward price-to-earnings ratios.
“That gap makes no sense,” said Martin Roberge, portfolio strategist at Canaccord Genuity. The recent “productivity boom” centred on the TSX should make cheap Canadian stocks an easy sell, he said.
How does this jibe with Canada’s productivity crisis? Economists have sounded the alarm over declining output per hour worked, which has made Canada 30 per cent less productive than the U.S.
The first thing to remember is that the stock market is not the economy. The TSX is globally oriented, with considerable strength in the resource industries.
The energy and materials sectors, for example, account for nearly 30 per cent of the Canadian benchmark index – a far higher weighting than in the broader economy. This affords the stock market a degree of separation from the domestic economic malaise that now confronts Canadian policy-makers.
Second, the TSX is a haven for oligopolies. Several key Canadian industries are dominated by a handful of powerful incumbents. Oligopolies in banking, telecoms, grocers, and railways account for around one-third of the market capitalization of the S&P/TSX Composite Index.
There are a few reasons our industries have evolved this way. The need to attain scale as a defence against the American juggernaut. A vast geography with low population density. And a legal framework that paves the way for industry consolidation.
There are obvious drawbacks to this kind of system from a competitive standpoint. Canadian consumers are largely forced to choose between Air Canada and Westjet, Rogers, Bell and Telus, or the Big Six banks.
But from an investor’s perspective, there is strength in concentration. Companies in these industries can fend off competitive threats without sacrificing their profit margins.
“It’s been very easy for many of these companies to increase prices as soon as inflation was rising,” Mr. Roberge said. The big grocery chains have managed to keep their profit margins steady, for example, even when food inflation hit 40-year highs during the pandemic.
Canada’s banks, meanwhile, are some of the most profitable on the planet, with an average profit margin of 26 per cent over the past 12 months, Mr. Roberge said. It’s no coincidence that there are just 35 domestic banks in Canada, including credit unions, compared with more than 4,000 in the U.S.
Pricing power is one big reason these Canadian companies have been able to improve their productivity through the unique market dynamics of the pandemic, Mr. Roberge said.
The TSX may lack the tech sector might of the S&P 500, but at least the biggest Canadian sectors are also the most profitable. The financial sector, which also includes life insurers, has a profit margin of around 20 per cent. For the energy sector, it’s about 14 per cent.
That’s not to say that Canadian stocks ought to command the same valuation as their American peers.
Profit margins between the two markets may be comparable, but S&P 500 companies still make much more money on a per-share basis.
“We should be trading at a discount, but it’s the magnitude of the discount that doesn’t make sense,” Mr. Roberge said.