The TSX feels the Trudeau Effect

Arecent column in The Globe and Mail entitled “The TSX isn’t invited in the stock market party. Here’s why” questions why major indexes around the world including the U. S., Europe, Asia and emerging markets are posting doubledigit gains while the TSX is almost flat. The writer concludes that it has to do with the uncertainty surrounding NAFTA and weakness in commodity prices.

While there is some truth to this, in my opinion the TSX suffers from what I call the “Trudeau Effect.” Since the federal Liberal government was elected with a majority on Oct. 19, 2015, I decided to compare the performance of two large- cap and highly liquid ETFs, namely iShares S&P/TSX 60 ETF ( XIU.TO) in Canada and SPDR S& P 500 ETF (SPY) in the U. S., from January 2016 to the end of 2017, and, for comparison and control purposes, from January 2013 to end of 2014.

The annualized return of the Canadian ETF between Jan. 1, 2016 and Dec. 31, 2017 was 15.3 per cent versus 22.3 per cent for the U. S. ETF. However, from Jan. 1, 2017 to Dec. 31, 2017, the Canadian ETF rose by only 6.8 per cent versus 26.3 per cent for the U. S. And 2017 was a year of co- ordinated global expansion! The two years prior to 2015, a worse period for commodity stocks, XIU also underperformed SPY, but the underperformance was more typical of the long-run underperformance of Canadian indexes versus the U. S. equivalents. The annualized XIU return from Jan. 1, 2013 to the end of 2014 was 11.8 per cent versus 17.7 per cent for SPY; the corresponding returns from Jan. 1, 2014 to the end of 2014 were 12.5 per cent and 14.1 per cent, respectively.

In other words, the underperformance of the Canadian large- cap market has increased dramatically and incrementally since the beginning of 2016. And the underperformance of Canadian stocks has become even more severe over the last two to three months. Moreover, the correlation between the Canadian and U.S. markets, which was always quite high, has fallen somewhat since January 2016. The above evidence indicates a fundamental change in the Canadian economy in the last two years. Investors in Canadian equities originally gave the benefit of the doubt to the Trudeau government, but as reality about federal Liberal economic policies started to set in, the Canadian stock market started to severely underperform the U.S. equivalent.

Maybe Prime Minister Justin Trudeau is a nice guy, while the guy south of the border is not. But this is not and should not be a competition of who is nicer. It is about who is a better steward and manager of the economy. While U. S. President Donald Trump has poor and declining poll numbers on whether he is a nice guy, his numbers on how well he manages the economy are high and have been improving. When Trump took office, 46 per cent of Americans polled said they had a positive impression of the state of the economy; in recent months the number has risen to 66 per cent according to a Quinnipiac University survey. Economists surveyed by The Wall Street Journal agree.

Unlike Trump, Trudeau is a progressive prime minister who believes that corporations must be benevolent organizations that put workers before shareholders. He favours taxing corporations and the rich, and adding regulatory impediments and red tape to corporate activity. He is a big supporter of income redistribution as opposed to making the pie bigger for everyone. He wants to regulate the economy and nudge corporations to submit to his social views and economic philosophy.

An economy like Canada’s cannot afford to be out of harmony with its major trading partners such as the U.S., China and Europe. Canada is a small fish in a big pond. Trudeau’s statements during his recent keynote speech at the World Economic Forum in Davos, namely that Canada will not be slashing taxes and regulatory tape to compete with the U. S., are not very helpful to Canada or encouraging to those considering investing in Canada. His speech promoting fairness and prosperity through taxes was nice in theory but reality is different. As baseball player Yogi Berra once said, “In theory, theory and practice are the same. In practice, they are different.”

All these policies hurt productivity and undermine the competitiveness of the Canadian economy. The stock market is a reflection of the economy and where the economy is headed. Canada’s stock market performance does not bode well. Foreign investments in Canada have stalled partly because of the uncertainty regarding NAFTA, but also because of the Trudeau Effect. Put them all together and one can understand why investors are voting with their feet.

George Athanassakos is Managing Director of the Ben Graham Centre for Value Investing and a professor of finance at the Ivey Business School at Western University.