The bizarre gap between the Canadian economy and stock market is widening by the day – The Globe and Mail

The relationship between the Canadian stock market and the domestic economy is verging on full estrangement.

In the midst of a broad-based, geographically diverse Canadian expansion that could make this calendar year the best in more than a decade, Canadian equity performance ranks as the worst in the industrialized world.

On Wednesday, the gap between the two widened a little further. After the Bank of Canada added to signs of a flourishing domestic economy with a hike to short-term interest rates, the S&P/TSX composite index tacked on to its losses on the year.

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“The disconnect between stocks and the economy is bizarre – and rare – but it’s not really a mystery,” said Eric Lascelles, chief economist at RBC Global Asset Management.

A confluence of forces has kept stocks from participating in the Canadian economic resurgence – none more potent than this year’s flare-up of the global oil glut.

As a result, absent a substantial rally in the price of crude, Canadian stocks face low odds reconciling with the real economy over the rest of 2017.

Generally speaking, there is no rule saying the stock market should be simpatico with the state of the economy.

That is very true of Canada – more so than most markets.

Steeped in resources, Canadian equities are more closely aligned to global, rather than local, economic conditions.

Even in its diminished state, the energy sector still accounts for a fifth of the market capitalization of the S&P/TSX composite index. And the dip in global oil prices this year has interrupted the sector’s recovery from the oil price shock. Year to date, oil and gas stocks are down 15 per cent, while energy and production companies specifically have dropped 23 per cent.

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By way of contrast, the energy weighting within the S&P 500 amounts to just 6 per cent, insulating the U.S. market from the oversupply of oil.

In addition to having too much of what hasn’t worked this year, the Canadian market has too little of what has.

The global updraft in equity prices has been led by the technology sector. U.S. tech stocks have advanced by 25 per cent since the end of last year. Apple Inc. alone is up 40 per cent; Facebook Inc. by 50 per cent.

Given Canadian sector weightings, it is not unheard of for Canadian stock trends to dislodge from the domestic economy. “But they usually at least rhyme,” Mr. Lascelles said.

Many of Canada’s worst stock market crashes have occurred during economic recessions. And a bullish market tends to coincide with a healthy economy.

This year has seen the Canadian economy truly awaken. Second-quarter growth hit an annualized pace of 4.5 per cent – the single highest reading in six years.

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“Almost every indicator you look at shows a solid year,” Bank of Montreal chief economist Doug Porter said. “Job growth has corroborated that strength. We’re headed for another record year in auto sales. And home building will be solid.”

This calendar year’s GDP growth is on track to challenge for the highest in the past 10 to 15 years, which represents a substantial improvement from the consensus forecast when the year started, Mr. Porter said. “Usually an upside surprise like that would benefit financial markets in general.”

Some financial markets have reacted proportionately. The Canadian dollar has added more than nine cents against the U.S. dollar over the past four months to hit a two-year high.

The yield on Canadian five-year government bonds, meanwhile, hit 1.66 per cent Wednesday for the first time in three years.

The stock market is the outlier, as the main Canadian benchmark is down 1.5 per cent on the year. The S&P 500 index has gained an enviable 10 per cent.

“Best economy in the G7 and worst stock market – go figure,” wrote David Rosenberg, chief economist at Gluskin Sheff + Associates, in a note. “We may as well throw those correlations out the window – either that or the local stock market has a whole lot of catching up to do.”

For the latter to happen, Canada’s resource exposure would likely have to swing once again to a source of strength rather than a hindrance, Mr. Porter said. “It would take a surprise move in energy or materials prices to really give a charge to the Canadian equity market.”

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