The TSX, Canada’s main stock market index, is made up of some of the largest companies in the country, so it’s natural to expect the performance of the TSX to track Canada’s economic growth. That’s why investors pay close attention to economic gages like gross domestic product (GDP), inflation, employment levels, consumer spending, and the housing market.
Positive economic data can boost consumer confidence which can help juice corporate profits. This in turn can energize investor optimism, increase buying activity on the TSX, and push share prices higher.
How Is The TSX Doing?
The TSX is up 9.5% since the start of November, which is when the U.S. Federal Reserve signalled it was done raising interest rates during this cycle and that interest rate cuts were on the horizon. The TSX is also not far from its all-time high of 22,213.07 in April 2022.
But there’s more to the equation than that; some economic data is forward-looking while some is backward-looking. Different stock markets are also weighted differently with cyclical and counter-cyclical sectors and geographic exposure.
Together, these factors can impact the economy and the way businesses operate in different ways. So, while there is a relationship between the stock market and the economy, there can be big divergences over shorter periods.
And that’s sort of what we’re seeing now. Despite the recent surge in the TSX, the Canadian economy remains fragile. Especially when compared to the U.S. In the third quarter, the Canadian economy contracted 0.3%. Oxford Economics predicts fourth quarter 2023 GDP will fall by 0.3% with first quarter 2024 GDP slipping 0.4%.
South of the border, the U.S. economy grew at a 3.3% rate in the fourth quarter and expanded an impressive 2.5% during the full year. Canada is probably in a recession while the U.S. economy is experiencing solid growth.
Part of the issue is that the U.S. is the largest economy in the world, with a GDP of $25.4 trillion, and is a relatively closed economy. The Canadian economy, meanwhile, is significantly smaller, with an annual GDP of $2.13 trillion less than the GDP of California at $2.89 trillion.
The Canadian economy is also much more open than the U.S. It needs to be. As a result, the Canadian economy is more susceptible to international events. In addition to geopolitical tensions, the Canadian economy is being negatively impacted by deflation in the Chinese economy and flattening economic data from the European Union.
The Canadian economy is three times more sensitive to the global economy than the U.S. is. This helps explain why the U.S. economy is doing so well and the Canadian economy is struggling. And will continue to.
The U.S. Federal Reserve and Bank of Canada are both expected to start cutting interest rates in the first half of 2024, but a hot inflation reading out of the U.S. has actually put a potential rate hike back on the table. And that led to North American stocks selling off.
Meanwhile, strong employment numbers in Canada means the central bank could introduce another rate hike, or, at the very least, push the date back to when it makes its first rate cut. Neither of which are good for the Canadian economy or stock market.
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While the TSX continues to do well, and is expected to hit record highs in 2024, at the moment, investors may be a little too optimistic, sending valuations unjustly higher. Continued strong economic data out of the U.S. and fears of interest rate hikes or even postponing the first rate cut, could shock the stock markets. What kind of equities should investors consider when the markets are unpredictable? Ask the trading experts at Learn-To-Trade.com.
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