The unshakable oversupply of crude oil is again proving capable of restraining Canadian stocks, which are falling ever further behind the U.S. market.
Although Monday's trading saw the S&P/TSX composite index make respectable gains, the domestic index still trailed the S&P 500 index, widening what is an abnormally large performance gap between the two markets.
The spoiler in an otherwise positive day was the price of oil, which retreated to about $47.50 (U.S.) on new signs of excess inventories.
"It is difficult to expect Canadian stocks to do well without expecting some form of a bottom in energy stocks," a strategy report by Pavilion Global Markets said.
Aside from oil, the balance of forces seems to tilt in favour of a rebound in domestic stocks.
Over the past six months, the S&P/TSX composite index has underperformed the S&P 500 by almost 11 percentage points. It's unusual for the two markets to diverge that much, according to the Pavilion report; particularly when the Canadian economy has surprised to the upside, as it has done for much of the year to date.
"Correspondingly, we believe there is now a mean-reversion case for Canadian equities versus U.S. equities," the authors said.
Interest-rate fluctuations this year are partly to blame for disappointing Canadian equity returns. As markets have priced in a less aggressive approach to reducing stimulus by the U.S. Federal Reserve, the Bank of Canada has surprised investors with a hawkish shift.
But the market may have overreacted. There are now three Canadian rate hikes over the next two years priced in, while just one Fed hike is expected over the same time.
"We do not think this is very realistic," Pavilion said. "We are tempted to believe that this is too little for the Fed, and too much for the Bank of Canada."
A reconsideration of those assumptions would likely help Canadian stocks make up some ground lost in recent months.
While the energy sector has been behind most of that weakness, Canadian bank stocks have also badly lagged international peers.
With a total return of only about 1.9 per cent so far this year, the group lags behind a global group of 39 banks by about 600 basis points, according to BMO Nesbitt Burns analyst Sohrab Movahedi. He attributes the shortfall in returns to "lagging concerns associated with the Canadian alternative mortgage broker market."
But Canada's big banks remain "well capitalized and profitable," Mr. Movahedi said, adding that earnings and dividend trends point to "low-double-digit annual total returns."
The broader Canadian earnings backdrop, meanwhile, also stands in contrast to the year's lacklustre stock returns.
With almost 90 per cent of companies in the S&P/TSX composite index having reported second-quarter financial results, profits are on track to surpass expectations by 6 per cent, according to Vincent Delisle, a portfolio strategist at Scotia Capital.
Over the next year and a half, however, "TSX earnings-per-share growth/revisions will be almost exclusively dependent on [West Texas intermediate] recovering toward bottom-up consensus for 2018," Mr. Delisle said in a note.
That would require $55-per-barrel oil, which has proven to be an elusive threshold. Over the past year, WTI has broached $55 just once – intraday – on the first trading day of 2017.
The latest leg down in crude oil has coincided with renewed concerns for both the demand and supply side.
The bullish case for oil recently lost a powerful voice, meanwhile, when Andy Hall, the renowned hedge fund manager, revealed in a letter to investors a new-found, pessimistic outlook for the commodity.
"The medium-term outlook for oil still looks challenging with, if anything, balances for 2018 having deteriorated in recent weeks," Mr. Hall wrote.
With a file from Bloomberg News