Chinese iron ore prices are an excellent gauge of the country's economic activity and, for a long time, the resource-heavy S&P/TSX Composite index followed right along. Beginning in June of 2013, however, the domestic benchmark and iron ore prices began moving in entirely different directions.
The chart below shows that, over the last 11 months, the TSX climbed while the bottom fell out of the Chinese iron ore market. The obvious question for Canadian investors is, after five years where Canadian equities piggybacked off Chinese growth, how long can this divergence go on?
A look at the primary drivers of the domestic benchmark’s 21.1 per cent return since the end of June 2013 suggests that while there are no guarantees, the decoupling of Canadian equities from Chinese growth is sustainable.
The S&P/TSX Health Care index, dominated by Valeant Pharmaceuticals International Inc., was the top performing market sector for the period, rising 32.4 per cent. Industrials, helped by the rails and Magna International Inc, and energy stocks followed close behind.
Unsurprisingly, slower Chinese growth placed the S&P/TSX Materials index among the worst performers; the index climbed only 4.1 per cent.
In terms of individual companies, bank stocks dominated the list of the largest positive contributors to the benchmark's returns. Toronto-Dominion Bank, Royal Bank of Canada, Bank of Montreal, Canadian Imperial Bank of Commerce and Bank of Nova Scotia are all in the top ten.
Recent equity returns imply that the TSX is perfectly capable of rising while China slows. The banks, health care stocks, railways and auto parts stocks that have shoved the benchmark higher are only marginally affected by emerging markets growth, if at all.
The primary economic forces behind equity returns have changed, and so have the risk factors. The domestic benchmark has shown it can withstand a slowing China. The current performance leaders, however, will depend on further strength in the Canadian housing market and an expanding U.S. economy to maintain growth levels.