03/21/2012 08:04 EDT | Updated 03/21/2012 08:22 EDT

Canada-China Trade: TSX's Lacklustre Year Shows Canadian Economy Follows China


Attention investors: as growth in China slows, the Toronto Stock Exchange may not be the wisest place to position your bets.

Despite a strong performance throughout the economic downturn, Canada’s largest stock exchange, which is heavily tied to resource-based sectors like oil and gold, has fallen behind U.S. stock markets this year.

While Canada’s S&P/TSX composite index has grown about 1.8 per cent since the start of the year, New York’s Dow Jones has seen a jump of about 6 per cent.

As BMO Capital Markets economist Robert Kavcic observed in a recent note to investors, at one point last week, the gap in year-over-year performance of the TSX and the S&P 500 was close to 20 percentage points -- the widest since 1999.

According to Kavcic, the shift is in part due to flagging Chinese demand.

“Commodity prices tend to move at the margin with the growth prospects coming out of China. By association, that has a bigger impact on Canadian stocks than on U.S. stocks,” he said in an interview.

Kavcic’s observations are a clear sign of a shift in the nature of Canada’s economy: Whereas traditionally Canada had seen its economy rise and fall in relation to the U.S., today China may be as large a factor -- or even larger.

“It’s not a direct relationship to what’s happening in China, but it’s a good indication that the TSX is more commodity-heavy and more sensitive to growth prospects,” he said.

Kavcic estimates that 60 per cent of the TSX is made up of “deep cyclical sectors” -- industries that tend to see large changes in prices -- like materials, energy and industrials, compared to 30 per cent for the New York-based S&P 500.

All of which, he says, should remind investors not to overlook opportunities south of the border.

“It’s one very good reason to keep diversification into U.S. markets in mind as Canadian investors,” he said, citing exposure to less cyclical sectors, such as defence and health care, as a particular advantage of American stocks.

“The other kicker is that you have a currency that is at or slightly above parity, too, so from a historical perspective, Canadians are getting pretty good relative value on U.S. equities right now,” he added.

CIBC World Markets economist Peter Buchanan has a similar take.

Though he maintains that concerns about the recent performance of the TSX are somewhat overblown, citing “the U.S. market’s hot performance based on the strength of the technology sector” as the primary takeaway, he concedes that Canadian stocks are particularly vulnerable to what happens in emerging markets.

And with growth in China predicted to slow to 7.5 per cent in 2012 -- the lowest rate in 22 years -- his suggestion to investors is to “not put all your eggs in one basket.”

“If you spread the risk around then you are more diversified. You are better able to withstand market turbulence,” he said.

In a report last year, TD Bank estimated that, if China’s growth were to slow only to 5 per cent per year, it would dampen Canadian real GDP growth by between one and 1.5 percentage points; meanwhile, nominal GDP growth would drop by about six percentage points, an income loss of about $100 billion.

“A hard landing in China would spark a substantial commodity correction,” the bank observed. “The analysis shows that Canada’s economic fortunes are deeply tied to developments in China.”

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