There was much to celebrate this Canada Day, especially for investors who own the S&P/TSX Composite Index and the loonie, which are up 13.7% and 2.8%, respectively, as we reach the year’s halfway point.

But that recent rebound doesn’t mean everything is rosy for Canadian equities. The last decade, after all, has not been kind to investors in Canada.

The crux of the problem simply comes down to the lack of diversification in Canadian markets. Three sectors — financials, materials and energy, which we call the good, the bad and the ugly — and 10 stocks account for approximately 64% and 40% of the entire S&P/TSX index. Compare this with the S&P 500, whose Top 10 constituents account for only 20.4% of the index, even as many of them are high-growth innovators such as Apple, Alphabet and Amazon.

Interestingly, Canadian equities still dominate many portfolios here — we wonder if most Canadians are truly aware of the concentration risk they are taking. 

The Good: Financials
The financials sector’s strong performance over the past decade has saved our collective bacon, as it represents more than 35% of the S&P/TSX. So far, it’s been a great 2019 with financials gaining 12%. Looking longer-term, over the past decade the Canadian financials have certainly delivered for investors, with an approximate 10.5% annualized return thanks to the strength of the banks, which encompass nearly 70% of the Capped Financials Index.

The reason the banks have been so successful is because they operate within a tightly held oligopoly, are heavily protected by self-regulation and as a result are able to cut costs and increase margins while fiercely working together to protect their market share. While it isn’t good for consumers, this has been outstanding for investors. 

The Bad: Materials
Materials were having another disappointing year but are ripping higher in June thanks to the recent rally in gold prices, which have reached their highest level since 2013. The sector is up over 16.5% this month, bringing its year-to-date return to just over 14%. This is great for recent TSX investors given the sector represents nearly 11% of the index. However, looking out longer term, the news isn’t as good, as the sector has been dead money over the past 10 years with essentially flat returns.

The Ugly: Energy
It’s been downright ugly for energy investors with the Capped Energy Index posting a paltry 1.4% gain this year, not much of an improvement over the approximately 4% annualized decline over the past 10 years. That said, it would be a lot worse if it weren’t for companies such as Suncor and Canadian Natural Resources that dominate the index that makes up 17.3% of the TSX. For example, many E&Ps have seen their share prices cut by more than half over this period, resulting in companies trading at distressed levels despite being in a position to operate as a growing concern.

Unfortunately, the outlook doesn’t get much better, as there is not only zero outside capital to fund growth but the operating environment has become that much more restrictive thanks to Ottawa’s recent decision to pass extremely punitive bills C-48 and C-69.

Perhaps there is something we can all learn from the folks in charge of our pension plan (the CPP Investment Board) who have taken a completely different approach by investing in 52 countries, giving only a 15.5% weighting to Canada.

Source: Financial Post