Chart Attack V.7 - A Synopsis

We hope that you enjoy the latest Chart Attack report, highlighting some of our key economic charts to keep an eye on. We have outlined below our thoughts on a few charts that stood out to us.

The Bank of Canada has had a busy year so far with raising interest rates, and the chart below analyzes the historical TSX dividend yield against the 10-year Canadian treasury bond yields. 10-year Canadian treasury bond yields are directly tied to the Central Bank interest rate, and the significance here is that prior to 2009, the dividend yield on the underlying companies in the TSX index were lower than that of 10-year treasury yields. Since 2009, 10-year bond yields have mostly been at a rate below the TSX dividend yield. Bond yields, for the first time since 2013, have risen above the TSX dividend yield. In instances where the dividend yields on profit-generating companies that can use leverage are higher than that of risk-free bond yields, the risk-reward ratio becomes skewed towards the TSX. This is because an investor would be earning a higher yield through dividends than on bonds, and potentially receiving capital appreciation on their equities. This showcases the rapid rise in bond yields over the past couple of years and changes the risk-reward landscape for investors. Bond yields now being above that of the TSX dividend yield implies better opportunities in the bond space today than over the past several years. This is a new dynamic that we plan to keep our eyes on. 

The two below charts demonstrate the total Canadian market Price to Earnings (P/E) ratio over time, as well as the total Canadian market value in dollars. What we can see here is that the Canadian market P/E ratio fluctuates mostly within a horizontal range, whereas the total market value has also fluctuated, but mostly trends up and to the right. When the P/E ratio is high, this indicates that investors are willing to pay more money per $1 of earnings for all Canadian companies, and conversely, when the ratio is low investors are willing to pay less for $1 of earnings. Although, since the total market value has increased over time, whereas the P/E ratio has mostly been flat over time, this means that Canadian companies on average have increased their earnings and are more profitable each year. The P/E ratio can be thought of as simply the value that investors attach to the Canadian market, and if the total market value is increasing over time while the P/E ratio stays flat in a horizontal range, then the companies are successful at increasing their profitability over time. 

This past year, the energy and commodities spaces have had a tremendous performance, and the quick runup in commodity indices helps to validate those valuation increases. We can see the prices of grains, copper, oil, gold, and the broader commodity basket over the past couple of decades, and more notably, the stagnant prices from 2016 to 2020 that eventually led to the ascent in prices over the past two years. The commodities sector is known to be one of the most cyclical sectors out there, and its prices are dictated by free-market factors such as supply and demand, inflation, GDP growth, interest rates, and others. While it is not quite clear yet if the commodities sector is destined to continue its ascent, or if this cycle has run its course. Oil companies and other commodities producers are certainly benefiting from these higher prices, and their year-over-year revenue and earnings growth are indicative of this. 

This has been a tough year for equities, and while there is a lot of bad news floating around out there, the recent uptick in Canadian consumer confidence sets an optimistic tone. Canadian consumer confidence measures the personal financial situation and forward six-month financial situation of Canadian consumers, as it relates to household or other purchases, job security, ability to invest, and others. The most recent rebound in Canadian consumer confidence is a positive indicator for future consumer purchases, which can lead to positive developments in companies’ earnings. All these forces have a positive feedback loop, and as consumers feel they have a higher ability to spend and save, so too do businesses, and this lends itself back into the pockets of Canadian consumers. 

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