Periods of outperformance of resources relative to financials generally tend to persist for many years
Author of the article:
David Rosenberg and Brendan Livingstone, David Rosenberg
The Toronto Stock Exchange in the financial district of Toronto. Photo by Cole Burston/Bloomberg files By David Rosenberg and Brendan Livingstone
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For the first time since 2014 (outside of a very brief period in 2020), resources (energy and materials) command a larger share of the TSX Composite than financials. Given the underlying strength in commodities of late, this may not come as a huge surprise. However, the question for investors is whether this development is likely to persist, or whether history suggests it will reverse in due course.
To answer this question, we pulled market cap data for the TSX back to mid-2002 (when data availability begins). What we found is that, over this period, resources have had a bigger share in the TSX about 55 per cent of the time. That being said, lately this has occurred much less frequently — over the last 10 years, resources have only spent about 25 per cent of the time with a higher weighting. This dynamic can be traced to the poor performance of commodities (until recently) over the past decade.
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From our standpoint, the underperformance of resources over the past 10 years actually sets this segment of the market up very well going forward. For starters, at a weight of 30 per cent currently, resources are well below their historical average of 37 per cent within the TSX. By way of comparison, financials, at a weight of 30 per cent, are much closer to their average share in the past (32 per cent). Put differently, based on the historical record, there appears to be more room for resources to expand their market share towards more “normal” levels.
In addition, the collapse in commodity prices in 2014 forced many resource producers to have much better capital discipline (out of necessity). The result of this is that the free cash flow yield of the TSX resources space, at 5.3 per cent currently, is near one of its most attractive levels on record (a 97th-percentile reading). This bodes well for future performance, since it means an enhanced ability to make dividend payouts and/or engage in share buybacks going forward.
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More On This Topic David Rosenberg: The Fed is tightening and that usually means recession, no matter what they say David Rosenberg: Declining equity risk premium turning TINA argument around David Rosenberg: How investors can navigate the global water crisis Finally, it is worth noting that periods of outperformance (or underperformance) of resources relative to financials generally tend to persist for many years (i.e., are not just short-term spasms). For example, resources spent the entirety of mid-2004 to mid-2014 with a higher weighting than financials before spending the next eight years with a smaller weight.
Thus, after a prolonged period of lagging the financials, it would be entirely reasonable to expect this trend to reverse and ultimately endure over multiple years. To summarize, when we consider that resources: i) are much farther below their average market share than financials; ii) have one of the most attractive free cash flow yields in their history and; iii) tend to experience prolonged periods of outperformance/underperformance, we believe that this sets them up well going forward.
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Article content Specifically, we see the resources space continuing to command a larger share of the TSX’s market cap than financials, which means investors should look to emphasize this segment of the market within their portfolio. It is also important to note that, in contrast to the U.S., the materials sector in Canada is mostly made up of gold names, making it more defensive in nature.
In the context of the current slowdown in economic activity, this is a particularly attractive attribute, and only further boosts the appeal of Canadian resources exposure.
David Rosenberg is founder of independent research firm Rosenberg Research & Associates Inc. Brendan Livingstone is a senior strategist there. You can sign up for a free, one-month trial on Rosenberg’s website.
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