Will the Canadian Stock Market Maintain Its Momentum?

Canadian equity markets have staged a remarkable rally over the past year, fueled by the Bank of Canada’s interest rate cuts. The Morningstar Canada Index is up shy of 24%, carving out new record highs in the final weeks of 2024. Since the Bank began cutting interest rates on June 5, the market is up 15%.

With the central bank expected to continue cutting interest rates to support the economy, stock market strategists are cautiously optimistic that the rally will continue. “The environment is very attractive for equities,” says Brent Joyce, chief investment strategist at BMO. “It’s been this trifecta of better global growth, interest-rate-sensitive companies themselves, and the interest rate sensitivity of dividends,” he explains. “These were headwinds for the two years that rates were going up, [but they] have flipped into tailwinds for the Canadian stock market now that rates are falling.”

While there’s been mild concern about overvaluation in pockets of stocks in US markets, “the Canadian market is still pretty attractively priced and sports a very handsome dividend yield for investors,” Joyce says.

Despite most stocks being dependent on global factors, many companies on the Toronto Stock Exchange are also cyclically oriented, meaning they are beholden to the economy and the business cycle for their fortunes at the margin. With the close connection between the US and Canadian economies, stable growth in the south has helped Canadian equities.

“Lower interest rates should spur growth at companies that have debt,” Joyce says, noting that there is also a focus on companies’ dividend payouts as falling rates make those dividends more attractive.

Financials, Materials, and Energy Lead 2024 Rally

Over the last year, the financial services and basic materials sectors have been the frontrunners in the stock market rally within the Canada Index, along with energy and technology.

Financial services, which hold the largest weight in the index, delivered a 42.57% return. This contributed a thumping 13.09 percentage points. “The global diversified bank has been doing very well, especially if you have US exposure,” says Charles Raymond, portfolio manager at Desjardins. “What we’re seeing right now is that the US customer is in way better shape than the Canadian customer, and banks exposed to the US have been outperforming.”

Despite holding only an 8.91% weighting in the Canada Index, technology stocks have posted a hefty 43.13% return, the highest among all sectors. The solid performance resulted in a 4.04-percentage-point boost to the index. While large players like Shopify SHOP and Constellation Software CSU helped carry the sector forward, smaller players like Celestica CLS also contributed. Celestica has surged thanks to its exposure to the artificial intelligence boom—a rarity among Canadian stocks. The company is up over 200% in the year to date, making it one of the bigger performers in the tech space.

Both basic materials and energy, which rely on global commodity prices, performed well on steady oil and metal prices. The energy sector (which holds the highest weight after financials) had a 28.36% return and contributed 5.3 percentage points, making it second highest among the leading sectors. Not too far behind are basic materials, which posted a solid return of 34.08% despite only having an 11.49% weight in the index. The sector’s contribution was 3.83 percentage points.

“Energy companies are in a great spot, as they have reached a certain net debt target with additional money being returned to shareholders through share buybacks or special dividends. So even if oil pulls back, given the companies’ clean balance sheets, they would still be able to deliver some returns to shareholders,” Raymond explains.

Healthcare and communication services were among the laggards, and have not contributed significantly to the portfolio due to their smaller allocations. The communication services sector has struggled, losing 7.80% in the year to date, while consumer cyclicals posted a 4.15% return. Fierce competition and the federal government cutting immigration targets have added pressure.

“While rates moving lower should be positive, the competitive landscape has weighed on communication services. On a more idiosyncratic basis, many consumer discretionary stocks have underperformed, given concerns on the debt-ridden consumer in a slowing economy,” observes Reetu Kumra, portfolio manager at Fidelity Canada.

A Constructive Stock Market Outlook

Analysts are mostly upbeat about the outlook for Canadian markets, with central bank rate cuts expected to continue in the near term. “There is still ample liquidity in the market, and we should see an increase next year,” Raymond said, noting that since 1982, excepting two cases, markets have been positive for 12 months after each initial federal interest rate cut.

There is also potential for tax cuts in the United States under the incoming Trump administration, which Raymond thinks could be positive for some Canadian companies with US exposure.

“We’re very constructive,” Joyce says, as there is an opportunity for solid growth in the US, Canada’s biggest customer. He adds that there is also an opportunity for growth for all countries that saw recession-like conditions for two years. “Despite Canadian markets having performed well in the past few months, it had basically gone sideways for two and a half years.”

Joyce asserts: “We’re just getting started with a bull market for most stocks. Markets are up around 60% from the lows seen two years ago. An average bull market lasts five years, and stocks go up 180%. So we’re only through the first third of an average bull market.”

Risks to the Outlook

Experts see tariffs as the biggest risk to markets, along with concerns in the consumer discretionary space and the possibility of higher interest rates returning.

Joyce believes the biggest risk for global equity markets would be if interest rates rise, which could happen because of inflation, strong economic growth, or high government deficits. “The one thing that stocks and bond markets cannot handle in terms of returns for investors is high government deficits and debt that spooks the bond market,” he explains.

Markets have been volatile, and Raymond thinks they will continue to be for a while, as there are many unknowns ahead, including the risk of tariffs. US President-elect Donald Trump has pledged to impose a 25% tariff on all products from Canada and Mexico, and an additional 10% tariff on goods from China. “We don’t know exactly how Trump will handle tariffs on our exports to the US, our largest commercial partner,” Raymond says.

Canadians having less money to spend also remains a risk to the discretionary space. “There is still some inflation, and though people came out of the pandemic with additional savings, they have gone through that and now have less discretionary money to spend,” Raymond explains.

Cautious Optimism

Experts say investor sentiment is “cautiously optimistic,” with liquidity improving since central banks began lowering interest rates. “It’s getting warmed up, but I still think it has room to run on investor sentiment,” Joyce says.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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