Despite challenges, Canada is poised to outperform in 2025

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Welcome to Advisor To Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves. 

Craig Jerusalim, senior portfolio manager and head of global GARP (Growth at a Reasonable Price) at CIBC Asset Management.  

When I think of Canada right now, one word comes to mind: uggh! I mean, population growth is on the decline, productivity is poor, and don’t get me started on the political front. But the good news for all of us is that the economy is not the market, and the market is not the economy. And from my vantage, the setup for Canadian equities is about as compelling as it’s been in years. And I would go even further and say that Canadian equities could even outperform U.S. equities in the year ahead, despite the dominance of the Magnificent Seven group of companies.  

Granted, I’ve been saying this for the past three years, but I haven’t exactly been wrong. Surprisingly, since the end of 2021, the S&P TSX is in a dead heat with the S&P 500 on a total-return basis. Both are hovering around the plus 30% total return level. However, unlike the performance of the S&P TSX, the S&P 500 has really relied on multiple expansion for a good portion of its success.  

Typically, an index benefits from a high multiple when earnings growth is strong and profitability is high. Both factors [are] squarely in play today.  

However, the TSX is also benefiting from many of the same tailwinds, and subsequently also offers comparable growth and profitability. The earnings growth for the TSX is expected to be low double digits, with 9% profit margins in 2025, versus about 13% earnings growth and 10% profit margins for the S&P 500.  

Double-digit earnings growth is likely enough to sustain the elevated multiples for the S&P 500. But the eight turn premium between the two indices are likely to narrow, either by the TSX multiple going up, or the S&P 500 multiple coming down. Either way, that spells out outperformance for the Canadian benchmark.  

A second reason why we like the TSX is the yield advantage. The TSX offers a dividend yield close to 3% — or more than double the dividend yield of the S&P 500. That yield advantage offers a nice safety net if the market becomes more volatile and takes a turn for the worse.  

And finally, we actually like the diversification of the TSX. The concentration of the Magnificent Seven has increased the risk to the U.S. benchmark if those great companies stall, especially as they bump up against the laws of large numbers. On the other hand, the TSX really benefits from global growth and has more diversified pillars covering financials, energy, and materials, not to mention emerging technology and industrial sectors.  

The setup for our large energy producers here in Canada is quite compelling. 

• They are trading close to trough levels. 

• They have lowered their cost base down to $45-50 per barrel, meaning they are generating excess free cash flow at today’s depressed oil prices. 

• They have largely paid down their debt, meaning all of their excess free cash flow is coming back to shareholders in the form of dividends and buybacks.  

• And given the decades-long mine lives of the oil sands, companies like Canadian Natural Resources will be amongst the last producers standing, no matter how long the energy transition takes.  

Also in energy, we are particularly positive on Cameco, given the world’s need for zero-carbon-emitting nuclear power, combined with the energy security of their North American tier-one uranium assets. Additionally, Cameco has now combined their commodity exposure with the predictability of their Westinghouse servicing business, which we expect to result in leveraged growth for many years to come.  

A final high-conviction core holding for 2025 that also fits into that energy bucket, but is all the way on the opposite side of that spectrum is Brookfield Renewable. The company has really been lumped in with all the other depressed renewable stocks, despite having premium assets, consistent double-digit flow-from-operations growth, global diversification, operating expertise and the unique capability to recycle assets globally to enhance their returns.  

Brookfield Renewable, Cameco, and Canadian Natural Resources are some of the reasons why we have a favourable view as we look out into 2025. 

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Some of the sectors that we may be shying away from are the ones that have pure exposure to the Canadian consumer. The Canadian consumer is really at a disadvantaged position relative to the strong U.S. consumer right now. So, sectors like the telecom sector and the staple sector — the grocery space — are areas that really could be at risk. The latter being having high multiples and slower growth, the former (being the telecom sector) are a more reasonable valuation, but fundamentals there aren’t as compelling for other sectors, largely because of the competitive intensity in the telecom sector.  

Amongst the telecoms, we think there is a differentiation amongst the group, with Telus being our leading candidate within that space, largely because of their declining CAPX profile. They’ve already spent the majority of their fiber rollout, which means their CAPX is going to be coming down, and their free cash flow is about to be ramping up. We think that they’re starting to shy away from some of their other investments, such as Telus International and the health care, and really focus on returning money back to shareholders in the form of buybacks and dividend growth. And we think that that’s going to separate them from the likes of BCE, Rogers and Quebecor.  

So, although we don’t love the sector and we are shying away from some of those sectors that focus on the Canadian consumer, we are finding some opportunity for alpha generation by choosing the best of those in that group of companies. 

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Following back-to-back years of tremendous growth in equities, some investors are starting to be worried about a pullback or a downturn.  

We have to remember that companies do get better over time. They do grow their earnings consistently over time. So just because the market has had strong recent performance, it doesn’t necessarily mean that the market is due for a pullback.  

Now, most years — almost every year — we do experience some 5% to 10% pullbacks. It’s quite common for, once a year, to get a 10 to 20% pullback. And really you only get a deeper pullback at 20% plus if the economy heads into a recession, or there’s some sort of shock to the system, like we experienced during Covid.  

Now, given that’s not our view, our outlook, looking forward, the key for investors will be to watch earnings growth. As long as earnings continue to grow, double digits, like they are in Canada and the U.S. for that matter, multiples can stay high. But the key will be to follow the earnings, as the best advice we can give for investors looking forward into 2025.

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