The top 3 Canadian equity sectors investors were talking about in the spring

The first half of 2024 was rather productive for Canadian equities — especially when you consider recession talk, stagflation concerns and geopolitical tensions were all weighing on investor sentiment. But because the market tends to move higher in conjunction with margins and earnings — which have by and large been beating expectations — we find ourselves in and around all-time highs for Canadian equities, despite the headwinds.

Energy

While crude oil prices are off their highs for the year, at least for now, they’re still relatively robust, boosted by geopolitical tensions and demand from emerging markets. The commitment oil companies have made to pay down debt and return cash in the form of dividends and buybacks to shareholders has been most important for the performance of energy equities. Canadian Natural Resources, for example, hit its debt target of $10 billion and said it will return 100% of its free cash flow to investors. What’s more, energy group valuations are below long-term averages despite their stronger balance sheets, return on investment, return of capital focus and low-cost long-life asset base. In other words, it’s a good time to be bullish on oil and gas.

Materials

Materials is the next best-performing Canadian equity sector. It’s been aided by the strong rally in gold and copper. Gold strength is driven by geopolitical factors and sticky inflation. We’ve also seen central banks, led by China, continuing to buy gold reserves. Copper is up handsomely this year and recently surpassed its all-time high. The incremental demand from electric vehicles and the electrification of the grid will require significant amounts of copper. We anticipate this demand will result in an estimated 10-million-ton shortfall by 2035, which positions the commodity favourably.

Financials

The third-best equity sector in Canada is financials. The largest sector on the TSX, its performance is a tale of two subsectors. The Big 6 banks have lagged behind the performance of the overall market, while insurance companies offering life, property and specialty insurance have been amongst the best performers year-to-date.

Canadian banks, from a valuation standpoint, are trading pretty close to their long-term price-to-earnings average. Although they offer attractive and growing dividend yields of around 5%, there are some near-term headwinds that could limit any further multiple expansion. These headwinds include slower loan growth and increased regulatory scrutiny. Typically, banks rally close to the point where peak provision of credit losses occurred, but we’re not at this point yet. Insurance companies, on the other hand, are experiencing better growth and higher returns on equity, which allows them to deploy excess capital at better rates of return.

No one really knows if the Bank of Canada will keep cutting interest rates and how deep any cuts will be. And just because these were the top three Canadian equity sectors in the first half of 2024 doesn’t mean they will necessarily be the top three sectors in the second half of 2024. Sound opportunities are typically found by seeking out high-quality growing businesses with defensible competitive advantages that can relatively outperform regardless of the rate or macro backdrop. 

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