(Bloomberg) -- The surge in oil prices has fueled a rally in Canadian stocks this year which strategists say still has room to run.
The S&P/TSX Composite Index has gained 3.1%, outperforming the S&P 500 by more than 8 percentage points. That’s the widest outperformance in a quarter in 13 years. Energy and materials stocks have surged as the war in Ukraine sparked a rush to oil and to haven assets, propelling the natural resource-heavy TSX to fresh highs.
The nation’s energy index jumped 27%, its strongest quarter in data going back to 1988, led by major corporates such as Canadian Natural (NYSE:CNQ) Resources Ltd. and Tourmaline Oil Corp, which have soared more than 40%. Large miners like Teck Resources (NYSE:TECK) Ltd. and First Quantum Minerals (OTC:FQVLF) Ltd. have led materials stocks to a 20% gain, while banks have climbed on the prospect of fatter profits from higher interest rates. Those three groups represent about half of the index.
“This is the perfect environment for the TSX and the commodities sectors,” said Greg Taylor, chief investment officer at Purpose Investments. “And it also doesn’t seem like it’s going to end any time soon. Some of these companies that have weathered the bad commodity environment are coming out on the other side and are really going to become incredibly profitable.”
Investors have another reason to be bullish. Average earnings per share are expected to grow 33% this year for Canadian firms, compared with 20% for U.S. companies, according to data compiled by Bloomberg. Energy producers are expected to drive the profit boom, with analysts forecasting that average EPS will soar 68%.
That’s making Canadian stocks look cheap: Companies on the S&P/TSX are trading below their five-year average valuation, at 13.9 times estimated earnings for the next 12 months. Companies on the S&P 500 are flying higher than their average at 19.4 times earnings.
Meanwhile, the S&P 500’s heavy tech stocks weighting pushed the index to its worst quarter since the pandemic shut down global economies.
“We’ve had a rotation into value,” said Ian de Verteuil, head of portfolio strategy at Canadian Imperial Bank of Commerce. “And at any metric, the TSX looks cheaper than the S&P 500.”
While a decline in commodity prices could affect investor sentiment, what’s more important is how companies allocate their capital.
“A decline in commodity prices would affect sentiment, but it’s not as if the TSX is pricing in $100 crude,” de Verteuil said. “These companies can make a lot of money at $80 per barrel. The thing that we will need to see -- and this is the most debatable part of it -- is whether the C-suites of these companies have found religion” on capital spending. During past commodity booms, Canadian energy companies used their cash flow to increase production. This time, there are signs they’re sticking with dividends and share buybacks, he said.