The ever-changing nature of the Toronto stock market index

Lyle Stein - November 12, 2011

While the industrial and forest product sectors have been gutted, the TSX index has beefed up on financials and gold

While day-to-day market gyrations capture everyone’s attention, lost in the noise of price movements is how markets change over time.

For example, the changes to the Toronto stock market index over the 30-year period, September 1981 to September 2011 are illustrative. Even the name of the Index has changed. Today it is known as the S&P/TSX Composite, reflecting the TSX’s adoption of US index standards. In 1981 it was known as the TSE 300.

Over the 30-year period, the TSX increased six-fold as inflation and interest rates fell dramatically. While the rate of inflation fell, commodity prices generally rose, reflecting a variety of supply/demand and general pricing constraints.

What have been the biggest changes to the Toronto stock market?

First, and consistent with global trends, is the ascendency of the financial services sector. Financial stocks were 13% of the TSE in 1981; today, they are 30%. Why such growth? We believe lower interest rates and baby boomer borrowing had much to do with it. Whether such strength can continue in light of the global financial upheaval witnessed since 2007 presents a huge question mark today.

The next biggest increase is in the gold sector. While bullion prices have ratcheted up smartly over the past four years, Canada has also become a global mining centre. Barrick Gold, through acquisitions, is the leading global player in the gold sector.

Where the gold sector gained, the base metals sector lost, primarily as a result of the takeovers of such heavyweight names as Alcan, Inco, Falconbridge and Noranda. Only time will tell how the loss of such Canadian leaders will influence the domestic economy going forward.

Also interesting is the gutting of the traditional industrial and forest products sectors. The forest products sector now represents 0.1% of the S&P/TSX, compared to a 2% weight in 1981. The steel industry has fallen from 3% to 0.3%. The forest sector has seen a steady erosion of its status as a leading Canadian industry; the steel sector has been restructured, with the remnants now owned by larger international companies. On the positive side, the rise of global fertilizer stocks, Potash and Agrium has been a plus.

In the consumer sector, Canada lost its flagship brands, Seagrams, Molson, Labatts; companies with centuries-old heritage. Again, foreign ownership has replaced domestic.

Canada has always been an oil and gas mainstay and that hasn’t changed over the years. Our pipeline and utility sector weights have remained stable over the decades.

Chart One

What is interesting is how foreign ownership (Canadian companies owning foreign financial and gold companies, foreign companies owning Canadian metal mining, industrial and consumer companies) has skewed the Canadian benchmark index.

Leon Frazer’s investment process has never been index-driven. When Leon Frazer considers diversification, it is in the context of exposure to a single industry, not relative to a benchmark that changes over time. Though weights may adjust in an index, we see no reason to change our clients’ ownership of dividend-growing companies on the basis of an arbitrary index adjustment.

 

 ADAPTED FROM LEON FRAZER MARKET PERSPECTIVES NOVEMBER 2011

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