Canada’s Financial Sector’s Correlation To The US Market

The Canadian banks have been tracking the US stock market for a while. Here is a quick correlation table showing that the group as a whole, correlates quite closely with the US stock market.

These stocks are widely held in Canada, but less so in the USA. However, for US investors they make a nice dividend payment and have a solid investor base that does not move much. If you are trying to outperform the market, these stocks move with the US index so that is a more difficult task, as they correlate similarly.

The good news is they have large asset bases and behave similar to each other. Call it an oligopoly of the 5 majors. Out of country investors have tried to short Canadian financials for years on the basis that Canadian property markets are overvalued.

Somehow these banking charts hold up, year after year. The lack of competitors is a big hurdle and you also will not be able to get Canadian portfolio managers to sell their Canadian banks out of a portfolio. They are stable, they reduce the risk profile and generate average returns.

Let’s take a look at a couple of the charts to look for clues from the correlation table and then investigate the differences in the chart.

As you can see on the purple shaded area and the fine scale on the right, RY trades pretty much in line with the $SPX. Recently the bank pushed to new highs slightly ahead of the $SPX, but this chart also includes dividends in what is called a ‘total return’ chart.

Not unlike the major US indexes, the momentum shown by the PPO has oscillated sideways since April. While price has a slightly upward bias, we do not see a big change in relative performance to the $SPX.

To contrast that RY chart, let’s look at the least correlated stock of the group, BMO.

BMO is the least correlated Canadian bank so it can be interesting to look at the difference.

The correlation tool makes it more obvious, but the chart shows the same information. On the purple shaded area, we can see that the stock is still making lower highs and lower lows, slightly underperforming the peer group. While RY recently broke to new highs, BMO has yet to break the downtrend. Over the past two weeks the volume for BMO has soared with no real accompanying move in price. That is an oddity that should be watched closely as the momentum trend is also lower over the last three years and currently sits around zero.

We have a stock with low momentum but volume soaring which is very out of character. This one looks less strong than RY on both price and momentum.

In a choice for investors, that fact that the BMO stock is correlating less with the $SPX as shown on the table above as well as underperforming peers like RY suggests staying with the stronger RBC. Stocks having a low correlation can also outperform $SPX by wide margins. In the example above, the low correlation is due to underperformance as we can see from the charts.