Canadians may like to argue with our neighbors about who makes the best beer or who plays the best hockey, but when it comes to your portfolio, the real argument is, who has the best returns versus the Canadian stock market versus the US stock market?
Both Canada and the United States are wealthy developed countries with stable governments, reliable financial systems, and reliable civil infrastructure.
That is, we don’t have violent dictators causing chaos (all recent evidence suggests otherwise), we genuinely trust the banking system with our hard-earned money, and if we flip a switch, the lights come on. We both value individuality, freedom of expression and the right to pursue a fulfilling life.
Perhaps best suited to wealth building, both countries have very strong property rights, advanced legal rules and competitive corporate tax rates. We are very similar.
So are the Canadian and US stock markets very similar – or are they different? How much should the average Canadian invest in the Canadian stock market versus the US stock market?
2023 Canada vs US Stock Market Update
I’ve decided to update the post below (which I wrote a few years ago).
Although the US stock market has crushed the Canadian stock market for years, T.He Canadian market has made some major ground in 2022. The TSX Composite fell 8.7% to 19,400, while the S&P 500 closed nearly 20% lower at 3,840.
It hasn’t been a great year for most investable assets, but Canada’s performance is tied to very low confidence in tech and growth stocks. Based on Canada’s relatively low valuations, the smart money appears to be in the Great White North for large-scale returns (as well as low-risk returns) in 2023.
A great way to trade Canadian or US ETFs for free
What’s in the stock market anyway?
A country’s stock market technically consists of the shares of all publicly traded companies registered in that country. A stock market’s performance is tracked using an index: a subset or sample of stocks in the entire market.
An index that tracks every company in a stock market represents that market very accurately; But in general, the set of largest companies in a stock market is much larger than other smaller companies, and the sample of the largest companies closely mirrors the market as a whole.
Two indices are most popular for representing the Canadian stock market: the TSX 60 Index and the S&P/TSX Composite Index. The TSX 60 tracks the 60 largest companies in Canada and the S&P/TSX composite tracks approximately 250 of the largest Canadian companies. The S&P 500 index tracks about 500 US companies and is the most popular index to represent the US stock market.
Comparing Canadian Stock Market Returns and US Stock Market Returns
Let the TSX composite index represent the Canadian stock market and the S&P 500 index the US stock market, how do these two indexes compare? At the time of writing, the TSX Composite is at 15,670 and the S&P 500 is at 3,310.
Canadian code is high!
Canada wins! right?
Not so fast.
The level of the index has a complex relationship with the prices of the stocks in the index. It is very instructive to see the percentage change in the index level over time.
The following chart compares index levels from October 2010 to October 2020. During that time, the Canadian index grew 23%, while the US index rose 176%! Over the past ten years, the Canadian market has grown sluggishly, while the US market has nearly tripled.
Approximate average annual returns over the last ten years are 2.1% for Canada and 10.7% for the US.
Note: These returns are calculated based on index size only and do not include dividend payouts. Including dividend payments will narrow the gap between Canadian and U.S. stock market returns, as Canadian stocks generally pay higher dividends compared to U.S. stocks.
Since 2010, the US market has clearly experienced higher growth compared to the Canadian market. What about other periods? The following graphs compare the indices of the two countries over different ten-year periods.
From October 2005 to October 2015, the Canadian index grew 30.3%, while the US index grew 72.3%. The respective average annual returns are approximately 2.7% for Canada and 5.6% for the US.
From October 2000 to October 2010, the Canadian index grew 31.5%, while the US index actually fell 17.2%. The respective average annual returns are approximately 2.8% for Canada and -1.9% for the US.
The two graphs above include the 2008 financial crisis that rocked the global financial system. Do you remember the doom and gloom of that moment? Now, that apocalyptic financial crisis shows up as a slight dip on the map.
From October 1995 to October 2005, the Canadian index grew 132.9%, while the US index grew 107.6%. The respective average annual returns are approximately 8.8% for Canada and 7.6% for the US.
During this period, the dot-com bubble of 2000 (seen in the middle of the chart) involved a lot of speculation on technology companies. Between 2000 and 2002 we can see the bursting of that bubble and its collapse. But the night seems darkest before the dawn and both markets are recovering strongly since 2002.
It is difficult to draw firm conclusions from the graphs above. The U.S. stock market has certainly outperformed the Canadian stock market over the past ten years, but there are periods when the Canadian market outperforms the U.S. market. The periods in the graphs above are chosen arbitrarily.
It is easy to spot periods when the Canadian stock market outperforms the US stock market and periods when the US market outperforms the Canadian market. Note also that the graphs above do not include dividend distributions (which can be slightly biased Canadian Dividend Stocks)
There is no clear winner in the US stock market battle against the Canadian stock market!
In general, Canadian and US markets seem to respond similarly to broader trends and major events. Both markets have followed boom-bust cycles over the past few decades, through the tech bubble, financial crisis, recent pandemic market collapse, and subsequent recovery. The magnitude of the respective responses differentiates the two markets.
Canadian and US Stock Markets: What’s the Difference?
In the Canadian stock market vs. US stock market conflict, several factors are at play. First, size. Take all the stocks in an index and multiply their price by the number of shares, and you get the total market capitalization.
As of 2023, the market capitalization of the TSX composite is USD 2.75 trillion and the S&P 500 market capitalization is just USD 32 trillion.
Next, the Canadian and US markets use different currencies. Fluctuations in the relative values of the Canadian dollar and the US dollar contribute to variations between the respective market index levels.
Finally, the third and most important factor that differentiates the Canadian and American markets is mix. Both markets are created by different companies in different sectors.
The Canadian market is mainly concentrated in financials (28.7%), commodities (15.7%), industrials (12.5%) and energy (10.6%). The US market is mainly focused on information technology (27.4%), healthcare (14.1%), consumer discretionary (11.6%) and communication services (11.2%).
Another way to get a feel for different market structures is to look at the key components in each index. These are the companies with the highest market capitalization (number of times the share price) in their respective index. Canada’s top ten is currently dominated by banks and the US’s top ten by technology companies.
|Top Ten Components of the TSX Composite||The top ten components of the S&P 500|
|Royal Bank of Canada||Apple Inc.|
|Toronto-Dominion Bank||Microsoft Corp|
|Enbridge Inc.||Amazon.com Inc.|
|Canadian National Railway Company||Berkshire Hathaway Inc. Class B|
|Canadian Pacific Railway Limited||Alphabet Inc a|
|Bank of Montreal||Alphabet Inc c|
|CANADIAN NATURAL RESOURCES LIMITED||Exxon Mobil Corporation|
|Bank of Nova Scotia||United Health Group incorporated|
|Brookfield Corporation Class A Restricted Voting Stock||Johnson & Johnson|
|Thomson Reuters Corporation||Nvidia Corporation|
We Canadians and our southern neighbors may share some similarities, but our stock markets are not the same. The US market structure is completely different from the Canadian market. This would be a good strategy for Canadians to diversify into the US market.
Investing in the US Market for Canadians
The easiest way to invest in the US market is to log into your discount brokerage Qtrade, and buy an index ETF like XUS (from iShares) or VFV (from Vanguard). Both of those ETFs hold U.S. stocks and aim to closely track the S&P 500 index. But those ETFs trade on the Canadian stock market and can be bought using Canadian dollars.
From a Canadian perspective, XUS and VFV returns are affected by fluctuations in the Canadian dollar relative to the USD. There are currency hedge versions of US index ETFs that try to counter or smooth out currency fluctuations.
Some examples are XSP from iShares and VSP from Vanguard. In general, for committed, long-term investors like MDJ readers, currency-hedged ETFs are unnecessary and may even be a waste. This is a discussion for another article.
More sophisticated investors may prefer to keep their US investments in US dollars and buy ETFs directly from the US stock market. Holding US resident stocks or ETFs from Canada can have complicated tax implications. Even tax sheltered TFSA accounts in Canada cannot completely protect a Canadian investor from US dividend tax.
If you have the room, it’s more tax-efficient to hold US stocks and ETFs in your RRSP account. For more information, check out our free eBook below “Can I still retire?” – Describes where to keep your different types of stocks.