The Toronto Stock Exchange (TSX) has ignited an impressive rally after succumbing to a pandemic-induced selloff in March when the benchmark index wiped out nearly 40% of its value. However, bulls appear to have lost steam after pushing the TSX to almost 16,000 recently from the 2020 low of 11,172.73. With a gloomy economic backdrop, it is very likely that things will get worse for the index before they get better.
Here are five reasons why the TSX will revisit the March 2020 low.
- Canada’s Economy Is Fragile
As the country loosens coronavirus restrictions in an effort to slowly get commerce humming, the economic fallout from the pandemic threatens a swift recovery. Canada is still struggling with a record-high unemployment rate of 13.7% which was registered in May. The number exceeds the 40-year record of 13.1% posted in December 1982.
The skyrocketing unemployment rate poses a serious threat to the country’s financial sector, considering that Canada is a world-leader in debt. MSN Money reports that the total credit for the non-financial sector stands at 305.7% of GDP. Household debt is at 100.3% in proportion to GDP, which is higher than U.S. household debt of 75%.
Compounding Canada’s problems is the prospect that over a million of its residents or 4% of the population are on the verge of bankruptcy according to a DART & maru/Blue survey. The poll also revealed that an additional 9% are in dire straits.
The economic landscape is not pretty and it is very likely that Canada’s big six banks will take a huge blow as millions of Canadians may default on their debt. That’s bad news for the TSX.
- The TSX Is Overweight on Financials
The performance of the TSX largely depends on the health of Canada’s financial market as the sector accounts for nearly a third of the index.
Historically low interest rates drove consumers to take on record-level debt, which fueled the growth of the financial sector after the 2008 crisis. The previously buzzing financial sector helped the TSX print an all-time high of 17,970.51 in February of this year.
But being overweight in one sector can be a double-edged sword. If the sector collapses, its gravity can take the entire TSX down.
The growing debt that pushed the sector and the TSX higher is now acting as a ticking time bomb for the index. If millions of Canadians fail to service their debts, the overexposed financial sector will crater.
In May, the big six banks allowed customers to defer payments on over $180 billion in home equity credit and mortgages. Even with borrowers putting off payments, it seems that the financial industry is simply delaying the inevitable. Unless the economy can print millions of jobs, the country’s financial sector is in deep trouble.
- The TSX Is Also Overweight on Energy
Another factor that can drag the TSX down is the struggling global energy market. The energy sector represents 13.5% of the benchmark index. Why is this bad news for the TSX?
According to the US Energy Information Administration, global demand for petroleum and liquid fuels is expected to see a massive dip in 2020. Consumption is predicted to average 92 million barrels per day this year, which is 8.1 million barrels per day lower than last year. The lower demand for oil this year reflects the impact of the pandemic on global economic activity.
The TSX is already feeling the headwinds presented by the energy sector. Last week, Canada’s main index slumped as the energy sector fell by 4.5% due to dropping oil prices and a glut of inventory in the United States.
- The TSX Is Underweight on the Tech Sector
The one sector that can be the saving grace of the index amid the pandemic accounts for less than 10% of the TSX; Technology. For instance, in the United States, the Nasdaq 100 (NDX) recently printed a fresh all-time high even though the country is still struggling from the pandemic and at the same time facing massive social unrest.
Tech giants such as Amazon (AMZN), Google-parent Alphabet (GOOGL), and Netflix (NFLX) have seen their valuations soar over the last few months. People are relying on tech companies now more than ever to deliver their needs in this time of crisis.
The same phenomenon could also be observed in the TSX. Shopify (SHOP) has managed to more than double its value after climbing as high as $1,206.08. The company helps brick and mortar stores set up and run their online shops.
Other tech companies such as Kinaxis (KXS), Constellation Software (CSU), and Real Matters (REAL) have all made dramatic gains this year.
Unfortunately, the growth of the tech sector will largely be negated by the poor performances of the financial and energy sectors in Canada.
- The TSX Is Now Languishing Bear Country
From a technical standpoint, the TSX has printed two signals indicating that the 11-year bull market is over.
The index registered its first lower low on the monthly time frame since 2002 when it dropped to 11,172.73 in March of this year. It also posted its first lower high since 2011 when it failed to take out resistance of 16,000.
These technical signals suggest that the move from the March low of 11,100 to almost 16,000 is a bear market rally and not a full recovery. The writings on the wall suggest that a massive selloff is on the horizon. With a gloomy economic outlook, it is very possible for the TSX to revisit its March 2020 low or even go below it.
Disclaimer: The above should not be considered investment or trading advice. The author does not own any shares of the companies mentioned.
Kiril is a CFA Charterholder who is passionate about the financial markets and analyzing different opportunities for investors. He specializes in researching and reporting on equities, ETFs, mutual funds as well as commentary on different market trends.