U.S. Investors, Look North: Why Toronto is Your Next Investment Destination

As 2024 approaches, it’s time for U.S. investors to re-evaluate their portfolios and consider a shift north to Canada. With a remarkable 18% advance in the S&P/TSX Composite Index, the Canadian market is proving itself as a strong contender, closely trailing the “exceptional” S&P 500. The key difference? Canada’s growth is driven more by solid earnings than P/E multiple expansions, suggesting a more sustainable trajectory for investors looking ahead to 2025.

Favorable Exchange Rates

Currently, the Canadian dollar sits at the lower end of its historical range while the U.S. dollar is perched at a high. This exchange rate dynamic can be advantageous for equity investors as the prior weakness of the Canadian dollar enhances earnings growth. When it comes to investing, the crucial question is: would you rather buy into an undervalued currency or an overvalued one? The answer is clear.

Controlled Inflation

Canada’s inflation rates, both headline and core, are at or below the 2% target, in stark contrast to the U.S. economy, which is still grappling with higher rates. This lower inflation rate is a silver lining of a sluggish economy, as it creates a more favorable environment for P/E multiples—critical for stock price movements.

Proactive Monetary Policy

The Bank of Canada (BoC) has slashed interest rates by 175 basis points in this easing cycle, a significant move compared to the 100 basis points cut by the U.S. Federal Reserve. With the Fed signaling a pause amidst numerous economic uncertainties, the BoC’s approach not only offers a respite against potential U.S. trade aggressions but also supports the case for further rate cuts in the future, boosting market appeal.

Attractive Bond Yields

With lower inflation and aggressive rate cuts, Canadian bond yields offer a stark discount compared to U.S. Treasuries—3.3% for a 10-year Canadian bond versus 4.6% in the U.S. This situation translates to a compelling equity risk premium in Canada, nearly 350 basis points above government yields. Meanwhile, the U.S. market trails with a negative equity risk premium of 10 basis points, providing a strong incentive for investors to consider the Canadian market as an attractive opportunity.

Superior Valuation

When diving into valuations, the TSX presents a more appealing landscape. The P/E multiple on trailing earnings sits at 20x in Canada compared to 25x in the U.S., and with a forward multiple of 15x significantly lower than the 22x for the S&P 500, the Canadian market is seen as a value proposition. Historically, Canada’s trailing P/E has been just one point lower than that of the U.S., making the current six-point gap noteworthy and indicative of potential mean reversion.

Lucrative Dividend Yields

In a climate of shrinking yields globally, the Canadian market offers a generous 2.8% dividend yield, dwarfed by the mere 1.3% provided by the S&P 500. This disparity highlights the attractiveness of investing in Canada, as investors can enjoy dividend yields approaching those of government bonds, a feat impossible in the U.S. market. The Canadian sectors of Utilities, Financials, and Real Estate are currently leading in terms of yield status, presenting lucrative opportunities for savvy investors.

As American investors weigh their options for 2025, seizing the moment to invest in the Canadian market with its low currency valuation—as well as high-quality dividend prospects—could yield impressive returns. The shifting dynamics of both the exchange rate and the economic landscape strongly suggest that it's time to think beyond borders and consider the substantial potential that Toronto and the greater Canadian market hold.