Correlation of TSX into the SP500 Futures

The Toronto Composite indicator or TSX for short is referred to because the S&P/TSX composite indicator. It’s a standard for the operation of the equity stores in Canada. A composite indicator is a set of stocks clubbed together to supply statistical measure of their store performance with time.

The combination catalog (S&P/ / TSX) is employed to track the total amount changes from the equity stores in Canada one of a select collection of businesses and is consequently applied as a reference for its general functioning of the asset store as well as also for respective equity portfolios too.

Typically, the objective of a equity portfolio or perhaps a hedge fund is to outperform the major composite indicator such as the S&P/ / TSX indicator. Even though composite indicator doesn’t cover the entire store, the selection criteria play a big role. It is often used as measure of the overall equity store performance of the economy or the country where the asset index is based.

Toronto Stock Exchange (TSX) Index

Because Canada and the U.S. are two major advanced economies and the fact that they are next to each other makes both the nations close trading partners. As a result, the monetary and fiscal policies as well as the strength and the weakness of one economy are often felt in the other. It is almost the similarly story when comparing the TSX and the S&P500, which are the two major benchmark asset indexes for Canada and the U.S.. There are many different versions of both the TSX and the S&P500. For example you can trade the ETF versions, as well as the futures derivatives versions of the similarly product. Regardless of what type of store, all the versions of the TSX and the S&P500 track the amount of the underlying cash store.

The S&P/TSX asset index is a float adjusted store financing index. A company that is listed on the TSX index has a float adjusted store financing which is calculated by removing the control blocks of 10% or more. In comparison, the S&P500 is a store capitalized asset index. In both the indexes, the criterion to add or exclude a share listing depends at the sole discretion of Standard and Poors.

Overview of the TSX Composite Index

Stock trading in Canada dates back to the 1950’s when the Toronto Stock Exchange was created in 1952. At the origin, only 18 shares were traded on the exchange and by 1977, things began to change with the advent of Computer Assisted Trading System (CATS). In fact the Toronto Stock Exchange was the before all else to introduce computer assisted trading besides introducing the decimal system for the asset index at a time when fractional pricing was used across other major exchanges in the world.

The TSX (Toronto Stock Exchange) covers ten business sectors in Canada which are: Utilities, telecommunications, materials, IT, industrials, healthcare, financials, energy, consumer staples and consumer discretionary.

The S&P/TSX originally comprised of about 300 top Canadian shares but the number of shares in the index varied over the years. The TSX Index originally started out as TSE300 and had 300 companies listed in the asset index with a yearly review where the listings could be changed. This was back in 1977.

By 2002, the TSX composite index was contracted to the Standard and Poors in the US which eventually saw the TSE300 being locked and gave rise to the S&P/TSX Composite index on May 1st 2002. The changes also saw the index’s structure and other aspects being overhauled as well, including the construction of the index and the management. New rules were introduced for shares to be included in the S&P/TSX index and number of the asset store sectors were brought down to the ten sectors listed earlier from the previous 14.

As the picture shows underneath, financials have the highest weightage on the TSX asset index followed by energy, where Crude oil forms an integral part which is a key export product for the Canadian economy.

TSX Futures – Sector Breakdown (Source – TMXMoney.com)

Unlike the TSE300 which was reviewed once a year, the new S&P/TSX index was reviewed every quarter and at the discretion of Standard and Poors. The index is adjusted at any of the quarterly reviews with the consent of the seven members making up the S&P/TSX index committee. One of the biggest factors that make the TSX unique over other global asset indexes was the fact that the number of companies in the asset index varied.

For example in one year, it could have contained 269 companies, while the next year, the number of companies could be dropped to just 204. For example in 2005 and 2011, the S&P/TSX excluded tech shares which were not performing so well.

These erratic changes to the TSX asset index made it somewhat volatile and hard to track over the longer periods of time. The TSX Composite index now comprises of 249 companies. Some of the well known companies listed on the TSX include: Air Canada, Barrick Gold and Bank of Montreal to name a few.

TSX Futures Contracts

The SXF futures track the underlying cash store of the S&P/TSX60 asset index which represents the leading companies across the ten different sectors. The TSX Futures are only offered on the Montreal Exchange which is the primary futures trading exchange of the Canadian derivates stores. In comparison, the S&P500 futures are traded on the CME Group futures exchange.

The SXF futures come with a multiplier of C$ 200 times the S&P/TSX60 index futures contract value. Similar to other equity index futures, the SXF contracts come in quarterly expiring contracts, for March, June, September and December.

SXF futures amounts are quoted in index points and expressed in up to two decimals. The minimum index point move is 0.10 point and the futures contracts are settled for cash. All SXF contracts are cleared by the Canadian derivatives clearing corporation. Besides the SXF, there are other versions of the TSX futures contracts including the emini versions of the contracts as well. A major distinction here is that the TSX futures track the TSX60 store and not the main asset index which tracks close to 300 companies.

The chart underneath shows the SXF futures amount chart.

TSX Futures Price chart (SXF futures)

TSX Futures and the S&P500 Futures Correlation

When talking about the correlation between two asset indexes from two different economies, one way to look at it is to compare how the indexes performed during key economic events. For example, the asset store crash of 1929 did not have any significant impact on the Canadian stores and thus on the TSX. While on the contrary, in the U.S. over 2000 investment and brokerage firms went bust.

However, bear in mind that the TSX has undergone a lot of changes over the years. For example, the TSX used to have some level of correlation to the U.S. Dow Jones Index when the TSX was tracking over 300 companies at one point. The store crash of 1987 for example was different as the TSX also fell sharply following the trends exhibited in the U.S. counterparts such as the Dow Jones and the S&P500.

The TSX futures and theS&P500 futures contracts show a fairly high level of correlation. Because of the fact that both the asset indexes are one of the major benchmark indexes of the U.S. and Canada, the respective equity indexes tend to exhibit a certain level of similarity.

While it is difficult to determine the correlation between the futures stores, the ETF version of the TSX and the S&P500 shows that both these indexes have a correlation of 0.78 as shown in the picture underneath.

Correlation between TSX and S&P500 ETF’s (source – Portfoliovisualizer.com)

Although the ETF’s are different stores, the correlation between the S&P500 and the TSX60 ETF shows that a similar correlation exists in the futures stores as well. In terms of confidence, the data shows that there is a 90% confidence that both the stores move in the similarly direction. Generally a correlation of 1 or positive correlation indicates that two stores are nearly identical in their behavior and tend to exhibit the similarly characteristics such as amounts moving at nearly the similarly rate. A correlation of around 0.90 indicates a near certain movement in both the shares, but not on a 1:1 basis. Overall, a correlation of 0.80 and above is said to be very strong, while a correlation of 0.70 – 0.80 is said to be strong.

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Therefore the correlation of 0.78, between the TSX and the S&P500 ETF stores suggests that there exists a similar level of correlation in the futures stores as well.

Besides the rather strong correlation, the TSX and the S&P500 stores are strongly interlinked due to the level of trade and interdependence between the two economies in question. While global factors that hit store sentiment such as political uncertainty in some region or other similar events tend to affect the global asset store indexes on the similarly level, other domestic factors that influence the index independently of each other exists.

The health of the U.S. economy also plays a big role in impacting the index performance for the TSX. For example a weaker economy would infer that the pace of exports from Canada will slow, likewise a healthy U.S. economy bodes well for Canada which translates to higher export volumes. Similarly, the U.S. dollar’s exchange rate is also an important factor in influencing the exports and imports, all of which tend to eventually affect the respective economy’s asset stores.

When comparing the TSX and the S&P500 asset index, it is important to also pay attention to the monetary policies from the Bank of Canada and the U.S. Federal Reserve. The BoC often lags behind the Federal Reserve, meaning that when the U.S. is in a rate hike cycle, you can expect to see Canada’s interest rates start to rise as well, and vice versa, lagging over a few quarters.

For example, the TSX also tends to closely follow the oil amounts as well. Because Oil is a big export product from Canada, the index has lot of companies that have exposure to crude oil, which tends to affect the asset index on the whole.

The chart underneath shows the Crude oil amounts and the TSX index compared together.

TSX and Crude Oil amounts comparison

On the other hand, the impact of Crude oil amounts on the S&P500 asset index is more limited as the asset index contains a wider set of industries than compared to the TSX index. Still with a correlation factor of 0.78, it is safe to suffice that the TSX and S&P500 futures stores are correlated. Although, having said that day traders should be looking at both the stores independently before taking up any traders with the correlation coming in only as a confirmation of the store bias.

When two shares are strongly correlated, it highlights the fact that traders who have exposure to both the stores are less diversified and therefore increases the risk to the downside. For traders, it is essential to understand how the stores interact under different store conditions. Correlations are never set in stone and tend to change over a period of time. Therefore, traders need to be aware of the current store drivers along with having an eye on the short term and the long term outlook off the stores in question.

One way to ascertain the level of correlation and the various periods is to watch how the stores react over a period of time which underlines the importance of paying attention to risk and diversification. A good example of this is the way the TSX had little impact during the 1929 crash, but the index also took a hit during the 1987 crash. This indicates that traders cannot afford to be complacent when comparing two different asset indexes. The correlation of 0.78 today could easily be higher or lower in a few months time and the major constant being the short term store drivers that can influence the correlation. It can come in different ways, from oil amounts to inflation to monetary policy to an outperformance of an underperformance of a particular sector.

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