Stock markets have been taking a beating over the last week or so because of the war in the Middle East involving Iran and the United States and the TSX has been no exception. Naturally, anyone with investments in the markets is concerned and wondering if markets are going to fall dramatically further. For Canadian markets, a lot hinges on the degree of uncertainty being generated by both the Middle East conflict as well as the U.S. Supreme Court ruling on the legality of President Trump’s tariffs. Markets have already fallen quite a bit due to the broadening of the Iranian conflict, and the price of oil and other commodities has risen. With respect to assorted fund managers as well as pension funds and RRSPs, it depends on how many of the investments are tied to the Middle East region and the degree of exposure in terms of the proportion of investments held in affected sectors.
The rise in oil prices if sustained could trigger a new burst of inflation and higher interest rates which in turn would further depress stock markets. A lot depends on how long the conflict lasts but the degree of uncertainty is high - making things worse for markets - because it is unclear what long-term plan is for Iran and the Middle East by the Americans. As for the Supreme Court ruling, it is a positive development that suggests that the days of tariffs on Canadian American trade flows may be numbered but again it depends on what the President's response is in terms of finding new ways to levy barriers to trade.
Yet, these are all short-term factors and the long-term trends in stock market valuations also need to be figured into the equation. This is done with a regression using STATA in which the TSX was regressed on a monthly time variable with num1 equal to January 1956 and num843 equal to March 2026 with the March value being the end of the first week only. Figure 1 presents the monthly closing value of the TSX from 1956 to 2026. Viewed over the long run, stock markets do trend up though closer examination suggests that the last three years represent a particularly exuberant upward trend. From January 2023 to January 2026, the TSX monthly closing valuation has risen from 20,767 to 31,924 – representing an increase of just over 50 percent which is quite astounding.
Figure 2 presents the same data but with linear and 2nd order polynomial fits and they suggest that the last three years are well out of the long-term trend of the TSX at least as measured by these two regressions. The linear fit suggests that the TSX should currently be at about 17,400 while the polynomial fit suggests it should be at 23,000. Both estimated valuations are based on rather crude simple regression techniques but are substantially lower than what we are currently at.
The polynomial fit closely tracks the data until 2024 when it falls quite below but with an r-squared of 96 percent, it does much better than the linear fit which with an r-squared of 82 percent starts to diverge substantially circa 2020 – also the year the pandemic started. The post 2020 era in general has been a rather severe break with what has gone before in many aspects of economic and social life. One could assume that post 2020 we are in a brave new world when it comes to stock market valuations and economic performance and “this time is different” when it comes to the recent surges in the stock market. We need not worry. It is onwards and upwards! On the other hand, if one believes that these regressions somehow capture the fundamentals of long-term performance, then we are in a very fragile market situation, and the recent declines may only be the tip of the iceberg. We are in interesting times.
