Steady Gains, Uneven Ground: Canadian Equities in Q2 2026

The S&P/TSX Composite posted its eighth consecutive quarterly advance in Q2 2026, but the headline return masked a more divided market — one where Financials and infrastructure-linked themes led while domestic demand-sensitive areas continued to lag. In this update, we share how we navigated concentrated market leadership, managed key positions in Energy and Materials, and stayed focused on what's always guided our approach: valuation discipline, free cash flow quality, and risk mitigation. It's a quarter that reinforced why selectivity matters as much as direction.

Garey, can you begin by commenting on the Canadian equity market in the second quarter of 2026?

• Canadian equities built on their first-quarter gains, with the S&P/TSX Composite Total Return Index rising 7.0% in Q2, compared with 3.9% in Q1. This marked the index’s eighth consecutive quarterly advance, although the underlying market remained more uneven than the headline return might suggest.
• The tone was more constructive than in Q1, helped by strength in Financials, Industrials, and areas tied to capital spending on infrastructure, power demand, and AI-related investment. At the same time, leadership remained concentrated, with the market continuing to reward a relatively narrow group of themes while several out-of-favour areas remained under pressure despite improving valuations. The Canadian economy itself also remained mixed, with consumers and housing still facing challenges, creating a noticeable divide between the stronger parts of the market and areas more tied to domestic demand.
• Sector participation improved from Q1, with 8 of 11 sectors posting positive returns. Financials were the standout, rising 25.6%, supported by a broad rally in the Canadian banks. Health Care, Industrials, Consumer Discretionary, Real Estate, Information Technology, Utilities, and Consumer Staples also advanced, while Materials, Communication Services, and Energy declined.
• U.S. equities were even stronger in the quarter, with the S&P 500 Total Return Index up 17.5% in Canadian dollar terms. That rebound was led by technology and semiconductor shares, as enthusiasm around AI infrastructure and related capital spending remained a major driver of U.S. market leadership.

Oil prices moved dramatically over the first half of 2026, briefly spiking above US$100 per barrel before ending Q2 much closer to pre-conflict levels. How do you view that round-trip, and what does it mean for Canadian Energy and portfolio positioning? 

• Energy has been one of the more interesting stories so far this year. Coming into 2026, sentiment toward oil was quite bearish, with many investors expecting WTI to remain in the US$50 to US$60 range. Instead, the Iran conflict and concerns around the Strait of Hormuz drove a sharp geopolitical premium into crude, with prices briefly moving above US$100 per barrel early in Q2. By quarter end, much of that premium had unwound, with WTI finishing at US$69.50 per barrel, much closer to pre-conflict levels.
• That round-trip was reflected in sector performance. Energy was the clear standout in Q1, rising 30%, but gave back some ground in Q2, declining 5.0%. The key point is that oil markets can reprice very quickly when geopolitical risk builds and then fades, so we do not want to anchor our view of the sector solely on a short-term commodity price spike.
• For Canadian Energy, we still view the broader setup as constructive. The sector was already benefiting from improving sentiment before the geopolitical shock, helped by a more constructive federal policy tone around permitting and infrastructure development. We continue to see progress on market access and egress options as important for the Western Canadian Sedimentary Basin, as better infrastructure can improve realized pricing and make future development plans more credible for investors.
• From a portfolio standpoint, our most significant activity was the elimination of ARC Resources following Shell’s accepted offer to acquire the company in a transaction valued at approximately C$22 billion. With the transaction crystallizing value and the consideration primarily in Shell shares, we chose to monetize the position rather than shift exposure from a WCSB-focused producer to a global integrated energy company through an extended closing period. We redeployed capital into Tourmaline and Canadian Natural Resources, maintaining exposure to high-quality Canadian Energy businesses with strong asset bases, scale, and long-term free cash flow potential.

Gold was a defining market story in 2025 and early 2026, but it pulled back in the second quarter after reaching record highs earlier in the year. How are you interpreting the volatility, and does it change your investment approach? 

• Gold remained an important macro asset in the second quarter, but the price action was much less positive than earlier in the year. After reaching an all-time high in January, bullion fell 13.1% in Q2 to finish at roughly US$4,039 per ounce, as a stronger U.S. dollar and higher real-rate expectations weighed on the metal.
• The pullback is a reminder that even when the longer-term drivers remain supportive, gold can be highly sensitive to shifts in positioning, currency moves, and real-rate expectations. The broader case for gold has not disappeared, including macro uncertainty, fiscal concerns, reserve diversification, and demand for hard assets, but the quarter showed that those supports do not prevent meaningful short-term reversals.
• From an investment perspective, our approach remains disciplined and selective. We continue to focus on gold-related equities where we see the right combination of asset quality, balance-sheet strength, capital allocation discipline, jurisdictional risk, and valuation. We are not looking to chase commodity price momentum, particularly after the scale of the move over the past year.
• Within the Fund, gold exposure was a headwind to absolute returns in Q2, with Franco-Nevada and Wheaton Precious Metals among the positions pressured by the pullback in the metal. That said, our relative positioning in Materials was a positive contributor, helped by our underweight to a sector that declined sharply and by positive stock selection elsewhere in the group.

Trade policy uncertainty and geopolitical tensions continued to represent key market themes throughout the quarter. How did they influence the macroeconomic outlook? 

• Although a truce reached in June helped ease peak concerns, the Middle East conflict remained a key geopolitical issue during the quarter, creating a more meaningful supply-side risk through higher energy prices, shipping disruptions, and renewed concerns about global energy security. While higher energy prices supported Canada’s energy sector and reinforced the strategic value of Canadian oil and natural gas exports, they also increased inflation risks and added uncertainty to the broader macroeconomic outlook.
• Trade policy uncertainty also remained elevated. Investors continued to assess evolving U.S. trade policy and the approaching Canada-United States-Mexico Agreement (CUSMA) review, leaving businesses cautious around investment decisions, cross-border supply chains, and Canada's export outlook.
• Against this backdrop, Canada's economy remained under pressure despite pockets of resilience. Interest-rate-sensitive sectors such as housing, consumer spending, and manufacturing continued to weaken, and real GDP was essentially flat in Q1 2026 following a contraction in Q4 2025, briefly placing the economy in a technical recession.
• This uncertainty further complicated the outlook for monetary policy. Following an easing cycle through 2025, central banks adopted a more cautious stance. The Bank of Canada maintained its policy rate while assessing whether economic weakness would outweigh lingering inflationary pressures, while the U.S. Federal Reserve similarly signaled that additional policy easing could be delayed if inflation remained above target. In fact, by the end of the second quarter, the market was pricing 25-50 bps of hikes from the Fed by year-end.

Despite higher energy prices, the Canadian dollar remained under pressure. What has been driving that disconnect? 

• Historically, higher oil prices would have been a meaningful tailwind for the Canadian dollar. This time, however, stronger commodity prices provided only modest support and were insufficient to offset broader macroeconomic headwinds.
• Canada's slowing economy, persistent trade uncertainty, and a wider Canada-U.S. interest-rate differential continued to dominate investor sentiment for Canadian-dollar assets.
• As a result, the historical relationship between oil prices and the Canadian dollar has weakened, leaving the loonie increasingly driven by economic fundamentals rather than commodity prices alone.
• Finally, the escalation of conflict in the Middle East increased demand for traditional safe-haven assets, including the U.S. dollar, adding further pressure on the Canadian dollar.

Canadian equities have continued to perform well despite a challenged domestic economy. How do you reconcile the strength of the Canadian equity market with Canada's more subdued economic backdrop? 

• As we’ve discussed before, it's important to recognize that the Canadian equity market is not a direct reflection of the Canadian economy. While we’ve been bullish on the Canadian equity market, we have not been particularly constructive on the Canadian economy. The S&P/TSX Composite is heavily concentrated in Financials and resource-related businesses, sectors that have been supported by very different drivers than those affecting more interest-rate-sensitive areas of the domestic economy such as housing, consumer spending, and manufacturing.
• Resource sectors have been particularly important to recent market performance. Gold was one of the defining investment themes through 2025, providing a meaningful tailwind for the Materials sector, while the escalation of conflict in the Middle East renewed investor interest in Canadian Energy. Beyond higher oil prices, the conflict reinforced Canada's strategic importance as a stable supplier of oil and natural gas at a time when governments are placing greater emphasis on energy security, infrastructure development, and improving market access.
• Financials have also been a major contributor to returns given their significant representation in the index. Canadian banks rallied strongly during the quarter as investor confidence improved around capital levels, credit quality, and the prospect for stronger returns on equity, helping offset weakness elsewhere in the market.
• Finally, many of Canada's largest publicly traded companies generate a substantial portion of their earnings outside Canada. That global diversification has made their earnings and cash flows less dependent on the domestic economy, allowing the equity market to remain resilient despite softer Canadian economic growth.

Can you please discuss the sector returns for the S&P/TSX Composite Index in Q2, 2026.

• On an absolute return basis, the Canadian equity market delivered a strong advance in the second quarter, with 8 of 11 GICS sectors posting positive returns. Financials were the clear standout, rising 25.6% and driving much of the index’s strength. Canadian banks performed particularly well as investor sentiment improved around capital levels, credit quality, and the potential for stronger returns on equity. This was a notable shift from Q1, when Financials were a modest detractor and market leadership was dominated by Energy.
• Several cyclical and infrastructure-linked sectors also participated. Health Care advanced 14.0%, Industrials rose 10.6%, Consumer Discretionary gained 8.9%, and Real Estate was up 8.4%. Industrials benefited from strength in select areas tied to capital spending, infrastructure, power demand, and broader “build Canada” themes, while Real Estate and Consumer Discretionary recovered somewhat from earlier weakness as the market became more willing to take on risk. Information Technology also rebounded, gaining 6.4%, after declining by over 20% in Q1.
• On the weaker side, Materials declined 11.5%, Communication Services fell 10.0%, and Energy declined 5.0%. Materials was pressured as gold pulled back further from its January highs, while Energy gave back some of its earlier war-premium gains as oil prices moved closer to pre-conflict levels. Communication Services remained under pressure as investors continued to focus on competition, leverage, and dividend sustainability across the telecom group.

Can you comment on Franklin ClearBridge Canadian Equity Fund activity during the quarter? 

• Trading activity remained elevated during the second quarter, as strong market returns and significant stock-level dispersion created opportunities to recycle capital. We added selectively to areas where share price weakness had outpaced our estimate of intrinsic value, while trimming or exiting positions where the risk/reward had become more balanced.
• Against a backdrop of continued AI-related disruption concerns, we added to Stantec, Thomson Reuters, and Colliers. The market has been quick to punish uncertainty, but in all three cases we believe the underlying businesses remain difficult to disrupt and that AI is more likely to enhance productivity and customer value than permanently impair their business models.
• These purchases were primarily funded by reductions to bank positions following strong performance and meaningful valuation appreciation. We trimmed Royal Bank, Scotiabank, and Toronto-Dominion Bank.
• In Energy, we eliminated ARC Resources following Shell’s accepted offer to acquire the company. With the transaction crystallizing value and the consideration primarily in Shell shares, we elected to monetize the position rather than shift exposure from a WCSB-focused producer to a global integrated energy company through an extended closing period. We redeployed capital into Tourmaline Oil and Canadian Natural Resources, maintaining exposure to high-quality Canadian Energy assets. We also added modestly to Keyera through its secondary offering, which was tied to funding the remaining 50% interest in KAPS.
• In addition to eliminating ARC Resources, we exited our positions in OpenText and Canadian Utilities. OpenText was removed as insufficient organic growth and leverage created a less favourable forward return profile, while Canadian Utilities was eliminated following share price strength.
• Other transactions included initiating a small position in TransAlta and participating in the Apotex Health IPO, which we subsequently exited after share price strength brought the stock closer to our estimate of intrinsic value.  
• Overall, the quarter reinforced the value of balance and selectivity. We used volatility to recycle capital into mispriced opportunities, while remaining focused on intrinsic value as macro uncertainty and AI-driven dispersion continued to shape returns.

How would you describe the current positioning of the Fund? 

• We continue to manage the Fund with a consistent, valuation-driven investment style grounded in free cash flow, maintaining a more attractive valuation profile than the benchmark. This discipline is particularly important in an environment where certain pockets of the market remain extended. Our focus remains on high-quality businesses with durable competitive advantages, strong balance sheets, and clear visibility into long-term profitability and growth.
• While we remain selective in more cyclical areas, particularly where benchmark leadership has been strongest, we have incrementally increased exposure where risk/reward has improved. At the same time, the portfolio retains important defensive characteristics, which proved beneficial during periods of heightened volatility throughout the quarter.
• We believe the portfolio is well aligned with the current opportunity set. Benchmark concentration remains elevated and market leadership continues to be narrow, creating inefficiencies across sectors and individual securities. In this environment, our emphasis on predictability, risk mitigation, and disciplined security selection remains central to delivering attractive risk-adjusted returns over time.
• Over the past year, sector positioning has evolved meaningfully as we have actively redeployed capital into areas of dislocation. Relative to the benchmark, this includes a 300 basis point increase in Financials and an equivalent 300 basis point increase in Industrials. These shifts reflect both additions to existing holdings and the initiation of new positions where relative underperformance created more compelling entry points. Within Financials, we added to Intact Financial, Manulife Financial, and TMX Group while initiating new positions in EQB and Onex. In Industrials, we added to Boyd Group, Canadian National Railway, Stantec as well as Waste Connections, and established a new position in Thomson Reuters.
• These investments were largely funded through the reduction of positions in Utilities and Consumer Staples following a period of relative outperformance. Our allocation to Utilities decreased by 410 basis points, reflecting trims to Fortis and full exits from ATCO, Canadian Utilities and Hydro One, net of establishing a position in TransAlta. Similarly, our overweight position in Consumer Staples declined by 210 basis points as we reduced positions in Loblaw and exited Saputo. This repositioning has modestly increased the Fund’s growth profile while maintaining our core emphasis on valuation discipline and risk management.