The Canadian stock market has had a split personality, repeatedly rising to set new record highs, then falling back again sharply. It’s left many investors wondering whether it’s a bull market – or a bear market. In many ways, it’s both.
A closer examination of the benchmark Canadian stock index, the S&P/TSX, shows that the strong performance is dominated by a handful of stocks. Take away the top 15 performers and the TSX, instead of being up around 600 points, would be down 600 points. In other words, the TSX’s top 15 stocks are up 1,200 points, while the remaining 285 stocks, in aggregate, are down 600 points. What’s more, these top 15 stocks are all from just two sectors of the economy – the energy and materials sectors – reflecting the burgeoning global demand for commodities such as metals, forest products, gold, oil and gas. These two sectors were up 21.9% and 13.3% respectively halfway through 2008.
Meanwhile, the financial sector – which together with the energy and materials sectors accounts for over three-quarters of the TSX – was down 3.1%. Most other sectors were also down.
So even while the TSX sets new record highs, most Canadian investors are experiencing poor returns because their investment portfolios are diversified across many sectors, not just the materials and energy sectors. Furthermore, many investors purposely limit their exposure to these two particular sectors, which can be very volatile, in favour of normally less volatile sectors like the financial sector.
Coping with the market’s split personality
Seeing their portfolio performance lag behind the TSX, many investors are wondering whether there’s anything they should do. The following are some strategies to manage the market’s swings:
1. Don’t try to time the market. Avoid the temptation to do this – or sell on the highs and buy on the lows. History shows that the long-term direction of the market is always up. But over shorter time periods, it’s impossible to predict with any accuracy what the markets will do. Not even the most successful investment professionals can do this consistently.
2. Keep some cash on the sidelines. With the markets being so uncertain, it may be wise to increase your allocation to cash and other liquid investments. This way, when the market’s direction becomes clearer, you will have some cash on hand to take advantage of potential opportunities.
3. Stay properly diversified. Loading up on stocks from the energy and material sectors because they’re “hot” now – while excluding the rest – is a risky proposition. Just because these sectors are outperforming now doesn’t mean they will be tomorrow. A properly diversified portfolio holds stocks from a range of sectors to reduce the impact of any one particular sector performing poorly.
