Both Canadian and U.S. stocks were lower while bonds were higher on the week, with most of the U.S. stock market's losses coming on Tuesday as investor angst grew with doubts about the passage of the health care bill in the U.S. House of Representatives. This week's U.S. stock market decline was the worst of the year, and Tuesday's 1.2% decline was the largest daily decline since mid-October, a span of 109 trading days. Given the post-election rally, we believe it’s a good time to rebalance your portfolio by adding to bonds – if it has become too overweight in equities – which can help protect your portfolio’s downside during market dips.
Canadian and U.S. stocks posted their worst week since the U.S. presidential election as policy uncertainties in Washington soured investors' moods. Here are a few takeaways from the market's most recent move:
The Benefits of Balance
The strength of the stock market has bolstered investor confidence. As a bull market ages, there are often three common tendencies among investors:
Now is a good time for a review to see if any of these tendencies have changed the complexion of your portfolio. Consider the following perspectives:
1. Will the bull market in stocks continue?
We think so. The fact that the market rallied to new highs does not, in and of itself, suggest the end is near. In our view, the gains in the stock market reflect improvement in the underlying fundamentals – trends and factors that tend to have the most influence over the longer-term performance of the market. Domestic growth remains subdued, but has perked up a bit more recently and the U.S. economy is on solid footing. We think the risks of a near-term recession in North America are still fairly low. There is also evidence of improvement in the global economy. This forms a fairly solid foundation for corporate earnings to continue to grow, and it’s the combination of economic and earnings growth that suggest to us that the broader bull market has life left in it. Trees don’t grow to the sky, but to the extent that market gains reflect further improvement in the investment backdrop, we think confidence in the bull market is warranted. That said, we’d caution against overconfidence, as this often leads to suboptimal decisions. And when overconfidence eventually becomes widespread enough to become euphoria, that’s when bull markets become most vulnerable.
2. Are you taking more risk?
The financial crisis caused many investors to become very risk adverse and have avoided stocks until recently. Others were attracted to the perceived safety of domestic investments, defensive sectors or those that offered high dividend yields. Stocks have delivered above-average returns and bond yields have remained historically low. Now, many investors are doing the opposite, raising allocations to higher-risk assets that have outperformed. If the required return needed to reach your long-term goals has not changed, your target balance of equity and fixed income hasn't likely changed either. Consider that a portfolio of 65% Canadian and U.S. stocks and 35% Canadian bonds at the beginning of 2013 would be 76% stocks and 24% bonds today, reflecting the strong performance of the equity markets. We believe it’s a good time to rebalance your portfolio if its exposure to stocks has dramatically increased.
3. Are you “letting it ride”?
In an extended bull market, it can be tempting to chase winners and avoid the laggards. An equal mix of Canadian and U.S. stocks has outperformed Canadian bonds for 5 straight years, with an average annual return of 15.0% compared to 3.3% for bonds. U.S. large-caps have led Canadian and overseas stocks. These differences can create imbalances that can affect your portfolio’s performance over time. As the bull market continues, we think asset class and sector leadership will rotate.
|S&P 500 Index||2,344
|10-yr GoC Yield||1.64%||-0.13%||-0.09%|
Next week, the industrial product and raw material price indexes will be reported on Thursday and January's GDP will be reported on Friday.
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Diversification does not guarantee a profit or protect against loss.
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