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How a rallying Canadian market hurts your portfolio

Here's the problem with a resurgent Canadian stock market. In a way, it's bad for your portfolio.

When the S&P/TSX composite index is doing well, it's a near certainty that financials and energy stocks are driving the bus. If you own funds or stocks that mirror the broader market, every tick higher by the TSX skews your portfolio to these two dominant sectors.

The composite index was up a robust 5 per cent for the month to Oct.10. Health care was the top performing sector, up 11 per cent over the same period. Energy and financials were next, rising 9.2 and 7.7 per cent, respectively. Now, check out the index's sector weightings. Financials is way out front with a 34 per cent weighting, with energy next at just under 20 per cent.

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Ten-year return data shows the Canadian stock market has underperformed the U.S. and international markets for most timeframes. Canada has some catching up to do, and Canadian investors are no doubt eager to catch the wave. One thought on how to do this without over focusing your equity holdings on banks and energy: Add some exposure to Canadian equity funds that don't track the S&P/TSX composite index. You'll have to be diligent in your search, though. Low-volatility funds have been popular in recent years, but their top sector weighting is often financials. Same goes for dividend funds. Stay tuned for a look at Canadian equity funds with low weightings in financials and energy.

Another way to address your portfolio diversification is to maintain exposure to U.S. and international markets. Even as you're scooping up the more attractively priced Canadian market, remember that the U.S. market in particular is a brilliant diversifier. Tech accounts for 23 per cent of the S&P 500, while health are is 14.6 per cent.

As for health care in the Canadian market, don't expect much of a bump from the sector's surge in the past month. As of Oct. 10, health care's share of the S&P/TSX composite index was all of 0.6 per cent. Furthermore, health care's big month was basically the result of a 40 per cent surge in the price of Canopy Growth Corp., a licensed producer of medical marijuana. Health care was just blowing smoke – banks and oil companies drive the Canadian market.

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