The near-record highs in Canada's most-watched stock index is the most promising sign yet that we're finally – finally – starting to emerge from the financial stagnation of the past eight years.
There are still many risks to the outlook, but Canada's stock market is ignoring them. Investors are either delusional or looking ahead to better times for the global economy. Let's run with the latter explanation.
As of mid-January, the two top-performing TSX sectors over the past 12 months have been materials, up about 67 per cent, and energy, up nearly 50 per cent. We are talking here about a pair of sectors that have been bludgeoned to the point where, even after surging this year, both are still down by double digit amounts in their cumulative five-year results. When investors are worried about global growth, they dump resource stocks. Now, the opposite is happening.
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Teck Resources, crushed when the global financial crisis hit in 2008, is up something like 600 per cent in the past 12 months. Encana, roadkill in recent years, is one of the best performing energy stocks of the past 12 months thanks to a rise of 246 per cent. Teck's benefiting from a jump in copper prices, while Encana is benefiting from rising natural gas prices and firmer oil prices. Copper, oil and natural gas prices are all influenced to some extent by global growth prospects.
The Canadian stock market has had some good years since the 2008-09 crash, but those rallies were not the kind that inspired much optimism about finally breaking out of the long post-crash malaise. Top-performing sectors were typically in the consumer staples, telecommunications and utilities sectors, which are the investing equivalent of a security blanket. Basically, blue-chip companies paying reliable dividends.
The past year has been such a good one for the Canadian market that nearly all sectors have made money. But consumer staples and utilities are well down the list of best performing sectors, replaced by energy, materials and industrials. This is a sign of a market pivoting from modest to great expectations.
The optimism might be overdone. Bank of Canada Governor Stephen Poloz recently reinforced the idea that an interest rate cut may still be needed to sustain the economy. Other reasons for caution include uncertainties about the economic program of U.S. president Donald Trump. Investors were clearly bullish about the prospect of Mr. Trump in the early going, but we're still a ways off from hearing any specifics.
In Europe, meanwhile, there are concerns that people are turning against the European Union. The EU and its currency, the Euro, provide a measure of stability to the economies and banking systems in member countries. But a recent referendum in Italy has raised the possibility that the country and its troubled banks might pull out of the Euro. Right-wing parties in other countries could do likewise if they were to gain power.
The euphoria driving the Canadian stock market right now would disappear if the EU was in danger, if Mr. Trump's economic plans go awry or if oil prices fall back. Since the financial crisis, investors have learned that there are always persuasive arguments why things could get worse.
Today, optimism reigns. To adjust your portfolio to this new reality, start with a rebalancing. Go back to your target mix of bonds and Canadian, U.S. and international stocks and see how far you've drifted. Sell some of your winners and buy more of your losers to get back into synch. That's how you get diversification to work for you.
Next, evaluate the extent to which your portfolio has been skewed to the kind of conservative stocks and funds that did well up until 2016. Low-volatility exchange-traded funds are a great example. They crushed the competition by holding comparatively stable stocks, but now they're lagging badly.
Make sure you have a mix of growth-oriented investments as well as the safe stuff. If you don't know what to buy, try a total market Canadian index ETF that includes small, medium and large companies. The shares of small companies have been surging lately, yet another sign that investors see better times ahead.