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U.S. equity market returns are being dominated by an alarmingly small number of stocks, increasing the odds for heightened volatility and more intense sell-offs.

Goldman Sachs’ chief U.S. equity strategist David Kostin noted that five stocks – Apple Inc., Microsoft Corp., NVIDIA Corp., Tesla Inc. and Alphabet Class A – have accounted for 51 per cent of S&P 500 performance since April of this year.

Mr. Kostin wrote that when market breadth narrows to this extent, the trend tends to continue for the following four months - the large-cap stocks continue to outperform. The catch, however, is that overall benchmark returns lag after breadth narrows. “Periods of sharply declining market breadth are followed by weak returns and deeper-than-average drawdowns,” writes Mr. Kostin.

The strategist’s analysis uncovers 11 episodes since 1980 when S&P 500 leadership has narrowed to the same extent as between April and October of this year. On average, the benchmark produced below average returns for the next one, three, six and 12-month periods. Sell-offs during these time frames averaged 10 per cent, double the historical median.

Thankfully, for investors, there are positive mitigating circumstances. Mr. Kostin believes that market prices already account for Federal Reserve monetary tightening – the withdrawal of asset purchases plus interest rate hikes. In addition, there are few evident signs of recession, and corporate earnings growth and profit margins continue to surprise to the upside.

It’s not straightforward to assess market concentration in the S&P/TSX Composite Index relative to the S&P 500 because of the constant dominance of bank stocks and less sector diversity. For what it’s worth, the April to October period saw the top five performing domestic stocks – Shopify Inc., Royal Bank, TD Bank, Brookfield Asset Management Inc. and Canadian Natural Resources Ltd – contribute 1,262 points to the index’s 3,603 point climb.

Market disaster may not be imminent, but history implies that drastically narrow markets are unhealthy and temporary. Investors should be prepared for heightened volatility in the months ahead.

-- Scott Barlow, Globe and Mail market strategist

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Stocks to ponder

Headwater Exploration Inc. (HWX-T) This small-cap energy stock has rallied more than 300 per cent in a little more than a year, taking its market capitalization above the $1-billion mark. As Jennifer Dowty tells us, this company stands out from its industry peers due to its proven management team, assets with strong economics, and its pristine balance sheet. The company’s chief executive officer is experienced in growing junior energy companies that attractive takeover bids. The stock has a unanimous buy recommendation from nine analysts.

The Rundown

How do you explain the markets’ latest mood swings?

Don’t look to Wall Street strategists for a year-end swig of good cheer. If they have one core message for 2022, it’s that it is time to put away the punch bowl and sober up. Consider the forecasts from 16 top investing teams. Half the prognosticators have year-end 2022 targets for the benchmark S&P 500 index of big U.S. stocks that are either below where the index (which closed Friday at another record high) currently sits or only a hair higher. The downbeat outlook is a dramatic shift from last year, when everyone was betting on a big lift from a reopening economy. Now many of the investing cognoscenti are warning we can expect more of the moody back-and-forth behaviour we have seen in recent weeks. Ian McGugan reports.

These are the ETFs that are most popular with mutual fund managers

Use of ETFs by mutual fund managers has quintupled in the past five years, and the number of ETFs used has more than doubled over that same period. Rob Carrick provides a list of the Top 10 ETFs most held in mutual funds.

Investors await faster taper, inflation view at Fed meeting

Investors this week are bracing for the last Federal Reserve meeting of the year, with market participants hungry to learn how quickly the central bank plans to finish unwinding its bond-buying program and pick up signs of when it may start to raise rates in 2022. As Lewis Krauskopf of Reuters reports, there is potential for renewed volatility if the Fed takes a more hawkish than expected view on rolling back the easy money policies that have helped stocks more than double from their March 2020 lows.

Also see: Funds place biggest bet on U.S. rate hike in nearly 3 years

Volatility, Fed undermine bitcoin’s inflation hedge claim

With annual U.S. inflation running at its highest since 1982, now would be the perfect time for bitcoin to stand up and cement its status as a “real” asset, a store of value and the hedge against inflation its enthusiasts claim. But even if you set aside defining issues like patchy liquidity or regulatory risks, bitcoin now faces a twin challenge of higher real-world interest rates, perhaps rising more quickly than previously thought, and ever more volatility in a jumpier financial market getting used to ebbing credit. Jamie McGeever examines the challenges that lie ahead for the cryptocurrency.

Others (for subscribers)

The most oversold and overbought stocks on the TSX

Monday’s analyst upgrades and downgrades

Monday’s Insider Report: This bank’s new CEO buys on the dip following quarterly earnings miss

Ask Globe Investor

Question: When will the annual TFSA contribution limit be going up? It seems like ages since we had an increase.

Answer: You’ll have to wait a little longer. In November, the federal government announced that the annual dollar limit for tax-free savings accounts will remain at $6,000 for 2022, where it has been since 2019.

Now for the good news: The limit could rise as early as 2023.

Here’s why: The TFSA annual dollar limit is indexed to inflation and rounded to the nearest $500. Before rounding, the limit for 2022 is about $6,162.70, according to Dorothy Kelt of TaxTips.ca.

That is just short of the $6,250.01 required for the TFSA limit to be rounded up to $6,500. All it would take is an inflation rate of about 1.5 per cent, as measured by the change in the consumer price index from October, 2021, through September, 2022, Ms. Kelt said.

Given that the CPI has surged by more than 4 per cent on a year-over-year basis in recent months – driven by supply chain disruptions, labour shortages and higher energy costs – unless inflation cools considerably the TFSA limit will almost certainly be going up in 2023.

--John Heinzl

What’s up in the days ahead

The Contra Guys’ stock picks of 2020 turned out to be all winners - a rare feat. This past year’s list? Not so much. They’ll review how things went.

Click here to see the Globe Investor earnings and economic news calendar.

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Compiled by Globe Investor Staff