INSTABILITY THE NEW REALITY FOR MARKETS.

For global stock markets, it was the worst opening in two decades. The S&P 500, which declined almost six per cent this week, has seen only one worse start to the year since 1929. In Canada, the S& P/ TSX Composite Index plunged into a bear market, defined as a 20 per cent or more slide from its previous high. If you haven’t thrown in the towel yet, there’s a good chance you’ve at least given it serious thought.

The trigger for all of this has been China, where flash market crashes seem to have lately become the norm. It has also led to fears that the world’s second-largest economy could be the trigger for another worldwide recession.

“The fact that market reactions were as tumultuous as they were suggests that China’s economic situation has become inherently unstable,” said Christian Keller, head of economics research at Barclays Capital.

All of that is unsettling for stock investors who have enjoyed a bull market for almost seven years now. The instability in China comes in a year in which many of the drivers of the current bull market are set to end. The U.S. Federal Reserve is in the process of normalizing rates, tightening the liquidity that has fuelled so much risk-taking in markets since 2009.

This, analysts and fund managers will tell you, is the new reality; you may as well start adjusting to it.

Brian Belski, chief investment strategist at BMO Capital Markets, said too many investors are still stuck in the past. “We continue to believe the majority of global investors remain overly focused on China, emerging markets, and commodities — the prior cycle trade.”

A BRUTAL MARKET WEEK PROVES EASY MONEY DAYS OVER

But part of the new reality for investors is that the stock market will be a place of greater volatility. Investors have enjoyed periods of relative calm in the past few years as trillions of dollars of quantitative easing programs have been undertaken by the Fed, the European Central Bank and the Bank of Japan to prop up their economies and stabilize capital markets.

Under those easing measures, assets that benefitted from the liquidity were the big winners. U. S. Treasury bonds, emerging market stocks ( until 2012, at least) and commodity prices all gained as borrowing became cheap and the bets became riskier.

But those are old trades under the old cycle, notes Craig Basinger, chief investment officer for Richardson GMP in Toronto. Investors hoping to cash in on the recent sell- off of commodities and emerging markets could find themselves burned, as what might seem like cheap prices are deceiving.

“Valuations are not nearly as important in the emerging market versus developed market debate, as is earnings growth,” said Basinger and his team in a note to clients. “Since earning growth is stronger in developed countries at the moment, and has been since 2012, we are not motivated to try and bottom-fish.”

Canadian investors, of course, have been among the hardest hit by the commodity and emerging market capitulation. With so many resource companies here, and the country relying on demand from China, Canadian stocks have been among the developed world’s worst performers.

Belski notes that sentiment on the country is extremely bearish, with most global fund managers being very underweight Canadian s t ocks. Many managers spent most of the past year reducing their holdings of Canadian equities.

“Our work c ontinues to suggest pessimism surrounding Canadian equities remains extremely elevated, led by fear and emotion,” he said.

But that does not mean it is time to give up on the Canadian market. Robert Kavcic, senior economist at BMO Capital Markets, notes that the TSX is currently trading at a two- point multiple discount to the S& P 500, with some attractive sector discrepancies.

“Financials, for example, trade just over 10x forward earnings versus around 13x south of the border,” he notes. “Canada might not be excessively cheap yet, but it sure is getting cheaper.”

Belski is more bullish on Canada, forecasting that the country’s stocks will outperform the S&P 500 this year.

“We believe any positive news stemming from emerging markets, Europe, and commodity prices will likely be a strong positive tailwind for Canadian stocks,” he said.

But he recommends investors stick to only a few sectors in t he country, avoiding areas such as mining stocks and over- priced health- care names. He recommends investors opt for banking, telecom and consumer companies.