Enjoy hot market, but be set for chill
An important lesson for investors to remember is that as powerful as we like to think we are, and despite how much we try, one cannot control Mother Nature.
Markets naturally cycle like the seasons and times like these are no different than any other, although perhaps this one is a bit longer than normal, thanks to a very active U.S. Federal Reserve.
The current bull cycle still has a lot of positive data backstopping calls for a continued long hot summer, but there are a few signs of investor exhaustion, such as the recent drop in trading volume and record low volatility.
There are also more pronounced signs that the leaves are only just beginning to change colour. Specifically, history shows energy and commodities typically rally only at the later stages of a bull market, while other sectors such as consumer stocks tend to taper off. Sounds awfully familiar, doesn’t it?
Fortunately, this is great news for Canadian investors who have watched their portfolios lag their neighbours to the south since we finally get to play catch-up.
After underperforming most other developed markets in 2013, the Canadian equity market is off to a respectable start with the S&P/ TSX composite index gaining approximately 11.2% this year to the end of June, with a lot of the gain due to the strong energy sector, which is up a whopping 22.1%.
The Canadian benchmark compares favourably to the 6% gain this year by the S&P 500, and the 3.4% and 1.9% increases by the MSCI EAFE and MSCI emerging markets indexes, respectively.
We are keeping a close eye on emerging markets and whether they can provide support to sustain the current momentum in Canada. Many forget that Canada tends to be a lower-risk, second derivative to emerging markets due to its underlying commodity exposure.
This is because of the recent shift in total demand for commodities from developed nations to emerging ones. For example, countries such as China and India now consume more oil than developed nations.
Interestingly, in the bull market from 2000 to 2007, emerging markets outperformed globally because of their rapidly growing economies. This, in turn, put pressure on commodity prices and sent them higher across the board, which was great for Canada.
However, in this bull market run from 2009 until now, emerging markets have been lagging behind many developed countries, while only certain commodities such as crude oil have remained robust thanks to heightened geopolitical tensions.
Given the historical relationship, we would like to see a rebound in emerging markets to help ease our minds about the sustainability of the recent upswing by Canadian equities, especially in the energy sector. We would also like to see a narrowing of the gap between the U.S. and other markets.
As most Canadians know, summer does not last forever, but it sure can be a long warm fall. Enjoy the good times while they last, but take advantage of the time to at least make some preparations for winter. This means maintaining a well-diversified portfolio, undertaking low-cost hedging strategies and locking in some profits.