The urge to flee to the safety of bonds and money markets during times of market turmoil may be a natural reaction, but it might not necessarily be the right one.
“Investors are avoiding risk like the plague and moving to bonds and money markets and away from equities,” said Paul Taylor, senior vice-president and chief investment officer of BMO Private Banking.
“That’s an emotional reaction to the market volatility of 2008 and 2009, but it might be the wrong move.
“History tells us that markets will go through downturns like ’08 and ’09 but there’s a danger that you could miss the forest for the trees,” Taylor warns.
“Although the economic recovery may be modest and weak, equities will outperform other investment classes in the long term.”
A great measure of how equities are likely to perform is the dividend yield of the market compared to returns on 10-year government bonds, Taylor said.
In late August, for example, the dividend yield of the Canadian market was about 4.5 per cent compared to a return of a little bit less than three per cent for a 10-year government bond.
“When dividend yields exceed bond returns, something is going to happen,” Taylor said.
“Either bond yields rise or equities rise.”
Canadian equities were trading at about 14 or 15 times earnings in August, a little below the long-term, historic level of about 17 or 18 times earnings.
“Equities are not trading at a high right now,” Taylor said.
“Investors should step back, separate their emotions, assess their own objectives and set their asset mix.”
In the current economic climate, stocks with a high dividend yield can give a positive bump to your stock portfolio.
“The correction in the S&P 500 and the TSX from the highs of mid-April has allowed investors the opportunity to buy stocks cheaper,” said Patricia Lovett Reid, senior vice-president of TD Waterhouse.
Lovett-Reid suggests investors stick with quality, large cap stocks and avoid stocks with high debt-to-equity ratios because rising interest rates will mean rising debt servicing costs.
On the other hand, companies which generate an operating cash surplus and have little or no debt will benefit from the higher interest they earn on their cash surpluses.
Lovett Reid suggests taking advantage of Canada’s strength.
“The TSX was the best performing G7 market in 2009,” she said. “There is growing Asian demand for our agricultural products, crude oil and metals in the long term, we have a sound banking system, and compared to other G7 countries we have a stable and prudent government.
“As money from the stimulus packages continues to get spent, it will benefit the infrastructure sector for some more time before austerity measures start kicking in.”
Taylor said there’s still of lot of investment money that is currently “parked” on the sidelines. Some of that money will go toward equities as it returns to the market.
Taylor recommends investors consider a slight overweight in base metals in their portfolios.
Energy is another good sector. Demand should rise due to constrained supply caused by the Gulf oil spill disaster.
Consumer discretionary stocks such as Magna International and Canadian Tire should benefit as the economy improves.
“Consider sustainable investing themes,” suggested Lovett Reid. “The BP oil spill has gotten investors increasingly supporting sustainable investing. Consider companies that focus on alternative energy, clean water and smart technologies that improve the efficiency of limited natural resources.”
“And protect the downside risk in the portfolio through asset allocation in line with your risk tolerance, adequate diversification across countries, sectors and companies, and the use of strict stop loss rules,” Lovett Reid said.
Talbot Boggs is a Toronto-based business communications professional who has worked with national news organizations, magazines and corporations in the finance, retail, manufacturing and other industrial sectors. He can be contacted at firstname.lastname@example.org.