Canada is in the news again. No, not the Canadian Olympic team in Italy, although with any luck we’ll hear our national anthem often in the coming days. What caught the world’s attention was our Prime Minister’s speech in Davos about the new global reality and how Canada is adapting to the changing world of global trade.
Leaving aside the political and patriotic arguments for and against Mark Carney’s stance, there is a lot of economic rationale for his approach – arguments that every long-term investor can and should be able to relate to. The United States accounts for approximately 75 per cent of our exports and 50 per cent of our imports as of 2023. To put that in perspective, China was Canada’s second-largest trading partner and accounted for a minuscule 4 per cent of our exports and 10 per cent of our imports in 2023. What Mr. Carney was, in effect, talking about – and now actively pursuing – was a policy of trade diversification.
As every smart investor knows, diversification is the fancy term for what our grandmothers used to tell us: Don’t put all your eggs in one basket. Sage advice, but proper diversification is a little more complicated.
Many understand the term to mean holding a variety of stocks, perhaps in one hot sector. But, as investors discovered during the 2001 Tech Wreck, this isn’t sufficient diversification. Invesco QQQ QQQ-Q, an exchange-traded fund tracking the top 100 stocks of the tech-heavy Nasdaq, dropped almost 83 per cent from peak to trough from March, 2000, through October, 2002. Over the same period, the broader S&P 500 index dropped “only” 49 per cent.
Canadian ETFs: The year opens with more monthly income funds
Today, many investors continue to pile into the Magnificent Seven stocks (Apple, Microsoft, Alphabet, Amazon, Meta, Nvidia, Tesla). These stocks, most of which are tech plays, have grown from about 13 per cent of the S&P 500 in 2016 to about 36 per cent in January, 2026. Economic history would suggest that a properly diversified investor should be concerned about holding too much S&P 500 funds or ETFs, as these would not be sufficiently diversified against a tech bubble bursting.
Others have learned the sector lessons of the Tech Wreck and broadly diversified across sectors. But this also may not be diversified enough. When the impact of inflation and rate hikes caused a bear market in 2022, the S&P 500 dropped 25 per cent while the Nasdaq slid 35 per cent. Meanwhile, international indexes fared much better: Britain’s FTSE 100 fell only 7 per cent and the German DAX dropped 13 per cent (all market data between January and October, 2022). Here, long-term investors would have been well served to diversify not only across industry sectors but also across geographies.
But in a complex world of globalized trade, even that is not sufficient diversification. History suggests that diversifying across asset classes also makes sense. For instance, during the Tech Wreck discussed above, while the S&P 500 dropped 49 per cent, U.S. 10-year Treasuries returned 25 per cent as rates fell. In the 2022 bear market, those same Treasuries only dropped 13 per cent versus the S&P 500’s 25-percent-decline, demonstrating the cushioning effect of diversification.
And, of course, investment purists would still go even further. They would argue that you should diversify to include non-traditional asset classes (e.g. private equity, private credit, hedge funds, etc.), investment style (e.g. growth vs. value), and so on. Not all of this is possible or even desirable. The point, however, is this: Proper diversification seeks to have assets in your portfolios that will perform well when other assets do not.
Lessons from the past on when portfolio diversification can really pay off
Which brings us back to Mr. Carney’s conundrum. The U.S. market has been very good for Canada – as investors, as exporters, as tourists and as neighbours. No one, at least no one sensible, is interpreting Mr. Carney’s remarks as suggesting a wholesale exit from the U.S. That would be akin to suggesting investors dump every last share of tech stocks in their portfolio. Both actions are equally imprudent. However, just as a properly diversified portfolio requires reducing concentration risk in any one stock, geography, or asset class, a middle-power trading nation like Canada requires a more robust perspective about concentration risk.
Many formerly successful investors, who profited from favourable tailwinds, got caught out by lack of diversification when the tide suddenly went out. U.S. fund manager Bill Miller beat the S&P 500 for 15 straight years from 1991 to 2005, then badly underperformed during 2006–08 and ultimately gave up management of his flagship fund in 2012 after years of redemptions. Cathie Wood of Ark Invest saw her funds soar as much as 500 per cent in 2020–21 on speculative tailwinds in EVs, genomics, and crypto only to vastly underperform the Nasdaq in 2022, erasing gains and prompting massive redemptions.
In these interesting and uncertain times, investors would do well to remember two famous maxims. As Nobel laureate John Maynard Keynes astutely pointed out: “The market can stay irrational longer than you can stay solvent.” In such a world, the advice of famous investor Sir John Templeton rings true: “Diversify. In stocks and bonds, as in much else, there is safety in numbers.”