A screen shows trading of the S&P 500 Index at the New York Stock Exchange. If stock-market history is clear about anything, it is that booms don’t last, Ian McGugan writes.Jeenah Moon/Reuters
Congratulations! Chances are you have just enjoyed a highly profitable few years. If you own Canadian or U.S. stocks, you are nearly certain to be sitting on big gains.
The question now is how to keep those gains.
If stock-market history is clear about anything, it is that booms don’t last. The go-go stock craze of the 1960s gave way to the dismal, inflationary 1970s. The dot-com frenzy of the 1990s was followed by the market crash of the early 2000s, then a global financial crisis in 2008.
Nobody knows when today’s boom will sputter out, but lofty stock valuations and wild trading swings in semiconductor stocks and other AI-related areas suggest we are nearing the end game for this bull market.
To be sure, stocks are still performing well. Both Canada’s S&P/TSX Composite Index and the U.S.-based S&P 500 Index surged to record highs this week.
But investors should remember the big picture. The market’s returns over the past five years have been historically unusual.
The S&P 500 has produced a total return of about 16 per cent a year since 2021 in Canadian-dollar terms. The TSX has also delivered outstanding results, churning out more than 15 per cent a year. Both indexes have doubled investors’ money in five years.
The recent results rank in the top third of all five-year periods since 1960, and they stand out even more when you consider that this was not a case of stocks rebounding from a brutal bear market. Shares were already rather pricey back in 2021.
Today, after five years of big gains, stocks are even pricier. Measured against underlying sales or long-term earnings or dividends, share prices are now at some of their most expensive valuations on record.
Granted, today’s lofty stock prices don’t look quite so outrageous when stacked up against forecasts for sky-high corporate earnings over the next year or two. But those happy forecasts rest on two key assumptions – that tech companies will continue to pour trillions of dollars into artificial-intelligence projects and that AI will soon begin to produce a gusher of profits to pay back all that spending. Those are rather large assumptions.
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If investors’ key premises don’t pan out, there will be a reckoning. The folks at Capital Economics expect the S&P 500 to rise from its current level around 7,700 and hit 8,250 by the end of the year – but they then expect the AI bubble to pop. The result will be a “major downturn” over the subsequent 12 months, they predict.
What should investors do to protect themselves against this possibility?
Start by gauging how vulnerable you are to falling stock prices. Stocks typically lose 20 to 35 per cent of their value in a bear market.
Yes, they tend to bounce back over the course of the next few years, but if it would devastate you to see a third of your portfolio suddenly go up in smoke – even if it’s just temporary smoke – you might want to dial back on risk.
This is especially true if you’re in or near retirement, and you’re counting on tapping your portfolio for living expenses. If so, you should consider what would happen if stocks tumbled and you were forced to sell some of them, at bargain-basement prices, to finance your immediate needs. The result might be a permanent dent in your portfolio.
To prevent that, it might be wise to build a cushion of cash or bonds to help carry you through any rough patch to come.
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Even if you’re not near retirement, you might want to consider tilting your portfolio away from the AI frenzy. In a recent note, Goldman Sachs pointed out the growing risks and the case for rebalancing your portfolio toward more sedate sectors.
Goldman suggested investors should look to real assets such as “infrastructure, prime real estate, energy, or gold.” It also suggested diversifying into dividend stocks and value stocks as well as putting some of your money into foreign markets that are less AI-obsessed than the ones in North America.
Some of us also see a case for bonds or guaranteed investment certificates. At current yields, many fixed-income options stack up well compared with dividends.
A couple of simple alternatives that might appeal to safety-seeking investors are the balanced portfolios offered by Vanguard Canada VBAL-T and iShares XBAL-T. These funds offer automatically rebalanced mixes of 60-per-cent globally diversified stocks and 40-per-cent bonds. They are low-cost, no-fuss ways of tilting toward caution.
Folks who want to stick to stocks only might want to consider the Avantis CIBC All-Equity Asset Allocation ETF CAGE-T. It’s a globally diversified portfolio of stocks selected according to a strict by-the-numbers research approach.
Finally, one old-school alternative that might appeal is shares of Berkshire Hathaway Inc. BRK-B-N
Warren Buffett is no longer running things, but his flagship is still churning out solid results. Better yet, it has amassed a huge war chest of cash to take advantage of any future market weakness.