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Finding bright spots in a cloudy investment market

There may be ways to avoid the downside of volatility. 

Compared to the record-setting levels that some stock markets rose to during the pandemic, much of 2022 has exposed the average investor to the downside of market volatility. Economic challenges, spearheaded by rapid inflation and rising interest rates, are generating indecisiveness among investors with respect to a range of investment options. 

While some economic fundamentals, including active consumer demand and spending, as well as robust employment figures, wage growth and sales, continue to underscore a resilient economy, market levels six to 12 months from now are difficult to estimate. There’s no instruction manual or crystal ball to help you know for sure, but in an otherwise uncertain investing environment, there are some bright spots to be aware of. 

High-quality dividends

During times of uncertainty and inflationary pressure, it can pay to invest in companies that have prospered through thick and thin, thanks to their market share and influence. For instance, large-market-capitalization (large-cap) companies with a desired product in the retail space can offset the higher cost of goods by simply raising prices for consumers, helping to protect their bottom line.

Regardless of their size, companies that have consistently delivered their dividend payments over time are generally looked upon as solid, income-generating investments. The biggest Canadian banks’ record of successfully paying regular dividends is a good example. And while the money shareholders receive in dividends can be used for any purpose, reinvesting the funds by purchasing more shares in the company provides an ongoing return on investment. 

In addition to individual stocks, a broad selection of exchange-traded funds (ETFs) focuses entirely on companies that continually pay growing dividends, across multiple sectors and industries that represent value for investors. The great advantage of ETFs is their ability to combine many – even hundreds of – different stocks in a single fund.

Economic engines

Canada has some economic muscle that makes investing within its borders attractive. The Toronto Stock Exchange, the country’s biggest stock market, features three main sectors that are considered the bedrock of the Canadian economy: financials, materials and energy. These sectors tend to have strong pricing power and may have some inflation protection built in, although they remain vulnerable to changing economic conditions. Market growth within any sector of the economy, including these economic engines, is highly dependent on continued demand for its products and services.   

Consider, however, that at mid-year, markets had slid from their lofty highs in 2021. The S&P 500 Index was down 20 per cent, the NASDAQ almost 30 per cent and the Dow Jones Industrial Average 15 per cent. Bitcoin, the popular cryptocurrency that skyrocketed in value in 2021, dropped nearly 60 per cent from its peak. Meanwhile, energy sector values, for example, were galloping towards a 30 per cent increase.[1] Even in periods of widespread devaluation, and despite indications of an oncoming recession, some sectors can retain their profitable momentum.

Canada’s oil and gas industry is a major economic contributor, job creator and essential supplier to a chain of global industries and foreign markets. And although alternative sources of energy are playing an increasing role in our economy, business is good for Canadian fuel companies these days. The per-barrel price of Western Canada Select oil surged nearly 30 per cent from August 2021 to August 2022.[2] And while any number of factors can impact market-based prices, the oil and gas sector remains closely connected to the overall strength and resilience of the Canadian economy. 

Foreign and domestic    

Although it’s been nearly 40 years since Canada’s rate of inflation has risen so high in such a short time, through 2022, Canadian stocks have outperformed some foreign markets. However, even during worrisome times, foreign markets still offer opportunities, especially when you consider they represent more than 97 per cent of global equity market capitalization.[3] Most financial experts agree that holding a healthy portion of your investments outside the Canadian market is a wise tactic for diversifying your portfolio for potential growth.

U.S. equities play a huge role in the global economy. At the beginning of 2022, U.S.-based stock markets accounted for nearly 60 per cent of the world’s total equity market value.[4] Investing in U.S. equities can also broaden a portfolio’s exposure beyond the U.S. market, since many multinational companies are headquartered in the United States and are therefore listed on American exchanges. Companies operating globally have an advantage, since they can benefit from local, regional and national growth wherever they do business around the world. 

Avoiding weak valuation

Not so long ago, opportunistic investors were driving the value of some technology stocks and “meme” stocks to astonishing values based purely on rumours and speculation. But the market optimism that sent those stocks “to the moon” has cooled, resulting in those stock prices coming back down to Earth as economic uncertainty increases. The issue is valuation. Without being able to show legitimate earnings and profitable forecasts to support the valuation of their stock, companies will have difficulty supporting a high stock price. 

Today, investors must look “under the hood” for proof of that ability. Companies that produce strong and stable earnings, are well capitalized and pay a dividend are likely to be more attractive to investors in the current environment. With rising interest rates, companies that rely heavily on borrowing money to grow may have a harder time. Just like a homeowner renewing a mortgage at a higher interest rate, a company that needs loans will have to figure out how to handle higher payments.

What about fixed income?   

Fixed income investing is generally a conservative strategy that generates returns from low-risk securities that pay predictable interest. Since the risk is lower, the interest coupon payments are also usually lower. Government and corporate bonds are the most common types of fixed income products accessible to the average investor. Consider watching this short video: What is a bond?

Since the Bank of Canada began raising interest rates to help curb inflation, lower-yielding fixed income investments (typically government and investment grade corporate bonds) have faced some challenges. Interest rate increases affect almost every type of debt. Banks charge higher repayments on their customers’ loans, lines of credit and mortgages. The problem facing the fixed income investor is not so much that interest rates are rising, but that they are rising quickly. For some investors, the thought of buying bonds today may not be overly attractive given the potential for even higher rates in the future. The good news is that when rate hikes slow down, newly issued debt should offer a more attractive yield for conservative investors.

Cashing in

During a market downturn, some investors may be tempted to pull money out of investments and set the cash aside with the hope of maintaining some gains through simple compounded interest before re-entering the market on an upswing. This move may be misguided for two key reasons: it’s impossible to accurately predict market behaviour, and inflation causes idle money to lose its value. Any interest gained on your cash savings would still be well below Canada’s rate of inflation, which has been parked above seven per cent since May 2022,[5] thus costing you money. Staying invested in market-driven funds and assets will test your resolve some days, but you will want to be positioned to take advantage of a market recovery when it occurs. 

Time horizon

Regardless of which type of investments you choose to achieve your goals, the most important factor to consider is the amount of time you have to achieve them. Just about any investment in a good company or fund has a chance of increasing in value the longer you own it. Long-term planning is what can help turn modest holdings into a potential windfall farther down the road. 

With time on your side, consider taking a systematic approach to moving forward with the markets. Applying a systematic approach means investing continually regardless of what’s happening in the markets at any given time. Regular, consistent purchases let you benefit from buying more units when prices are low and fewer when prices are high – a concept known as dollar cost averaging. It takes much of the emotional guesswork out of investing, takes advantage of slow or negative market activity, and positions your investments to thrive when markets rally. 

Trusted advice

Achieving your long-term financial goals takes patience and persistence – but knowing which investments will help you succeed, especially during times of volatility, requires sound, knowledgeable advice. There is tremendous value in seeking the guidance of a trusted advisor who not only has the experience to navigate the continuous changes within the markets but does so with your best interests at heart.

[1] www.cioninvestments.com/insights/q3-2022-outlook-an-investors-guide-to-making-bad-decisions/ 

[2] https://economicdashboard.alberta.ca/oilprice 

[3] www.statista.com/statistics/710680/global-stock-markets-by-country/ 

[4] www.statista.com/statistics/710680/global-stock-markets-by-country/ 

[5] www.tradingeconomics.com/canada/inflation-cpi

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