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Despite geopolitical conflicts and stubbornly high inflation, stock market indexes have hit new records and the price of other assets, such as gold and bitcoin, are trading at multi-year highs.
While the rally since the bear market of 2022 has been strong, some investors worry the market is ignoring headwinds including high valuations, elevated interest rates and political uncertainty. So, the question now is whether advisors should be concerned about a market downturn – and what to do about it.
“I remain worried about valuations around the world, but in North America in particular,” says John De Goey, portfolio manager at Designed Securities Ltd. in Toronto.
He notes that although the S&P 500 index has been averaging an annual return of about 14 per cent for the past 14 years, it’s considered prudent to plan for a total return of half that.
“In other words, markets could be flat for the next 14 years and it wouldn’t be particularly surprising,” he says. “I worry others are not worried. I worry about optimism bias, investor hubris and complacency. If we experienced a lost decade and a half, I’m pretty sure most people would be shocked and, after the fact, would say something like, ‘Who could have possibly seen this coming?’”
In addition to valuations, Mr. De Goey points to the possibility of wars in Gaza and Ukraine spreading, causing further geopolitical instability, supply chain blockages and inflation. He also cites runaway U.S. debt levels and the risk that climate change may cause more infrastructure loss and insurance claims.
To protect against a possible market downturn, Mr. De Goey is recommending investors increase exposure to alternative assets, structured investment products that are inversely linked to primary markets, and shares of gold-producing companies.
“I’m looking for things that generate equities-like expected returns while avoiding equity markets, and with low correlations and volatility,” he says.
Mike Vinokur, portfolio manager and wealth advisor with MV Wealth Partners at iA Private Wealth Inc. in Toronto, says the market “always climbs a wall of worry.”
“However, at this point,” he says, “I think market participants have been throwing caution to the wind.”
He points to the runaway performance of chipmaker Nvidia Corp. NVDA-Q and the return of so-called “meme stock” speculation as indications of a “last euphoric gasp” before a correction takes hold. He also highlights other negative factors such as budget deficits, a slowdown in consumer spending, geopolitical conflicts, high interest rates, and the failure of central banks to bring inflation comfortably within targets.
Mr. Vinokur says the market is overbought and, from a technical perspective, in need of a correction. He says it’s possible the U.S. technology stocks that have been leading the way may “go nowhere for a while” as cash on the sidelines comes into other sectors of the market that are much cheaper.
To prepare for a possible market downturn, Mr. Vinokur’s firm has been raising cash and building a list of stocks they would like to own should they come down to an attractive price.
One stock he advises adding to a watchlist is Rogers Communications Inc. RCI-B-T, praising the company’s business execution, inexpensive valuation and progress integrating Shaw Communications and extracting expected cost synergies out of the combined business.
A U.S. stock he favours is FedEx Corp. FDX-N, which he says is well-managed with a large share buyback in place. Furthermore, the company stands to benefit from trends such as “re-shoring,” which should help increase delivery demand for packages within North America.
Some investment professionals aren’t forecasting a correction but see little immediate upside for stocks.
Emily Davies, president of Linde Equity in Vancouver, says that with moderate growth expectations, already low unemployment and modest interest rate reductions anticipated, there appear to be limited catalysts to drive the North American markets considerably higher from here.
Political risks as the U.S. election approaches may also cause market participants to seek safety in case there’s an uncertain outcome or civil disruption around the results, she says.
Furthermore, inflation remains a significant risk, Ms. Davies says.
“A resurgence of inflation could cause a rise in interest rates instead of the decline most are anticipating,” she notes. “That would be a shock, particularly in Canada where there is a large cohort of mortgage renewals coming up that are counting on declining rates.”
The Bank of Canada (BoC) lowered its policy rate on June 5 to 4.75 per cent from 5 per cent, and is expected to announce additional cuts. BoC governor Tiff Macklem Macklem said more relief is likely coming, although he warned that the path down for rates could be gradual.
Ms. Davies says it’s prudent to be prepared for a downturn by owning some defensive stocks expected to hold up better than the market during a selloff. She favours Canadian pipelines, noting their strong performance during the 2008 global financial crisis.
“Canadian pipelines benefit from stable and predictable cash flows and inelastic demand,” she says. “Even during a recession, the need for energy transportation remains.”
Her firm holds positions in Enbridge Inc. ENB-T, TC Energy Corp. TRP-T and Pembina Pipeline Corp. PPL-T, with TC Energy the favourite thanks to its dividend yield of more than 7 per cent, modest price-to-earnings multiple, and exposure to the booming artificial intelligence sector through demand for natural gas to fuel data centres.
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Editor’s note: This article has been updated to clarify how Mike Vinokur's firm manages client accounts.
