Often times, investors lose track of the long-term picture with equity markets. When the market is hitting new highs year after year—a bull market— there is a tendency to think a perpetually upward-moving market is the new norm. Similarly, when markets are declining month after month or year after year—a bear market—investors become pessimistic and think it will last forever.
This type of thinking explains why investors often buy prolifically even after markets continually hit new highs, and sell in a panic after markets decline 20% or 30%. Taking a long-term view reveals the folly of this sort of behavior, as there have been 12 bull and 12 bear markets since 1956, and the bull markets often last significantly longer with a higher percentage gain than the bear markets.
The result is that trying to time market cycles (trying to sell at a market high for example), often results in much poorer performance. It has been found that missing the best five weeks during a 20-year period drops the average annual return from 6.4% to 3.6%.
This underscores the importance of staying invested through all market cycles, but this doesn’t mean it is not important to be aware of market valuations, and have a portfolio allocation that maximizes upside and minimizes downside during all market conditions.
Why the current bull market is running out of steam
The current bull market began in March 2009 and the TSX has grown approximately 123% since that point. This would mean that the current bull market is approximately 74 months old, and this is a fairly significant piece of information.
Historically, the average bull market on the TSX has been about 48 months. This would mean that the current bull market is approximately 54% older than average, and while this does not mean a bear market or correction is imminent, it is reason to look twice at market valuations.
Even more concerning, however, is the fact that the longest bull market in the history of the TSX was approximately 90 months and occurred during the massive 1990’s American economic expansion, which lasted 120 months, and was the largest in American history fueled by the Dot Com bubble.
The current economic expansion, while significant, is unlikely to reach the same duration and gain as the historical 90’s expansion. This means that is unlikely that the current bull market will reach the same duration, since economic expansions and stock bull markets are correlated. While it is possible the current bull market could last another two years to become, by far, the longest in Canadian history, this seems unlikely.
In addition to this, common market valuation measures are indicating cause for concern. A popular one is known as the “Buffett Indicator,” which is a country’s market capitalization divided by GDP. This gives a measure of how expensive a market is relative to the gross domestic product. The current ratio of market cap to GDP for the TSX is 131%, which is above the historical mean of 119%.
How to prepare your portfolio
Rather than selling now and trying to time the market, it is best to have a portfolio that responds favourably during both bull and bear markets. In this regard, one of the most proven tactics is to invest in stocks with strong histories of dividend growth.
These stocks have stable cash flows, and their ability to continually grow dividends is evidence of strong, long-term earnings potential, which is, in turn, evidence of a business with an economic moat. During the 2008 recession, the U.S. Dividend Aristocrats index (which tracks companies that have increased their dividends for 25 years or more), fell 21% compared with 37% for the broader index.
These stocks also typically outperform during good times. In Canada, Enbridge Inc. (TSX:ENB)(NYSE:ENB) is one stock that fits this criteria. In addition to this, investors can also purchase units in the Vanguard U.S. Dividend Appreciation ETF. This ETF is available on the TSX, and allows Canadian investors to gain exposure to high-quality American dividend-paying corporations; there is a currency hedged version available as well to control for any currency risk.
