With the TSX down 8.5% for the year, and Canada recently entering into a recession (judged by two consecutive quarters of negative GDP growth) investors may be wondering, is it time to change investing strategies, perhaps to something more defensive?
The answer depends on your current strategy. For the most part, changing investing strategies in response to market conditions is a bad idea, because it involves timing the market, or trying to predict what the markets next move will be. This has almost always been a losing strategy over time.
A better idea is to have a properly diversified portfolio for all market conditions, and this means the only reason you should change your strategy is if your portfolio is currently not diversified. If you are a Canadian, this may be an issue because the TSX itself is very poorly diversified—70% of the TSX is concentrated in the energy, financials, and materials sectors. This is compared with 27% of the American S&P 500 Index for those three sectors, and 30% of the global market.
If you want to better diversify your portfolio to prepare for a slowdown, here are some simple steps to take.
- Reduce energy exposure
While Canada is technically in a recession, the fact is that this recession is mainly caused by and limited to the energy sector. The recent declines in the economy were largely the result of a 12% fall in business investments in the first quarter, and a 17% decline in business investments during the second quarter. These declines were mainly due to the energy sector cutting back capital expenditures.
The rest of the Canadian economy is actually performing well; consumer spending, jobs, hours worked, and housing are all performing well. While oil prices have performed badly for 2015 so far, the outlook for oil prices going forward is also likely to be weak. Growing supply kept high by improving technology coupled with declining global growth will keep a lid on prices.
Currently the TSX is about 25% weighted towards energy compared with only 7.3% for the S&P 500. With all this in mind, reducing energy exposure is a good idea. Reducing exposure to names like Canadian Oil Sands Ltd. (TSX:COS) that are 100% pure-play oil companies is wise, as these companies are most affected by changes in the price of oil. Keeping integrated, dividend-paying names like Suncor Energy Inc. (TSX:SU)(NYSE:SU) with stable dividends is a low-risk approach.
- Reduce exposure to other commodity names
The TSX is also overexposed to the materials sector, with 9.5% compared with 2.9% for the S&P 500. In the current low-growth environment, many of these commodity-focused stocks will do poorly, and the outlook for many of them is weak going forward, especially for producers of commodities like copper and coal.
For the past decade, the largest buyer of these resources has been China, which saw double-digit growth rates as its economy invested heavily in infrastructure and manufacturing for exports. Unfortunately, China’s economy is now slowing—likely permanently—as the economy reduces investments and transforms into a lower-growth consumer-spending economy.
With China’s GDP falling from the double digits to an expected 5% by 2020, commodity prices will likely remain weak. Canadians who have too much exposure to materials names like Teck Resources Ltd. (TSX:TCK.B)(NYSE:TCK) should consider reducing exposure.
- Add healthcare, consumer discretionary, and technology names
Going forward with weakness in the energy and materials sectors, investors can still find growth in the technology, consumer products, and healthcare sectors. While these sectors only comprise about 16% of the TSX, they comprise almost 50% of the U.S. S&P 500 index.
Adding exposure to these sectors is not only a key part of a diversified portfolio, but it can also align your portfolio to areas of the economy that are growing. In this regard, Valeant Pharmaceuticals Intl Inc. (TSX:VRX)(NYSE:VRX) is an excellent way to gain exposure to double-digit earnings growth over the coming years and solid business diversification.
