The market is feeling the tremors as a 2008-like recession grapples US banks. While the Fed’s accelerated rate hikes from 0.25% to 4.5% in 12 months is a major cause, panic triggered the sell-off. Do not succumb to herd mentality and sell in panic. Now is the time to think about what Warren Buffett would do. “Be greedy when others are fearful.” Choosing an individual stock could be risky. That is where passive index ETFs come in.
What to do in the current market dip?
The TSX Composite Index has fallen 5.8% in 10 days, and a deeper dip is likely as news about the collapse of three US banks surfaced in less than a week. The bear market was long overdue as rising interest rates inverted the yield curve, making long-term deposits less valuable than short-term deposits. Such an inverted yield curve signals that a recession is in the making because it changes the direction of deposits as people pull out money from long-term savings.
The dip will pull down demand and slow the inflation triggered by rising oil prices. The next 8 to 12 months could be challenging, with the stock market facing bearish momentum. Now is the time to invest in index and sector ETFs and give your portfolio diversity within the sector for a minimal management fee.
Never bet against Canada
Recessions remove inefficiencies in the market and only the fittest survive. Thus, when the market rebounds after a dip, it has a better chance of growth from the newfound efficiencies.
The S&P 500’s historical data shows that the frequency of stock market dips between 10% and 20% slowed from once a year before World War II to 13 corrections in 41 years. Also, the average length of the dip reduced, hinting at the improving market efficiencies. This trend explains why you should never bet against Canada.
The TSX 60 Index ETF
The TSX 60 Index lists the top 60 stocks trading on the TSX by market capitalization. In a recession, investors exit stocks with inflated market caps. For instance, Shopify overtook the Royal Bank of Canada to become the most valued stock by market cap in the 2021 tech bubble. But its value vanished, and so the TSX 60 index corrected in the 2022 bubble burst. The 2023 bear market could leave only the fundamentally sound companies in the index, making it a good value investment.
The Horizons S&P/TSX 60 Index ETF (TSX:HXT) tracks the TSX 60 index for a management expense ratio of 0.03%. This ratio is charged annually depending on the daily average net asset value. Like the index, this ETF has high exposure to the financials (36%), energy (17.6%), materials (11.7%), and industrials (10.2%) sectors. Each of these sectors is influenced by different factors.
For instance, energy and materials depend on commodity and oil prices and the geopolitical situation. The ETF’s strong exposure to market leaders of these sectors helped it benefit from bull prices in oil and other metals and reduce its downside risk from the tech bubble burst. HXT’s strong exposure to financials has pulled the ETF down 5.7% in March. The exposure to uncorrelated sectors diversifies the risk and generates stable long-term returns. That explains the ETF’s 53% jump from the March 2020 crash.
The Technology ETF
The market ETF gives you significant exposure to financial and energy sectors, but one sector with strong growth potential is technology. As you likely noticed, the tech sector outperformed the market in the current market crash because tech stocks corrected in 2022. They are now trading at their pre-pandemic levels. There is no denying technology is reshaping the future. A recession is when companies focus on efficiencies that come from technologies.
The iShares S&P/TSX Capped Information Technology Index ETF (TSX:XIT) has holdings in 28 tech stocks trading on the TSX. The ETF will benefit from e-commerce growth with holdings in Shopify, Descartes Systems, and Nuvei. Constellation Software and Dye and Durham are niche software platforms that will benefit as corporates improve their operating efficiencies amid the recession.
The ETF has ample scope for growth as secular trends are unaffected by the recession.
Never put all your money in one sector. Invest small amounts every month in these ETFs throughout the market bearishness and book your early seat in a recovery rally.