The TSX Composite Index has dipped 9.1% since September 15. The TSX Index keeps falling, vanishing its 12 months of gains. Is this dip temporary or has the recession arrived? In either case, what should investors do?
Why does the TSX Index keep falling?
The TSX Index began descending in March 2022 as the central bank increased its interest rate from 0.25% to 5% to control inflation. The market kept falling every two months by 4-5% after recovering slightly due to concerns about rising interest rates. This aggressive rate hike inverted the yield curve, which means short-term bonds offered higher yields than long-term bonds. But the long-term bond yield has also surged to 5%, hinting that high-interest rates are here to stay.
High borrowing costs have been pinching most mortgage holders. Some withdrew their savings or took out a loan for daily essentials as their mortgage comprised a bigger share of their income. Not just individuals, companies are also burdened with rising interest expenses at a time when sales are slow.
All these rate hikes have lowered inflation, although not to the target level of 2%, at the cost of contraction of real GDP by 0.6% in the second quarter. Another contraction is expected in the third quarter as well, meeting the definition of a recession (two consecutive quarters of contraction).
If third-quarter GDP figures show a contraction, it could trigger a sell-off. The TSX is more about investor sentiment than fundamentals in the short term. I won’t be too optimistic about a market recovery anytime soon, as any recovery may not be sustainable in a high-interest environment.
What should investors do when the TSX falls?
The current state of the TSX is nothing to be worried about. Instead, it is an opportune time to invest in stocks with a long-term perspective. As the market keeps falling, it is better to invest small amounts on every dip and take advantage of dollar cost averaging.
No one can tell when the market will bottom out. So why not keep adding to your investments on every dip? But where should you invest?
Gold stocks
In a weak economy, gold tends to outperform. Barrick Gold (TSX: ABX) stock jumped 16.7% in October when the TSX fell almost 5%. While you missed the September dip, you can buy this stock now, as it is likely to rally sharply if the GDP numbers come out negative. This negative correlation between equity and gold comes because it is the only precious metal held as reserves by central banks worldwide and can be used as an alternative to any paper currency.
When investors’ confidence in fiat currency weakens, investors rush to buy gold as a safe haven. Now is the time to buy gold stocks before a recession takes place. When other investors participate in the gold rush, you can exit at a gain.
The technology ETF
While gold can hedge against the market downturn by moving in the opposite direction, a sector ETF can help you participate in the recovery. If you invest in one stock, the chances of it falling are high. But with the iShares S&P/TSX Capped Information Technology Index ETF (TSX: XIT), you can have exposure to the price momentum of 26 tech stocks.
I would call buying the XIT ETF equivalent to buying four successful tech stocks, Constellation Software, CGI, Shopify, and OpenText for less than $41 a unit. The XIT ETF invests almost 80% of its assets in these four stocks, which makes it price sensitive to these stocks.
Tech stocks are growth stocks relying heavily on capital appreciation, which makes them grow in a strong economy. Instead of buying a tech stock, you can buy an ETF. While the ETF carries a 0.6% management expense ratio, it can give you higher returns during a recovery phase.
Now is the time to buy fundamentally strong stocks instead of sitting on the cash.
