The Canadian stock market has delivered exceptional returns in recent years. Using iShares S&P/TSX 60 Index ETF (TSX: XIU) as a benchmark, including reinvested distributions, the market has returned about 136% since 2023, equating to annualized total returns of roughly 27%. By comparison, the Canadian stock market has returned approximately 367% over the past decade, representing a compound annual growth rate of about 16.7%.
Valuations have obviously gone up. According to World PE Ratio, the Canadian stock market, using iShares MSCI Canada ETF (NYSEMKT: EWC) as a benchmark, trades at a price-to-earnings (P/E) ratio of about 21.2, compared with rolling five-year and 10-year averages of roughly 16.2 and 15.4, respectively. That suggests the market is trading at a premium of more than 30% relative to its historical averages. While elevated valuations alone do not signal an imminent correction, they do imply that investors should be increasingly selective and disciplined.
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Maintain diversification and re-balance regularly
One of the best ways to keep investing wisely during a strong bull market is to stay diversified. Rather than allowing recent winners to dominate your portfolio, maintain appropriate position sizes across both sectors and individual holdings. For example, you might target a long-term portfolio of about 20 stocks, with no sector representing more than 25% of the portfolio and no individual stock exceeding 5%.
Reviewing your portfolio annually can help identify positions that have grown beyond your target allocation. Rebalancing by trimming oversized holdings not only preserves diversification but also reduces the risk that a single investment will have an outsized impact if market sentiment changes.
Don’t ignore valuations
After an extended rally, it can be sensible to gradually take profits from positions that have become significantly overvalued. Maintaining an appropriate mix of stocks, fixed-income investments, and cash provides flexibility and helps manage risk. As market valuations become more stretched, some investors may choose to hold a larger cash allocation, providing dry powder to deploy during future market pullbacks, even though no one can predict when they will occur.
Canadian bank stocks offer a timely example. Led by Bank of Montreal (TSX: BMO), which has gained about 44% year to date, the Big Six Canadian banks have averaged gains of roughly 34%. Their valuations have climbed to levels not seen in at least two decades, supported by optimistic expectations for earnings growth.
While these companies remain high-quality businesses, much of that optimism may already be reflected in their share prices. If Canadian bank stocks now represent an outsized portion of your portfolio, trimming positions to your target allocation could be a prudent way to manage risk without abandoning long-term ownership.
Put idle cash to work thoughtfully
Deploy new capital carefully by focusing on business quality, reasonable valuations, and long-term growth prospects rather than simply chasing momentum. If you are holding a sizable cash position — perhaps around 30% — consider keeping part of it in a high-interest savings account for liquidity, while investing another portion in laddered guaranteed investment certificates (GICs). This approach can generate attractive interest income while preserving capital and ensuring funds become available at regular intervals for future investment opportunities.
Investor takeaway
A rising TSX can tempt investors to become complacent, but disciplined investing matters even more when markets appear expensive. By maintaining diversification, rebalancing oversized positions, respecting valuations, and putting excess cash to work strategically, you can continue building long-term wealth while being prepared for whatever the market does next.
