New investors are in a tough spot: you need to build a portfolio while stock indexes are setting records. But there are ways to find value in the market and build a correction-proof portfolio, too.
Breathe easy, says Ryan Lewenza, private client strategist for Canada at Raymond James.
“Just because the market is up big, doesn’t mean the top is imminent,” he says.
His analysis says the market is five years into a long-term bull cycle that could go on for another decade. So far, companies’ rising price-to-earning ratios have driven the market. He points out that in 2009, companies in the S&P 500 had an average price-to-earnings ratio of 10. Now it’s 17.5.
Now, economic growth is picking up, which will fuel company earnings.
Where to be cautious
If you don’t want to invest in equities, there are few alternatives that provide significant return on investment, he adds. Bonds yields are low, and other investments may be either unrealistic, or still tied to traditional asset classes.
North American commercial Real Estate Investment Trusts (REITs), for instance, can lose value when interest rates go up, says Michael Sprung, President and CIO of Sprung Investment Management. When interest rates increase, investors expect a higher return on their properties. Higher cap rates push property values down. Interest rates are expected to rise in the next year, so these investments would lose value.
Barry Schwartz, CIO and portfolio manager at Baskin Financial, says mortgage funds are less volatile than equities because their returns are based on regular rent payments. But private funds come with fixed ownership periods, possibly locking you in during a correction. They’re also only available to accredited investors. Publicly-traded funds don’t have such restrictions, but like all other equities, they’re exposed to market volatility, so they aren’t a safer investment choice.
Wealthy investors could turn to private equity, but that’s not practical for those with less capital, says Lewenza. Instead, he recommends you get private equity exposure by buying the companies brokering deals, like Onyx Corporation or Brookfield Asset Management.
Most investors don’t have the capital to go outside of the stock market. And right now, they must be selective to find equities with potential.
Where to invest
Sprung and other experts say there are still sectors and stocks worthy of a new investor’s portfolio. For instance, as the bull market enters its economically driven phase, investors should turn to high-quality companies, says Lewenza. During the first part of the recovery, low-quality stocks can outperform, he says, because they often have the most ground to recover after a recession. “Later into the business cycle, you’ve really got to focus on high-quality stocks.
The advisors say Canadian banks continue to be a sound investment. They’re “trading at a price-to-earnings ratio of about 13 times,” says Lewenza. “That’s a 20% discount to the overall market, considering the TSX is trading around 16.5 times.”
The banks often pay dividends, notes Lewenza. “If the stock market were to decline, TD Bank and Royal Bank are still going to be paying a dividend of 3.8% or 4.8%, and they’re going to be growing their dividends,” he says.
Swartz agrees dividend-paying stocks are a good bet. But he cautions that in some cases, money could have been better used by management. “We’ll also look for companies that use that capital in other places, such as mergers and acquisitions, paying down debts, or buying back stock.”
Returns for life insurance companies have lagged behind banks, and those companies could soon see a boost, say Lewenza and Sprung. The fortunes of those companies are tied to interest rates and bond yields. When rates rise, so should returns.
If you have a long time horizon, Sprung suggests the materials sector. He cautions it can be volatile, but prices are lower than usual because of lower demand in China, North America and Europe.
In the long term, once worldwide growth picks up, demand for materials should pick up too, as construction and manufacturing increase. Economists say this could be months or years away. In fact, TD Economics is calling for many materials prices, including those of metals, coal and some grains, to drop further in 2015.
The market has long-term security projected and if you’re a long-term investor, even if there’s a brief slump, you’ll be okay as long as you hold on.
“Even if [you] invested today and there was a 15% pull back in the next year or two, over the next 10 years you’re still going to do well in stocks, given [the] long-term bull market,” Lewenza says.
Investing in dividend-paying stocks will also help cushion portfolios in a downturn, provided companies can keep paying out in difficult times, notes Sprung. “You’re going to have some correction in the capital portion of your portfolio, but you’re still going to be paid those dividends going forward. You can afford to wait through the period until the markets correct again.”
Cautious investors could also invest their principal in batches, Lewenza says, by buying into the market a chunk at a time.
Now is also a good time to choose low volatility stocks. While low-volatility stocks aren’t immune to price swings, “if the stock market goes down, they’ll go down much less.”
“We don’t say go out and buy the whole market,” he says. “We say buy these specific areas of the market at current conditions.”