For years now, investor portfolios in Canada have been taking an undue amount of punishment from the oil and gas sector. So much so, that you’d figure it would grow tired of inflicting all that damage and start being nice again in 2018. Guess again. Canada’s stock market is being a real dog again this year and energy stocks are leading the way down.
In the last 10 years, the energy subindex on the S&P/TSX Composite has dropped by more than a third, acting as a major headwind on the broader market. The TSX has gained only 14% in that same period, compared to an advance of 101% for the S&P 500 in the U.S.
Think about it; if you were unlucky enough to buy into the stock market at the peak in 2008, just before the financial crisis hit full force, your gains (excluding dividends) wouldn’t buy you much more than two loaves of price-fixed bread at Loblaws and a bag of President’s Choice sour grapes. If that was your nest egg and you need to start pulling the money out today to fund your retirement, that has got to hurt.
Here is the TSX in the last 10 years.
And here is what it looks like so far in 2018.
The good news is all those declines in energy shares means the sector isn’t throwing as much weight around on the index these days. Four years ago, the TSX was weighted 27% to energy. Today it’s dropped a few weight classes to about 18.5%, which means it should be punching lighter.
The bad news is, like a declining prize fighter, energy is still punching hard enough to hurt. And that’s pretty clear message to investors that too much of a volatile sector like oil and gas is not a great idea for your investment portfolio. Last year, energy dropped 10% to restrain the TSX to a meagre 6% advance (vs a gain of 19.4% for the S&P 500). So far this year, energy is the worst performing sector in Canada, helping to drag the broader market into a 5.3% slide.
With that kind of dim performance, Canada’s market is not only bad; it’s the absolute worst performing market in the world. Okay, we’re leaving Venezuela off the list, but among the 106 global markets tracked by Bloomberg, we are number 105. (The energy market is also devastating the Venezuelan market but that country’s crisis is a much more complex story, with inflation expected to hit 13,000% this year while unemployment climbs to 30%.)
Here in Canada, the economy is strong and pretty good when it comes to diversification, too. Not so the Canadian stock market, which is why we are all acutely feeling the painful effects of a bear market in energy and why this would be a great time to think about whether you’re getting enough diversification from your holdings.
In recent years, just three of the TSX’s 10 main sector groups—financials, energy and mining—managed to account for more than three-quarters of the TSX’s value. Today that concentration is down to two-thirds, which is still high. It’s not what’s in the TSX that’s the real problem; it’s what’s missing and would bring it some balance. In an age when technology is driving economic change and innovation at an accelerating pace, investors aren’t getting a piece of it; the TSX’s exposure to tech is just over 3.5%. We have no Nortel (OK, that one left a bad taste but was good for a long time), no Facebook, no Google, no Amazon, no Netflix, no Salesforce, no Nvidia, no Apple. Not even a boring, old Microsoft or IBM.
We do have Shopify and it’s on a major run, and happens to be the top performer in 2018 with a 40% gain. But there isn’t much else going on, except Constellation Software and most Canadians have never heard of it even though its shares are trading above $800. If the infotech subindex had a weighting of 20%, it’s safe to assume the TSX would be much more resilient and cushioned from energy’s ups and, mostly, downs.
Your MoneySense editors would love to find the tech companies of tomorrow, take them public and set them on a course to bulk up and diversify the TSX, but no one has asked us. Instead, we’ll just offer sensible advice, which is to make sure you have some exposure to tech in your portfolio and that means going outside Canada. We love exchange-traded funds and there are many to choose from with a good mix of leading U.S. names. You shouldn’t have all your money in the Canadian market anyway, so this is a good way to diversify by geography as well as by sector.
As for oil, conditions could improve or get worse. We aren’t going to guess. Right now, Canadian crude is trading at a deep discount to a barrel of West Texas Intermediate, so that’s part of the problem. We are big believers in putting most of your money to work in low-fee, diversified ETFs and leaving it to work, rather than trying to time the market. But we will say that bear and bull cycles balance out over time. And all you have to do is look at the 20-year picture to see that energy’s gains have outpaced the broader TSX’s by 50%.
All of which is a reminder to seek out diversification but don’t necessarily do it by selling off energy stocks. Just add some tech. And it’s worth noting for contrarians: the last time energy’s TSX weighting declined to its current level (in 2015), it went on to almost triple the broader market’s gains the following year.
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