Investments for a market rebound
After the COVID-19 pandemic really accelerated throughout the world last winter, economies were hit hard in many areas and this was reflected in the performance of stock markets around the globe. Stocks fell dramatically in a short amount of time, with markets in the U.S. and Canada losing over a third of their value in a month. Some sectors like airlines and smaller companies fared even worse. Since the end of March, stocks have climbed back as economies slowly adjusted and reopened. Even though the economy remains far below where it was in February and could still falter if the virus comes back stronger, the general tendency is for the market recovery to continue, even it will be slow. Policymakers are reluctant to return to wide lockdowns unless the health crisis worsen again significantly. Though there will be periods of high volatility like we just experienced in September and October, the likelihood is that riskier investments like stocks will continue to recover and reward investors, while safer investments really won’t give much in terms of returns. Here are a few investment choices for a continued market recovery.
In most (but not all) of the following cases, I would recommend investing in index exchange-traded funds or ETFs. While you can purchase some of the underlying investments directly, it is far easier to buy them indirectly through a pooled investment vehicle, namely a mutual fund or an ETF. These also offer the convenience of professional management. However, lots of mutual funds are expensive, while also failing to match market averages or their own objectives. Therefore, it is probably better for most people to concentrate most of their investments into passive or index mutual funds or ETFs.
Stocks, which represent part ownership of companies, remain the single most important asset class for building wealth for most investors. They typically outperform most other investments over the long term, despite (or in reward for) their high short-term volatility. They should probably be your largest holding so long as you can tolerate the volatility. Vanguard, iShares, BMO and others offer a variety of choices when it comes to plain-vanilla stocks index ETFs. Any of their basic offerings could be enough to cover the major geographic areas (Canada, U.S., Developed Markets, Emerging Markets…). But they also have some variations that can offer different results or fill different needs. iShares, BMO and WealthSimple, for instance, all offer ETFs for those who want to invest in a socially responsible manner. Other potentially interesting themes for investing are dividends. Some ETFs invest in high quality companies that are likely to grow their dividends payments over time. My list of recommendations includes some suggestions in these categories.
A trickier question is the role and place of less risky investments, namely bonds or fixed income. It is often recommended to have a portion of the portfolio into safe bonds, especially developed government bonds. High quality bonds are used to produce some stability that counters stocks’ volatility and often rise when stock markets go down. They are also supposed to produce some steady income in the form of interest. However, bonds do not perform nearly as well in an environment of economic and market recovery. On top of that, government bonds now can’t produce much income as interest rates are near zero in much of the developed world. In some countries, they are even negative, meaning you are paying for the privilege of saving your own money. That is not an attractive proposition.
Instead, I would recommend venturing beyond government bonds and putting money into investment-grade corporate bonds, emerging markets bonds, and high yield bonds. Investment-grade corporate bonds, especially the best rated ones, are issued from companies with a very low probability of failing. They thus offer safety that is only just below that of government bonds, but their interest yield is also typically slightly higher than government bonds, producing a modest amount of income. High yield or “junk” bonds and emerging markets bonds are quite a bit further on the risk spectrum. High yield bonds come from compagnies or governments with a higher probability of failing than investment-grade corporate or government bonds. Emerging markets bonds are also considered riskier than most developed markets bonds. To compensate for their riskiness, they both offer substantially higher yield. Both these asset classes perform best when the economy is recovering, as the chances of these investments going bad lowers their prices go back up. Over a full economic cycle, their volatility is still lower than stocks. In sum, replacing high quality government bonds with high quality corporate bonds, junk bonds and emerging markets bonds would best take advantage of an upswing in the economy and markets while providing better much income than you would get otherwise from sticking to safety. The biggest danger to this view is that the economy takes another dive, especially if full lockdowns come back due to the pandemic. So far, governments seem unwilling to re-enact the drastic measures from last spring but the situation should be watched closely.
In the tables below, I have highlighted a handful of ETFs that represent each of these investment choices. These are only examples and there are tons of options out there, but these are, I believe, good ideas for a closer look.