People are worried about the stock market. We can tell because we get phone calls. This happens pretty much every time the markets hit new heights, and I guess it’s not surprising. After all, we are by definition in uncharted waters, and who knows what might happen next? Certainly the news media are doing their best to fan the flames of anxiety, with headlines and stories prophesizing doom, or at least discomfort. We don’t know what is going to happen next, and nobody else does either. However, our views of the market are based on fundamental analysis of what is happening in the economy and the companies that make up the index, and we get considerable comfort from the following:
While the TSX index is at a record high, so too is the Canadian population, household wealth, personal income and GDP. Since the last market high in June, 2008, Canadian GDP has increased by about 18%. If the TSX index was keeping up with growth in the economy, it would be at 17,700 instead of 15,000. It is natural for stock markets to rise over time as economies and companies grow. By definition, they will set new highs as they rise. This is good news, not bad. If stocks did not rise over time, people would not be very interested in buying them.
It took six full years, to the very day, for the TSX to claw its way back to where it was in June, 2008. This means that an investor in the entire market (through an index fund, for example) had no capital growth at all in six years. (Our clients, of course, did much better than this, as our portfolios do not mirror the index). This is highly unusual. In fact, it is impossible to find a worse six year period in the past fifty-eight years. To say that the market hit a new high is only to say that long suffering investors finally recovered to where they were six years earlier. Bear in mind that in the period from 1958 to 2008, fifty years, the TSX gained 6.8% per year on average. Had that happened between 2008 and 2014, the TSX would be over 22,000 by now.
Stocks have gone up because the only real investment alternative, bonds, are so unrewarding. Investors in ten year Canada bonds are being paid less than 2.5% per year. Compare that to the long term average bond yield of over 7%. After taxes and inflation, bond investors are lucky to break even. In contrast, many high quality stocks including banks, telecommunications firms, utilities and real estate companies pay dividends that are higher than long bond yields. In fact, the spread between blue chip stock yields and long bond yields has not been this high in the entire post-war period. The stock market has been going up because money must go somewhere, and equities are much more attractive than fixed income.
Finally, the TSX is at a record high because the profits of the companies included in the index are at a record high. We buy stocks to participate in the profits that companies earn. If the profits go up, we expect the shares of that company to rise as well. The price to earnings ratio of the TSX Index is very much in line with historic norms.
An old expression says that stock markets climb a wall of worry. In other words, every time new highs are being set, some investors are concerned that it is too far, too fast. This time is no different. While no one can know what world event or catastrophe might shake the markets, the available evidence suggests that there is really not too much to worry about.