A client called me earlier this week and told me that we should trim his equity allocation because his gut tells him the market is going to have a bad year. “We had such a good year in 2009, there is no way we can make money again this year”. Really? Is that a logical investment strategy?
In 2001 and 2002, the TSX dropped a combined 28%, somewhat similar to the drop experienced in 2008. In 2003, the TSX recovered 24%, somewhat similar to the rebound experienced in 2009. Had you listened to your gut in early 2004, you would have missed out on a 68% gain from 2004 to the end of 2007.
As you can see from that example, listening to you gut after having a good run on the market can be very hazardous to your portfolio. At Baskin Financial, we focus on the fundamentals to drive our investment decisions. To determine if we should overweight equities versus fixed income we take a two step process.
Step 1: Determine if the stock market is under or over valued. For 2010, we expect the TSX index to have earnings of $775-$800. If we assign a reasonable market multiple of 16 and multiply it by the average of $775-800, we get a fair value level for the TSX of 12,500. This would represent a gain of about 6% for the year before dividends.
Step 2: Determine if the equities are under or over valued compared to fixed income. For 2010, this should be a no brainer. Our favourite dividend paying stocks yield in excess of 3.5%. Or I can buy a five year government bond that pays 2.4%. Bonds look even less attractive to us since we believe interest rates will start to march higher this Fall.
2010 should be a rewarding year for investors whom overweight good quality dividend paying equities.