Market outlook: current highs make stocks pricey

Conventional wisdom is, well, conventional—and often inappropriate. Sunil Vidyarthi, president of Oakville, Ont.-based Value Sciences Inc., says the wisdom of putting bonds in your RRSP is flawed. In fact stocks and equity based exchange traded funds are better candidates for your tax deferred and tax free savings accounts, given the current market outlook.

Now that you’ve filed your taxes, rearranged your RRSP and are about to sock away $41,000 in your tax free savings account, it’s time to figure our which of your assets go where.

This can be confusing, given all the advice that’s out there, much of which may be useless anyway. For example, some “experts” will urge you to keep dividend-paying stocks outside an RRSP, but interest-bearing bonds inside.

Does this, though, make sense? As I’m certain you know, bond yields now hover at historic lows. Moreover, bonds are unlikely to yield any capital gains. In fact, were you to stock your RRSP with only bonds, you could lose money if interest rates rise.

Simply put, bonds are now a terrible investment. As Bill Gross, once known as America’s bond king said recently, U.S. government bonds present the best short sale of the millennium.

Still, if interest rates do rise, the bond market outlook for corporate and high yield bonds may not be as bad as for government bonds in general. But don’t forget that high-yield bonds are often called junk bonds. And you don’t want junk in your portfolio.

Preferred shares, which are equivalent to bonds, may be more secure than junk bonds. But preferreds offer a big tax advantage when they’re held in non-registered accounts. If possible, then, keep your preferreds outside your RRSP, or other registered accounts.

Market outlook for Japan and Europe

So, now you’re left with stocks. But which types? Canadian, U.S., European, or equities in emerging markets? Unfortunately — fortunately, if you’re now long — many stock markets are at or near all-times highs.

And although both Japan and Europe are not, any Japanese or European stocks you buy could take a big hit, given current volatility of both the Yen and the Euro.

In fact, now that Japan is the world’s biggest debtor, your Japanese holdings could be thumped if Japan devalues the Yen.

The only way to invest in Japan, Europe and in emerging markets is to buy exchange traded funds hedged to the loonie.

For Japanese stocks, the iShares Japan Fundamental Index Canadian Hedged (TSX─CJP) will do nicely; for Europe, try the Vanguard FTSE Developed Europe Index (TSX─VE).

There are few ETFs covering Canadian stocks, although there are plenty south of the border. But except for funds that track energy, utilities and some regional banks, most of the U.S. ETFs now trade near record highs. And that’s scary.

High prices don’t mean the market outlook is down

So what should you do? First, don’t panic. Just because U.S. stock markets are now at a new high doesn’t mean they’re going to go down.

In fact, technical analysts and certain growth managers only buy stocks when they’ve hit new highs. After all, these folks figure, there must be something good about a hot company or sector to make it so popular among investors.

Examples? Apple Inc. (NASDAQ─AAPL) in the U.S. and Valeant Pharmaceuticals Intl. Inc. (TSX─VRX) here at home.

So, don’t panic and dump your holdings just so you can find another big run-up in the market.

In the meantime, if you’ve enjoyed good gains and want to invest in growth stocks, which are now near all-time highs, there are ways to protect your gains.

Use stop loss and options to hedge your market outlook

Some investors use stop loss orders by which a conditional sell order is placed on a stock if it falls, say 10 per cent, below its current price.

You can also sell options against the stock. By doing so, you can get out of a stock at a higher price, rather than at the lower price of a sell order.

And although it may appear intimidating, selling options is actually quite easy. Let’s say you have 100 shares of Apple which recently traded around US$126. You sell one call option expiring in December at a strike price of $130. You’ll immediately take in $900.

And should the stock shoot up above $130 by December, you’ll be taken out at another gain of $400.
Of course, this strategy isn’t all peaches and cream because if the stock goes much higher than $130, you’ll be left with money on the table.

Still, you can unwind your position any time you like in case things change.

The beauty of selling an option as a hedge is that you can do this in your RRSP, although not in a TFSA.

A TFSA, by the way, is now the best registered account to have. Not only can you keep salting away $10,000 every year, you can withdraw it any time without paying taxes.

So, once again, I recommend you buck convention. To capitalize on stocks’ higher income, put them in your RRSP, RESP or TFSA. In this way, you can also profit from any capital gains.

But to balance your asset risk, keep small amounts of preferred shares and low-yield bonds in your non-registered account.


Investor’s Digest of Canada, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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