Market Factors: Why diversification is cool again

Every dormant trend comes back to life sooner or later. Like baggy jeans. Or diversifying your investments. This is investment reporter Tim Shufelt and today we’re talking about investors rediscovering the virtues of a well-rounded portfolio. We’ll also look back at the peak of the dot-com bubble 25 years ago and how investors have fared since, plus a few Canadian stock picks that could pop once we finally get some clarity on tariffs.

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DIVERSIFICATION

Of eggs and baskets

Just a few short months ago, the U.S. stock market was still the only game in town. It was assumed that Trump 2.0 would only strengthen the era of American exceptionalism that had dominated financial markets through the decade prior. Over that time, U.S. equities generated an incredible 15 per cent annualized rate of return, more than doubling the performance of non-U.S. stocks, which had lots of investors wondering why they needed to bother with international equities at all.

Then Trump manufactured a shock that has put a U.S. recession back on the table and has revived the spectre of inflation. Consumer confidence is tanking. Big Tech has hit a brick wall. Suddenly, there’s life outside of U.S. stocks. Let’s look a little closer at some diversifiers getting a fresh look by investors.

Non-U.S. stocks

Few expected long-ignored European stocks to be the hottest trade in 2025, but here we are. The MSCI Europe Index is up by 15 per cent since the start of the year, compared to a decline of about 3 per cent in the S&P 500. At this point, you may be thinking you missed out on the European comeback. Two points to keep in mind. First, the valuation gap has closed a bit, but not by much. European stocks are still relatively cheap at around 14 times forward earnings, compared to the U.S. multiple of around 20 times earnings.

Secondly, there has been a complete role reversal in terms of government spending. The U.S. fiscal position is weakening after years of enormous budget deficits, which, incidentally, helped prop up U.S. stocks. “A hyper-accommodative fiscal policy in the eurozone provides a margin of safety to the economy and stocks, while the opposite is true in the U.S. with the Trump administration determined to shrink the budget deficit,” Martin Roberge, portfolio strategist at Canaccord Genuity, wrote in a note.

Canadian stocks also have a valuation advantage, which is perhaps one reason foreign investors seem to be returning to the TSX, according to Brian Belski, chief investment strategist at BMO Capital Markets. “Our view on Canada remains resolute,” Belski wrote Wednesday. “Canada remains a strong relative value play that can and will continue to converge with the U.S.”

Bonds

This is traditionally where investors park money in moments of economic distress, and for good reason. “Bonds have been the best place to be in most previous recessions,” Morningstar portfolio strategist Amy Arnott writes. The problem is, that might not hold up this time around. Bonds are a defensive investment, in part, because central banks tend to cut rates as a stimulus effort, which in turn, elevates bond prices. But inflation is perking up, which could keep the Federal Reserve from cutting rates even if the U.S. economy falters.

This is why investors need to think about “diversifying their defensives,” writes Craig Basinger, chief market strategist at Purpose Investments.

Gold

The forces that drive gold prices can be a difficult thing to pin down. Gold has long been thought of as a hedge against inflation. But when consumer prices went haywire in 2021-22, gold went nowhere. Then gold prices shot up last year as inflation came back down to target.

The primary driver of gold’s latest run? The rise of global economic uncertainty, according to Econofact, which is published by Tufts University. Nearly half of the rally in gold over the last year or so can be chalked up to spiking uncertainty indicators, the authors said.

The upshot is gold should do well as long as economic uncertainty remains high. For more on that, check out the chart below.

MARKET PEAKS

Oh, no! I invested at the top!

If you’re like nearly every other investor in the world, you’re a terrible market timer. But don’t despair, the stock market has a way of fixing even the most poorly timed trades.

Tuesday marked the 25th anniversary of the peak of the dot-com bubble, as measured by the S&P 500 index. Money invested on that day would have lost nearly half of its value over the next two-and-a-half years. But even such a star-crossed investment would have turned out fine eventually.

From the market peak to today, the S&P 500 generated annualized returns of more than 7.5 per cent over those 25 years, including dividends. Bespoke Investment Group compiled a list of “100-baggers” – stocks in the Russell 2000 index that grew by at least 10,000 per cent over that time.

As I wrote a few months ago, money invested at the worst possible moments of the past century will recover given enough time in the stock market.

CHART OF THE DAY

Uncertainty in Canada has literally gone off the charts. The Economic Policy Uncertainty Index for Canada scans major media for indicators of uncertainty related to things like government spending, regulation, tax and central bank policy. And it catapulted to unprecedented highs in February, towering over previous calamities like the COVID-19 pandemic, the global financial crisis, and the popping of the dot-com bubble. Such is the power of Donald Trump’s tariff debacle to cast doubt over Canada’s economic future on a bewildering, existential scale.

What does this mean for investors? You may have heard it repeated four or five times daily that the stock market hates uncertainty. So, it follows that even a sliver of clarify about Canada’s economic fate could prove positive for domestic stocks that have been hit hard by the trade war. ATB Capital Markets identified four TSX listings that could see some relief: Air Canada, Cargojet Inc., Exchange Income Corp., and NFI Group Inc.

THE ESSENTIALS

Looking for our updates on market movers, analyst actions, stock technicals, insider trades and other daily, weekly and monthly insight? Click here to visit our Inside the Market page.

Globe Investor highlights

Norman Rothery updates us on how his stable dividend portfolios are performing

Investing professor Dr. George Athanassakos thinks we’re in a new era of deglobalization and even bottom-up value investors need to price in the risks

The rosy U.S. earnings vista is at odds with a gloomy growth outlook, warns Reuters’ Jamie McGeever

Forex markets – including traders in the Canadian dollar – still suspect Trump is bluffing

What’s up next

Buckle up for some potentially market-moving economic readings later this week. Most notably, on Friday, the U.S. will release the PCE price index for February – closely monitored by the Fed for any signals of inflationary pressures – as well as the latest University of Michigan consumer sentiment index. Friday also brings Canada’s GDP report for January, which is forecast to rise modestly. Of course, the biggest market event will likely need to wait until April 2, when Mr. Trump is promising “Liberation Day” for American trade. Get your bets in now for what he’s about to unveil, because it’s almost anyone’s guess at this point.

See our full economic and earnings calendar here (You can bookmark the page – it gets updated weekly)

TFSA Investors, we want to hear from you

Last year, we launched our new TFSA Trouncers series, where we profiled Canadian investors who’ve accomplished incredible feats with their tax-free savings accounts. We’re still on the lookout to find more Canadians who wish to share their experiences – especially those who’ve had tremendous success or failures to tell us about. To participate, drop us an e-mail at dakeith@globeandmail.com.