Why does stock market peaks do not always translate into portfolio gains?
We’ve all seen the headlines. The Dow Jones, that iconic American benchmark, has smashed another record, closing above the 22,000 level. But your portfolio statement for the month of July paints another picture, and it’s hard not to be disappointed with its drop in value. There are two main culprits at work here: the Canadian dollar and the Canadian stock market.
1. A strengthening Canadian dollar
Unfortunately, or fortunately, depending on which side of the fence you’re on, the Canadian dollar has shot up quite strongly lately, gaining approximately 10% in a few short weeks.
As a Canadian investor, it can be perfectly appropriate, even recommended, to hold up to 50% or more of your stock market investments outside Canada. Such a diversification strategy helps lower the risk for your portfolio while often providing better returns over the long-term. However, to determine the value of your portfolio in your local currency – the Canadian dollar – investments made in foreign currencies must be translated to the Canadian dollar, but a stronger Canadian dollar means the value of foreign investments, when converted to Canadian, decline. As a Canadian dollar buys more goods in US dollars today, your previous purchases now have a lower valuation.
Our research shows that currency fluctuation has a very limited long-term impact on common share holdings, as opposed to its effect on the fixed income and cash portions of a portfolio. Since currency is an instrument that tends to revert to its mean, increases are ultimately cancelled out by potential decreases. Although currency movements can cause a drop in value over the short-term, the combined effect of high long-term returns generated by common stock and the mean-reverting process of currency fluctuation tends to cancel out this impact on your portfolio. We saw gains while the loonie was slipping; unfortunately it hasn’t been as pleasant lately.
2. The Canadian market
Canadian equities failed to achieve the same momentum that fueled U.S. stocks. Unfortunately, the securities that comprise the TSX, mainly concentrated in the resource (oil and gas) and banking industries, did not generate as strong returns as did their U.S. counterparts.
Together, these are the reasons behind the disconnect between portfolio results and the headlines featured on your favorite newsfeed.
The Claret Team