The World Is Connected
I wrote an article titled, The Latest Approach to Constructing Investment Portfolios, in May 2007 for Canadian MoneySaver. In that article, I showed two key concepts. First, how incredibly connected the world’s equity markets are. The direction of global markets plays a vital role in determining the course of the TSX or the S&P 500. World equity markets do not move in a vacuum.
The second idea was performance. Professional money managers aim to match, or (hopefully) outperform, the benchmark S&P 500 Index, a feat that remains distant for virtually all money managers.
This article will update those concepts that I highlighted 17 years ago.
Market connections are tighter now than in the last 10 to 20 years. Information on world market conditions that used to be only accessible to financial institutions is now available to anyone with an internet connection. Efficient trading platforms, Artificial Intelligence (AI), and abundant online sites can give self-directed investors all the tools they need. Yet, with all this data supply, the ability to equal or outperform the key indexes still seems to elude most professionals and retail investors.
Chart 1 is a composite of the Dow Jones Global Index (DJW), the S&P 500, and the TSX over the last 10 years. The first noticeable element is the close connection between all three market indexes. Though each index's fundamentals and economics differ, the market treats them the same. Market peaks and lows all coordinate.
The majority of managed funds use a bottom-up approach to stock selection. This means that when professionals pick the individual company, it is of primary importance, followed by the sector. Finally, in last place is the trading direction of the overall market. The long-standing belief is that fundamentally strong stocks will rise, regardless of overall market and sector conditions, and ultimately “beat the tape.” However, according to a recent S&P Global report, over 95% of managed funds cannot outperform the S&P 500 over any five-year period1. Since the low in 2016, all three indexes have advanced about 140% to the present or, on average, 13% per year.
The Bottom Line:
The trading direction of global markets has a direct impact on the trend of market indexes. This is largely due to the instant transfer of information and the continued globalization of economies. Individual stock markets seldom track in a course that is counter to the overall path of the “herd” in today’s financial arena. These composites, in turn, have a powerful pull on individual sectors and stock groups. Though the examples are for the U.S. and Canadian equity markets, the same pattern applies to the FTSE and all European stock markets.
Therefore, in investment selection, I would suggest considering the trading direction of the Dow Jones Global Equity Index as a starting point. Ask yourself: is your growth portfolio averaging 13% annually after commissions? If not, then perhaps look to buy the TSX (iShares S&P/TSX 60 Index ETF(XIU) or iShares Core S&P/TSX Capped Composite Index ETF(XIC), or the S&P 500 (SPDR S&P 500 ETF Trust (SPY) or BMO S&P 500 Index ETF (CAD) (ZSP.TO)) and forget about the standard multi-stock portfolio.
Donald W. Dony. FCSI. MFTA is an analyst with over 35 years of financial market experience. He is a past instructor for the Canadian Securities Institute and editor at www.technicalspeculator.com
He can be reached at e-mail: dwdony@shaw.ca or Twitter: @DonyFcsi
1 https://www.spglobal.com/spdji/en/research-insights/spiva/#canada