Independent Investor

Like many Canadian investors, you might have thought that you were well diversified since your portfolio contains a nice mix of telecoms, REITs, utilities and financial stocks. As a result, your dividend income has been high for years and your portfolio seemingly did nothing but go up.

However, many Canadians in the past month have had a very rude awaking. In addition to the devastation in the gold sector, dividend stocks are now getting clocked. Stocks once seen as "safe" and "stable" have gone down 7%, 10% or more within a few weeks. What’s going on?

Well, it is simple sector rotation, my friends. Investors — suddenly concerned about rising interest rates — are questioning their willingness to pay 24 times earnings for a utility company that doesn’t grow much, or paying 15 times cash flow for a REIT that gives out all its cash flow to shareholders. Investors are desperately seeking something else — anything — that might survive in our new economic conditions.

We usually would say at this point, if you are properly diversified, there is no need to panic. But most investors don't seem to have properly set up their portfolio for a regime shift in the markets, if it is indeed occurring.

Here then, are FIVE things you could add to your portfolio to help offset the meltdown in all your other safe and secure holdings.

• Growth stocks

Yes, you read that right. If the world economic climate is shifting, investors — after a long, long avoidance — are going to want growth stocks again.

The best way to play this: The iShares Russell 200 Growth Index Fund (IWO/NYSE). Consisting of the smallest, fastest-growing companies in the U.S., the fund is up 18% so far this year as growth has come back into fashion. There could be lots more room for it to move, though, if this sector rotation in the market continues.

• Manufacturing stocks

Generally, when rates shift, cyclical companies do very well. A company such as Magna International Inc. (MG/TSX) could really start to attract investor attention. It is up 41% this year already, yet it's still only trading at 11 times earnings. Against a weak market backdrop, it hit a new high on Tuesday.

• Biotech/health-care stocks

Canadian investors tend to detest biotech stocks. And why shouldn’t they? The Canadian sector has been a complete disaster for years.

But while your REITs have been declining, the iShares NASDAQ Biotech 100 ETF (IBB/Nasdaq) has risen more than 30% this year, as the shares of many biotech companies hit all-time highs. These gains could continue if more money shifts into the sector away from income stocks.

• Technology stocks

Technology stocks, such as CGI Group Inc. (GIB.A/TSX) or Constellation Software Inc. (CSU/TSX) are both up more than 20% so far in 2013.

Historically, tech companies trade in the mid-20s in terms of price-earnings multiples. Most now, though, are barely in the mid-teens. There is certainly still upside under the right conditions.

• Dividend-growth stocks

Despite recent market weakness in income stocks, we do not think Canadians will completely abandon dividend stocks. But you are going to want to ensure that you own companies whose dividends have the ability to grow. These companies should be able to keep investors interested in them if interest rates do spike.

In this category, we would suggest Vanguard’s Dividend Appreciation Index Fund (VIG). It is up 14% this year, not including dividends. Certain sectors of the TSX, meanwhile, have declined that much in the past month.

Peter Hodson, CFA, is CEO of 5i Research Inc., an independent research network providing conflict-free advice to individual investors (www.5iresearch.ca).