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With global economic growth increasing, profits should continue to follow suit which will provide a strong backdrop for rising stock prices. The timing of such a large move back into stocks is obviously the key variable. The chart below shows that some of the largest long-term moves in the stock market over the past 80 years have come after periods in which the 10-year return on stocks dropped sharply below the 10-year return on bonds. This is shown below as the lower red line on the chart. When it has reached a low point (blue circles on the red line), that has coincided with strong long-term stock returns. We saw such moves around 1940 and again in 1980. We seem to be coming off an even lower low this time around. For those with a longer-term view, this really suggests it is time to position yourself in stocks which have the potential to show continued earnings growth.
Our top sector choices for the long-term include the industrials, technology, telecom and energy services. Financial service companies should also participate in the advance since they are the prime beneficiaries of stronger financial markets and increased corporate activity. In the U.S., the banks are also one of the largest beneficiaries of the recovery in the housing market. Areas we would avoid would be the defensive sectors of the stock market, such as Utilities and Consumer Staples, where earnings growth is still low but valuations have moved to record high levels. We also continue to favour stocks over bonds or cash and are still carrying a 15-20% overweight position in stocks in all of our Balanced Fund accounts. This is somewhat lower than the 25% overweight position we have had for most of the past six months, but that has more to do with the sharp gains we have seen recently in most markets (excluding Canada) and the increased risk of at least a short-term correction of 5-10% sometime in the spring. At those levels we would take stocks back up to their maximum allocation.