Will the boom continue?

The Toronto Stock Exchange was the best place for your money in 2005. Most sectors scored big gains, with energy, metals, utilities, gold, and financials leading the way. When all was said and done, the S&P/TSX Composite finished the year with a healthy gain of 21.9 per cent.

So now what? Can we expect more of the same in 2006? It would be nice to think that another 20 per cent+ year lies ahead but I doubt it. In fact, there’s a chance the TSX could end 2006 down from its current level.

Here’s why. We’re in the late stages of an economic recovery. Years ago I wrote a book in which I compared the economic cycle to the passing of a day and described the twilight period in this way: “The day has been so glorious, we aren’t really conscious of nightfall fast approaching. But there are plenty of signs around. The government has declared inflation to be a major problem. Short-term interest rates are high. Commodity prices are soaring — oil, copper, wheat, aluminium, potash, timber. House prices in Toronto and Vancouver have begun to move back into the stratosphere, as have prices for cottages in Muskoka and condos in Whistler. The stock markets are setting all-time recos. Younger people believe that prices have nowhere to go but up. The world looks like it’s heading for a new Golden Age. And then it all unravels. Night falls and the world is dark again.”

“Dark” in this metaphor refers to an economic slowdown.

Obviously, all the conditions I described are not in place yet. But enough of them are present to suggest that a new recession is lurking out there somewhere, just beyond the horizon. Remember that the stock market is a leading indicator — it will start to fall months before it becomes clear that a full-fledged slowdown has taken hold. When it does, the Canadian market will be especially hard-hit because of its heavy tilt to commodities like oil and metals.

However, that doesn’t mean there aren’t some profit possibilities. I believe the best area for potential strength is dividend-paying stocks. Now that the tax rate on dividends has been lowered (that happened on Jan. 1 even though the legislation has not yet been passed by Parliament), companies with a strong dividend record are likely to be in greater demand, especially for non-registered portfolios.

We have many great dividend stocks on the Recommended List of my Internet Wealth Builder and readers are already enjoying nice gains in such companies as Enbridge, Fortis, and Manulife. But we see more upside potential in many of these issues because of the tax changes.

Although I am not wildly optimistic about 2006, a major correction is unlikely to happen for several months. There are still some profits to be made although careful stock selection will be critical with dividend stocks getting top priority. But watch out for some bumpy times, especially in the second half of the year. Certainly, you should not abandon the stock market but when profit-taking opportunities present themselves, consider taking advantage of them and building some cash reserves.

Adapted from an article that originally appeared in the Internet Wealth Builder, a weekly investment newsletter edited by Gordon Pape that features contributions from some of Canada’s top financial experts. For more details, go to http://www.buildingwealth.ca/partner.cfm?partner=50Plus