Two years in one

In retrospect, 2008 has actually been not one year but two. Perhaps we could describe it as the good twin and the evil twin.

The good twin held sway during the first six months. Yes, there were some problems but they seemed to be largely confined to the U.S. housing market and some shaky financial institutions that had taken on too much dubious debt. Worrisome, sure, but not a disaster-in-waiting.

Here in Canada , the good times were still rolling. Oil and potash prices surged, bringing even more prosperity to Alberta and Saskatchewan and raising new concerns about the regional economic imb alan ce that had already pushed Ontario into the position of a have-not province for the first time in history. Buoyed by high commodity prices, the TSX surged to an all-time high in early June, topping 15,000. There was talk of $200 oil and $1,000 gold. The loonie flew high.

However, there were signs of trouble brewing. The Bank of Canada began cutting interest rates in December 2007, signalling worries about a weakening economy. For several months, the cuts were minimal; a quarter-point at a time. But as spring approached, the Bank became more aggressive, cutting by half a point in March and April. The clouds were gathering.

Investors were slow to take heed, however. After a scare in January when the markets took a big dip, they turned sharply higher again. By mid-April, the TSX had recovered all the January losses and was in positive territory for the year. The worst was over, or so many people thought.

I wasn’t convinced. In May, I wrote an article reminding readers of the events of 2000 when an Easter week market plunge was followed by a strong summer rally which in turn was followed by a collapse which in the case of Nasdaq saw the index lose 80 per cent of its value. At the time I said: “If one more Wall Street giant finds itself contemplating the chapter 11 option, we risk seeing a market plunge that would make the January set-back look like a hiccup.”

But at that point, everyone seemed to be mesmerized by the commodities boom which some money managers were betting would continue for years because of growing demand from China and India . Thinking back, they were saying the same thing about stocks and the rise of the Internet in 1999-2000. We never learn.

A lot of money was made by shrewd investors in the first half of 2008. The really smart ones took some of those profits off the table, as I advised doing on several occasions. Looking back, perhaps I should have been even more strident in my warnings. The best move would have been to get out of the stock market entirely last June and put everything into government bonds. But that kind of all-or-nothing approach is not my style and never will be. It’s like putting all your chips on a single number and praying the roulette wheel will favour you, just once. Once in 1,000 times you might win. The other 999 times, you lose everything.

I have always counselled taking a b alan ced approach to your portfolio, one which includes equities, bonds, and cash in proportions with which you are comfortable. That strategy served us well when the evil twin took over in July and sent stocks crashing down with such unexpected speed and ferocity that 2008 now ranks as one of the three worst years of the past century (1931 and 1937 being the others). Anyone with a reasonable percentage of cash and bonds was partially cushioned from the blow. Yes, some money was lost but their damage was minor compared to the blows sustained by those who had remained fully invested in equities.

The evil twin is now fully in charge, as last week’s announcement of a 75 basis point rate cut by the Bank of Canada confirms. We haven’t seen the overnight rate this low since the Second World War. The accompanying statement from the normally stolid central bankers was about as grim as we have ever seen: ” The outlook for the world economy has deteriorated significantly and the global recession will be broader and deeper than previously anticipated. Global financial markets remain severely strained… While Canada ‘s economy evolved largely as expected during the summer and early autumn, it is now entering a recession as a result of the weakness in global economic activity.”

Back in April, the International Monetary Fund issued a report in which it predicted that, although growth would slow, Canada would stay out of recession. So much for that! We’re in the same mess as everyone else and if the Bank is correct it is not going to be over soon.

Looking ahead to 2009, I advise maintaining a b alan ced approach. I expect good-quality corporate bonds to do well next year so the bond portion of your portfolio may actually be the performance leader. But at some point the stock markets will turn around and history shows us that when they do the initial upward move can be dramatic. So don’t abandon equities completely; just adjust your weighting to a level you can live with.

Gordon Pape’s new book is Tax-Free Savings Accounts: A Guide to TFSAs and How They Can Make You Rich . Copies can be reserved now at