Investors popped the bubbly as the stock market hit new highs in July but the party paused when the market wobbled into August.
The market’s ebullience reminded me of the Champagne portfolio, which seeks to invest in stocks when they hit new all-time highs and hides out in bonds the rest of the time. The hope is to get a performance lift from stocks while the going is good without taking on a great deal of risk.
More specifically, the Champagne portfolio uses the S&P/TSX Composite Index to invest in Canadian stocks and the S&P Canada Aggregate Bond Index to invest in Canadian bonds. It checks the Canadian stock index at the end of each month to see whether it has hit a new all-time high and, when it has, moves into it for the following month. Otherwise it invests everything in the Canadian bond index. (The returns herein are based on monthly total-return data from Bloomberg but do not include fund fees, commissions, inflation, taxes or other trading costs.)
The Canadian Stock Market Index outperformed the Canadian Bond Market Index in recent years with average annual gains of 9.1 per cent from the end of January, 1993, through to the end of July, 2024. The bond index climbed at a 5-per-cent annual rate over the same period.
The Champagne portfolio found itself in the stock index about 28 per cent of the time over the period and it was invested in the bond index the other 72 per cent of the time. But, despite owning bonds for most of the time, the portfolio gained an average of 7.7 per cent annually over the period.
You can examine the return history of the Champagne portfolio and the market indexes in the accompanying graph.
You’ll notice the return line for the Champagne portfolio was remarkably smooth until recently. It didn’t suffer from the big swings experienced by stock market investors, but its bond-heavy nature came back to bite it in 2022-23 when the bond index plunged.
The second graph focuses on down periods for the Champagne portfolio and the market indexes. It shows how far they fell, from their prior highs, in bad times.
The stock index was the most erratic of the bunch over the last three decades because it tumbled 43 per cent on two separate occasions. The first time was after the internet bubble burst in 2000 and the second time occurred in the financial crisis of 2008-09. Both the Champagne portfolio and the bond index were barely inconvenienced by the stock market downturns.
On the other hand, bond investors came in for a rude awakening when both inflation and interest rates surged after the COVID-19 pandemic faded, which prompted the bond index to fall 21 per cent from its former high in 2021 to a low in 2023. Even worse, the bond index has yet to fully recover from the decline. It’s a sorry situation and shows that bond indexes are not immune from downturns.
The Champagne portfolio was mauled by the bear market in bonds and had its worst showing on record with a 16-per-cent decline to a low in the fall of 2023. However, the portfolio fully recovered earlier this year and moved on to hit a new high at the end of July.
Overall, the Champagne portfolio offered a good combination of upside potential with a moderate downside-risk profile in recent decades. But investors had to pay attention to it every month over the years because it swapped bonds for stocks, or stocks for bonds, an average of about two times each year. Such frequent trading comes at a cost and can trigger taxes, which makes the approach better suited to tax-sheltered accounts.
The Champagne portfolio shows that buying the Canadian stock market at all-time highs was a good idea – at least in the short term – for investors who were willing to hastily retreat at the first sign of trouble. It’ll be interesting to see if it continues to offer pleasing returns in the future.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
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