Tuesday, April 22, 2014

Investing in Stocks at Toronto Stock Exchange

A stock index is a weighted average of the value of the stocks of companies quoted on a stock exchange. It summarizes the overall performance of the financial market or the performance of a sector of that market.

Companies listed at Toronto Stock Exchange (TSX) are classified into eleven sectors:
  1. the consumer discretionary sector made up of hotel chains, resort companies, and firms manufacturing or selling consumer durable goods (cars, household appliances) and semi-durable goods (apparel),
  2. the consumer staples sector made up of firms producing or selling consumer non-durable goods (food, drink),
  3. the energy sector made up of coal, fuel, and oil companies,
  4. the financial sector made up banks, insurance companies, and other financial institutions,
  5. the gold sector,
  6. the industrial sector comprising companies producing or selling machinery and equipment, and other capital goods,
  7. the information technology sector,
  8. the materials sector,
  9. the diversified metals and mining sector,
  10. the telecommunication sector, and
  11. the sector of utilities comprising companies supplying electricity, gas, and water.  
In the figure below, I have plotted the Standard & Poor’s (S&P) stock index for these eleven sectors as well as the composite index. 

Standard & Poor's Stock Index by Sector, TSX, Canada, 1998:M1-2014:M3, Source: Statistics Canada
Figure: Standard & Poor's Stock Index by Sector, TSX, Canada, 1998:M1-2014:M3, Source: Statistics Canada
One can observe from the above figure that, recently, while stocks in the sectors of consumer discretionary and staples (panels 1 and 2), financial (panel 4), industrial (panel 6), and telecommunication service (panel 10) tend to gain values, the value of stocks in the sectors gold (panel 5) and material (panel 8) are downward trended. 

Panel 7 shows the information technology bubble that took place in 2000, period where the stock index in that sector more than doubled to reach a peak of 111.59 in August. In Panel 10, it appears that the bubble in the sector of information technology was coupled with another one in the sector of telecommunication service. In March 2000, the stock index in the latter sector reached a high of 120.87. 
The bubble in these two sectors burst in 2002, with the stock index of the sector of information technology reaching the low of 11.21 in September and that of the sector of telecommunication service reaching the low of 37.08 in July. 
Soon after, the telecommunication service sector regained vitality thanks to a new generation of cellphones, the smartphones. The convergent smartphone Blackberry released in 2003 by Blackberry Ltd (formerly known as Research in Motion) was one of these innovations.  

The 2008 financial crisis also occasioned price fall on the stock market especially in the sector of consumer discretionary (panel 1), energy (panel 3), financial (panel 4), industrial (panel 6), material (panel 8), and diversified metals and mineral (panel 9). 

Table: Return and Risk by Sector, TSX, 1998:M1-2014:M3, Data Source: Statistics Canada
Return and Risk by Sector, TSX, 1998:M1-2014:M3, Data Source: Statistics Canada

 Column (a) of the above table displays the expected monthly returns on stocks by sector. The returns have been computed as the month to month percentage change in the stock indices. 
The stocks yielding the highest returns are by far those from the sector of diversified metals and mining. Then follow stocks from both the sectors of consumer staples and energy. The returns in the sector of utilities are the lowest.  
The expected returns on investing in the various sectors of the TSX are higher than the return on acquiring a risk-free asset such as a treasury bill. Actually, over the sample period, the monthly equivalent average yield on a three-month treasury bill is .22 %.

The risks associated with investing in the various sectors of the TSX are measured by the standard deviation of the returns and reported in column (b). The unitized risk, in column (c), is the ratio of the standard deviation to the average return. 
The risk that the actual returns be different from the expect return is lower in the sector of consumer staples than the other sectors. The information technology sector is the riskiest one of the stock market. Both the expected return and the risk on investment in the sector of diversified metals and minerals are very high.

Column (d) shows how the performance in each sector is linked to the performance of the market. The sensitivity of the return in each of the eleven sectors to the return of composite index (the market return) is positive but low in the case of the sectors of consumer staples, gold, and utilities. 
Both the information technology and the diversified metals and mining sectors are the most sensitive to the market performance. A one percent increase in the market performance induces respectively a 1.54 % and a 1.43 % increase in the performance of each of these two latter sectors.