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The S&P 500 hit a new all-time high last week, ignoring warnings of a softening global economy.

This may be due in part to the isolationist view of U.S. investors. The American economy continues to perform well from the point of view of job creation and GDP growth. So, why worry?

The TSX is going along for the ride.

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But if the comments of our central banks are any indication, we should be getting edgy.

Everything went as expected when the Bank of Canada and the U.S. Federal Reserve Board announced their interest rate decisions last Wednesday.

The Fed cut by another quarter-point. The Bank of Canada held the line.

But both Banks expressed concern about the future, with U.S.-China trade the centre of concern.

The Fed was more reserved in its commentary. There was no direct mention of the U.S.-China dispute, only a comment that the governors are concerned that “business fixed investment and exports remain weak”.

But it doesn’t take much between-the-lines reading to understand the message. Exports are weak because of the massive tit-for-tat tariffs the U.S. and China are throwing at each other. Business investment is down because of widespread uncertainty about where all this is going.

The Bank of Canada was more direct. It projected that Canada’s growth rate in the second half of this year will slow to “below potential” and that real GDP growth for the full year will be only 1.5 per cent.

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In his comments to the media, Governor Stephen Poloz said: “We need to remember that tariffs and trade restrictions will work over time to permanently reduce potential output everywhere, while raising the prices of consumer goods—a stagflationary scenario.”

He went on: “Canada is not immune to these global developments…Indeed, this uncertainty has been weighing on investment in Canada for the past three years.”

The bottom line is that if there is no change in the situation, we should expect exports to slow even more, business investment to continue to contract, commodity prices to keep declining, and a “significant” depreciation in the value of the Canadian dollar.

Given this grim outlook, delivered on the day before Halloween no less, it’s a wonder the Bank of Canada didn’t cut. Holding the line means we now have the highest central bank rate in the industrialized world. This seems hard to justify, given the Bank of Canada’s view of what lies ahead.

There seems to be a disconnect from reality here. World growth continues to slow, future GDP projections are being cut, but the stock market ignores it all.

I am concerned that, sooner or later, the destructive trade policies of the U.S. administration are going to come back to haunt Americans. Canada may be hit even harder, if Mr. Poloz is right. Stocks won’t escape.

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Some of our readers see the writing on the wall and taking action. Here’s an email I received recently.

“You recently spoke of the need to keep in mind that a serious drop in the markets is a certain eventuality, albeit at an unknown time. With the headwinds currently facing world markets, I can only agree with you.

“Although you make some valid suggestions as to how to react to the next drop, I would love to see a ‘crisis portfolio’ which one could build before the crisis strikes. I have sold half of my investments, which currently reside in daily interest accounts, in preparation for such an eventuality. The remainder is invested along the lines of your suggestions.

“To my mind, it takes years to build solid returns but only a few weeks or even days to destroy a large part of it. Can you propose such a portfolio which would ‘anticipate’ a sudden drop – and rise quickly from the ashes?” - Alain H.

It’s a reasonable question. The answer is not so straightforward. The real key to any so-called “crisis portfolio” is not the specific securities it holds but rather asset mix. As I have mentioned before, the higher the percentage of cash and bonds that you own, the less the risk if the stock market melts down.

The interactive Steadyhand Volatility Meter tells the story. By adjusting the asset allocation for any year back to 1961, you can see how various portfolios (Canadian, U.S., or blended) would have performed.

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For example, in 2008 a blended portfolio composed of 60 per cent equities, 40 per cent fixed income would have lost 15.1 per cent. But if you changed the mix to 10 per cent equities, 90 per cent fixed income, the portfolio actually would have gained 2.7 per cent that year.

I’m not suggesting that radical a transformation. Overhauling a portfolio can be expensive in terms of sales commissions and, if the account is non-registered, potential capital gains taxes.

But if you’re worried about a stock market setback, a shift of some assets to fixed income should be considered. Bonds have performed well so far this year; as of Nov. 1, the FTSE Canada Universe Bond Index was ahead 7.47 per cent year to date.

As for stocks to hold in a crisis portfolio, my Canadian list would include BCE Inc., Royal Bank of Canada, Fortis Inc., Canadian Utilities Ltd., Canadian Apartment Properties REIT, and TC Energy Corp. In the U.S., I would look at JPMorgan Chase & Co., Verizon Communications Inc., Visa Inc., Costco Wholesale Corp., and McDonald’s Corp.

Let me conclude with a few guidelines for nervous investors.

Don’t time the market. No one has ever done it successfully on a consistent basis. Selling everything and hiding under the bed is not the answer.

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Do review your asset allocation. If you feel you are overexposed to stocks, make some adjustments. This can be done by directing new deposits and/or cash inflows to fixed-income securities or high-interest deposit accounts.

Don’t assume everything will unfold as predicted. The Bank of Canada and the Fed make their projections based on the knowledge available to them at the time and the trend patterns they see unfolding. But a single major event can change the patterns dramatically. Consider the effect on stocks if the U.S. and China actually do sign a deal and the trade war cools. Every central bank and brokerage firm would have to revise their outlooks.

Do stay with your plan. If you have an investment plan you are comfortable with, stay with it. Even if the market crashes, good companies will survive and prosper. In the meantime, their stocks will be available at bargain prices.

Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters.

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