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Investors pop open the Champagne when stocks hit new highs. But after quaffing down a boatload of bubbly in recent months, the newly rich might wonder how long the good times will last and whether now is a good time to put new money to work.

I created the Champagne portfolio to explore the situation. It invests in the Canadian stock market when it hits a new all-time high, but hides out in Canadian bonds the rest of the time. The result was stock-like performance with a bond-like downside profile.

The Champagne portfolio uses the S&P/TSX Composite Total Return Index as its proxy for the Canadian stock market and the S&P Canada Aggregate Bond Total Return Index for Canadian bonds. Each month it tracks the returns of the Canadian stock index to see when it hits a new all-time high. When it does, the portfolio moves entirely into the stock index, otherwise it invests everything in the Canadian bond index.

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Over all, stocks beat bonds from the end of January, 1993, through to the end of October, 2019, when the stock index climbed at an average annual rate of 8.8 per cent. The bond index climbed 6.1 per cent annually over the same period.

The Champagne portfolio invested in the stock index about 27 per cent of the time over the period. It was in bonds the other 73 per cent of the time. But, despite owning bonds for most of the time, the portfolio gained an average of 8.5 per cent annually over the period, which was just shy of the returns of the stock index. You can examine the return history of the indexes and the Champagne portfolio in the accompanying graph.

You’ll notice that the return path for the Champagne portfolio was remarkably smooth. It did not suffer from the huge ups and downs that stock investors experienced.

The second graph provides a closer look at the downside profile of the indexes and the Champagne portfolio. It displays how far the different investments fell in poor periods as a fraction of their prior peaks.

The stock index offered the wildest ride by far. It fell 43 per cent from its prior peak twice. The first time was after the internet bubble burst in 2000 and the second time was in the 2008-09 crash, based on monthly data. The worst decline for the bond index came in 1994 when it fell 13 per cent and the worst downturn for the Champagne portfolio also occurred in the same year when it fell 12 per cent.

As it happens, interest rates jumped in 1994, which led to losses for the bond index. The incident provides a good reminder to investors that bond indexes (and funds) are not immune from downturns.

The Champagne portfolio looks pretty good owing to its strong upside potential and limited downside history. But the numbers didn’t factor in a variety of costs. For instance, the portfolio required a good deal of attention from investors who had to check the market’s returns each and every month over the years. It also generated an average of about two swaps each year when it moved from stocks to bonds or vice versa. But the returns mentioned herein do not include fund fees, taxes, or trading frictions. As a result, the performance of the indexes and the Champagne portfolio would be lower in practice.

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Nonetheless, history 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’s a strategy more active index investors might consider for their tax-sheltered accounts.

Canadian stocks hit new highs at the end of August and September, but slipped slightly in October. As a result, the Champagne portfolio is currently in bonds. But, with a little luck, the index will bubble up beyond its old peak by the end of November.

Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.

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