Wednesday, September 29, 2010

Quick update

September has been much better than I dared to hope for. October is the last of the annual scary months and I don't mean Halloween.  So if you like me have increased your cash position for this scary market time, now is the time to start looking for bargains.

Microsoft is such a bargain. Also look again at Canadian banks they have settled back and are still yielding above 3% with likely a dividend boost in the coming two quarters. Inspite of these latest sunny days, do not lose sight of caution and focus on quality companies with solid dividends. Preservation of capital should remain closely to the core of your investment strategy.

After October, the investor crowd may get excited again. Don't get caught up in it. We're still in a lot of trouble. Better to buy early than trying to keep up with a fall rally, and with the focus on dividend income you'll do fine even if the late year rallies would stay away. My guestimate is that we might get quite a vigorous rally and that the upbeat mood is likely to last until February. This may become a period of overconfidence; don't get caught up in it and keep a lot of your cash powder dry.

Alberta should start to economically perform well next year. If you plan to buy real estate consider buying between now and the spring. After March you may buy into a rally. If you want to sell properties hold off until the spring (opposite to the buyers).

Saturday, September 25, 2010

Is Europe really passé?

Many North Americans look down on Europe as being passé and stodgy. In many ways the opposite is true. Europe has learned from its mistakes in the past and successfully applied policies that places it much closer to a sustainable economy than many of the currently considered economic highflyers such as Asia and China in particular.

When statistics in the 1970s and 80s showed that we moved to world overpopulation, Europe was one of the first to successfully apply birth control, now it experiences the unintended consequence of a potentially declining and excessively aging population. Europe was, in those earlier days, in the forefront of flower-power and the environment. Also, it suffered greatly and learned greatly from the oil-shocks.

Today, rivers that were heavily polluted and with water unfit for recreation in particular swimming, have been cleaned up and often form a beatifying element in the lush green rural landscapes. Europe increased its gasoline taxes dramatically and forced smaller and more fuel efficient cars that today dominate the car fleet. It has a public transportation system we can only dream of here in North America. You can go nearly everywhere by train, including traveling below the English Channel. The Danes are leaders in wind energy, and geothermal energy is gradually gaining ground.

Don't get me wrong! If Europe was so good in everything, I would prefer living there rather than here. But for me, Europe is the model for when the world population growth will start to level off. For here in North America, future economic growth may be a lot less vigorous than today. Today in North America, we need a consumer who forever needs to buy more and take on more consumer debt. Europe is one of the early 'experiments' for how a more sustainable and less consumption driven world may look like.

So we can learn a lot from that continent, including home quality and ownership. Here in North America we still live in a 'throw-away' economy. Housing is not expected to last more than 30 to 40 years. After that it goes flat and new facilities are built. Compare that with Holland, where houses are expected to last a century and many inner-cities are filled with buildings that are hundreds of years old. Look at their building density compared to here. And irony of irony, places like Garrison Woods and Marda Loop here in Calgary are to reflect this 'trendy European look and feel'. Yet, they are still built with a short economic life expectation.

Also home-ownership is much less common. The thought of coming out of school and buying a house with 5% down, as Thomas mentioned, is in Europe considered ludicrous. Renting well into your 30s before you have a good solid down payment is much more the norm. Compared to the U.S. we, Canadians, may have a conservative outlook on homeownership and banking. But Europe in turn is quite a bit more conservative than we are.

European Banks made the mistake of buying a lot of U.S. prime loans (in particular Deutsche Bank and UBS). Others got tempted to encourage the same low interest policies in the 2004-2008 booming real markets of Spain and England. The results are for everyone to see. ABN a solid Dutch Bank got caught up in the takeover battles of the failed UK banks similar to the healthy Bank of America when taking over troubled Merrill Lynch in 2008. So Europe clearly doesn't have it right all the time either. The overly generous social system has led to significant government debt. But the U.S. has also a lot of debt and a lot poorer social network. I guess we have to look for a balance in the middle.

But to come to the point of this posting; we can make home ownership more difficult; we can raise gasoline consumption taxes hoping this leads to a more stable and sustainable economy. I think we have no choice to follow these policies. And Europe is our model, including learning from its mistakes.

Thursday, September 23, 2010

This is blah blah!

September turned out a lot less disastrous than many expected but it is not very exciting; A truly blah blah market. That is the Ken Fisher principle at work for you. But there is not a lot of news either, other than that Guru opinion has shifted away from the double dip. I hope October will be similar, with only minor ups and downs.

In the meantime, the economy will continue to improve at a snail's pace. But having a snail's pace improvement and fair to cheaply priced stocks may make November and December markets behave better yet again with a decent rally fuelled by bargain hunters. The Basel agreement is now mostly out of the way and, especially Canadian Banks are expected to increase their dividends in the coming quarters. What will happen if they don't? Another buying opportunity for banks in April or May, I would guess.

Real Estate in Calgary is reaching valuations that maybe interesting for investors. I just bought a 2-bedroom apartment unit in NW Calgary at a cap rate above 4%. With a slow real estate winter ahead and people scared by rising interest rates, investment grade properties may be reaching bottom. I expect the best appreciation of 2011 will be in the spring. So consider buying between now and March 2011 because these low real estate prices won't last.

Don't hurry, it is not that prices are likely to rocket up, but even a 3% appreciation with 25% down represents an ROI of 12%. I suspect that once the economy gains more tracktion, both oil and ,to a lesser degree, gas prices will increase. This in turn will fuel Calgary and Edmonton real estate and in a few years time you may be longingly look back on the missed opportunities of 2010 and 2011.

It is now nearly a toss-up whether to take a variable rate mortgage versus a 3 or 5 year fixed mortgage. If you fear rampant inflation and thus high interest past 2012, than this is the time to lock in your variable rate and, with new financing, going for a 5 year fixed mortgage should be seriously considered.

If you have high cash levels in brokerage accounts or money market funds, consider 1 year GICs that are cashable on short notice without penalty (yielding 1%) or opening a 1% interest bearing no-fee account at ING. Also, short term corporate debt with maturities below 2 years is an option or short term corporate ETFs bought through your discount broker (yield 2-5%). Consider the tax effect though. Interest bearing investments are best held in RRSPs and TFSAs, while dividend paying short term or floating rate preferds are best for taxable accounts.

Thursday, September 9, 2010

How to use your main investment scenario


As part of risk management, the prudent investor looks at a number of possible investment scenarios or forecasts. These are 'what if' cases and you don't have to make them all yourself. You can use books or news paper articles as your scenario. For example, as your worst case scenario you could use Harry S. Dent's book "The Great Depression Ahead' or Nouriel Roubini's double dip news paper predictions. Just add to that your estimate as to how your investment portfolio would perform under those conditions and what you should do to protect yourself against such a scenario.

The best case scenario can also be found in news and book; for that I use authors like Jeremy Siegel. My favorite is his book: 'The future for Investors'. Jeremy's is not truly the sunniest scenario around, but if his long term scenario becomes true, I would be very happy. Yet his views (in my opinion) are quite realistic. So then I have to decide what is the most likely investment scenario for the coming year or five? This will set my ultimate investment course keeping the other scenarios in mind. My 'Main Theme Scenario' is not static and adjusts on a nearly daily basis.

So how do I build this Main Theme Scenario? Well, it is by reading the news paper, watching BNN, reading books and surfing the internet. Obviously, you cannot take all you read seriously. In fact, the opposite is more likely the case – there is a lot of cr.p or more politely stated 'noise' out there. That is why REIN's Don Campbell always talks about 'looking behind the curtain'. You also have to include an optimistic attitude when you read all this. If you're a pessimist, why invest at all? You're trying to make money (income and appreciation) from what you're investing in – so you hope for better things to come. O yeah, there are those who short sell and hope to make money from doom and gloom. Reality though is that the future is bright and pessimists over long haul always miss the boat. The doers make this world, not the naysayers. Bill Gates and Steve Jobs have an unshakeable vision of the future and they build big empires. I never heard of a perpetual pessimist who did create a large successful business. I am not saying that you have to put on rose colored glasses because they may not make you see the stumbling blocks on your path! But overall the successful investor has a long term view of societal progress.

Combine your MTS - I am such a geek and use this abbreviation for Main Theme Scenario :) – with your Asset Allocation Spreadsheet (see earlier posts) to map out the near term road to you personal Belize. My last MTS was formulated October last year. Since then I have posted an update in April ('Godfried's 10th forecast of the year'). Reading the news and following economic numbers (just a few, such as consumer confidence, unemployment, interest rates, durable goods index, etc.) helps me to define our current economic state. I often look for good news during bad times (looking for light at the end of the tunnel) and for consistent bad news during the good times (clouds building at the horizon). So right now, I am looking for evidence that we won't have a double dip and that the world is not coming to an end. When times are good it is easy to make money; when times are bad it is your priority is to protect your net worth while seeding the investments that make you money when the good times return. He, even Berkshire Hathaway has down days!

So after a while, you get your moment(s) that the pieces of the puzzle come together and the old MTS plus many pieces of daily information create a new snapshot of where we are and where we are likely to go in the investment world. This is the time when I sit down and write down my new MTS and use it to guide me in my investment decisions over the coming months. Jeremy Siegel is my long term investment optimistic scenario (my investment portfolio goal) and Harry S. Dent and Nouriel Roubini frame the downside and help me formulate the things I have to do in order not to lose my shirt if things turn sour, my MTS sets the near term investment direction.

Right now, my MTS paints a modestly rosy picture. We are coming out of a large downturn and stand at the beginning of a 3 to 5 year bull market. The TSX is likely to peak over the next years around 18000 (see some earlier posts). Real estate will appreciate between 3 to 6% percent per year and with homeownership declining there will be increased rental demand and higher rents. With higher interest rates (unavoidable in an improving economy) houses become less affordable; also home buyers may be a bit more conservative compared to the early 2000s. Baby boomers reach maximum savings years but will also keep on spending at levels much higher than previous generations. They also will keep on working to well into their seventies, despite their dreams of 'freedom 55'. As said 'freedom 55' was only a dream and certainly not the one baby-boomers worked for to achieve. If there is one thing I learned about my generation than it is that they say one thing and do something else entirely.

Everyone knows about the potential of China and other BRIC countries. The outcome will be likely as predicted but those markets are so fully priced based on those expectations that stock market profits are likely to be mediocre. My guess is that profits lay in Canada, the U.S. and W. Europe excluding the Mediterranean. Growth in these areas will be moderate but many 'gurus' will underestimate the economic vigor of the old world and the old new world. Thus the pricing of their stock markets and other investment assets will remain reasonable and the combination of high dividend yields, improved rents, modest interest rates and low expectations will create a good and stable investment climate for the next 5 to 10 years. A true 'Goldilocks' investment setting! The initial worries of double dip and other scares will gradually decrease and after climbing a long and slow wall of worry. Five years from now the TSX will reach 18,000 and real estate values will have increased by some 30 to 40% (from current Calgary levels). Vancouver real estate will be not as strong but still do well, with many Asian immigrants preferring the less hectic but prosperous lifestyle of Western Canada over the hectic growth and 'ups and downs' of their home economy.

Canada overall will become the multicultural poster-child of the world – this will be our Golden age! But for now we're climbing a slowly rising wall of worry. Focus should be on cash and cash flow. Investment opportunities will be plenty, but our forward looking view is obscured with potential stumbling blocks. Preservation of capital is number one; adding cash flow from good rental properties and dividend paying stocks is number two; buying only investments at the right price and reducing risk to a minimum is number three. Playing call options is just that, playing. It may come in handy from time to time but it is definitely not a priority. Don't be in a hurry to buy; the current environment will offer plenty of opportunities so don't shoot all your powder right now. And when everybody is shouting "Buy, buy, buy!", you sell, sell and … sell."

Friday, September 3, 2010

Life is not fair, get used to it! Really?

Potash is well below its price peak earlier in 2007-2008. The market in potash has fallen dramatically over the last few years, but has turned around lately. The issue with potash in fertilizer is that farmers, during bad economic times can skip applying it for 1 and a maximum of 2 years. That time frame is now over and like drug addicts they now badly need their fertilizer shots.

Both Agrium and Potash (POT) saw demand shoot up in the last quarter and more is to follow. So many small investors were hoping to recover their losses or make a quick buck. Of course, Billiton also sees this oppertunity and tries to buy when even with a 30% premium they still buy POT cheap.

In takeovers, it is usually the 'small investor' who loses. I have been going through this over and over again. You find a good investment and then a bully like BHP comes in and steals the deal from you. Small investors get steamrolled in these deals and end up having no choice but surrendering their shares because 'big money' has decided so. Basically POT management and BHP are the big winners in this take-over if successful. It is not in the interest of the investor who loses out on a good holding in their portfolio for years to come. A lot more profit than the current offered 30% premium over market price!

I owned Potash and bought it cheap a few months prior to the take over. I took advantage of the initial speculative frenzy and sold at $155. BHP is the only bidder and it will likely go for $130-$140. The only thing that can really stop this deal is government interference. This depends on how Saskatchewan feels about the new ownership and its impact on royalty income and employment. The Chinese are known to be ruthless and as such, their ownership would likely to be considered against the interest of Canada and in particular against Saskatchewan.

So basically, this is not even a 50/50 split typical REIN joint venture (and I think even this split is too high when you don't put up the money). This is at best a distorted artificially low sale of the property and then you, the small investor, will get a 10/90 (for the executive) split. Also, executives are often not the founders of a company and they often cannot claim responsiblity for the corp's growth over the years. They don't take any risks either other than that after a few years at the corporate helm they may have kept (as in this case) profits at an acceptable level. How much of the profits are due to market forces rather than skill is highly questionable and for that dubious contribution management walks away with many millions. If the entire senior executive is included their haul will likely approach a billion.

When senior managers make a 100 times or more what the normal basic staff makes, things are clearly out of whack. This is not a 'free market' this stuff is rigged; even the appointment of the senior executive is rigged and hardly decided by the shareholders but by management's buddies on the board of directors. There are of course exceptions but in general shareholders are not much more than glorified lenders who better do what the management and the board wants. Because, although management has often little money in these companies invested themselves, although they often haven't build the company over many years like company founders and many employees; they tend to be in power and take a lot of the profits. Executive compensation is completely out of whack and certainly not an example of capitalism at its best! If senior managers don't get more reasonable with compensation, this may become an area of government regulation! Not something to be desired, but then neither is current behavior of the management class.

My two cents.

Thursday, September 2, 2010

Have you followed the economic news lately?

Things aren't that bad after all! Unemployment claims are down in the U.S. over the last 2 weeks. Uh? What? Oh and the European Central Bank announced that economic growth has increased from 1% in June to 1.4% today and sees future growth at 1.6%. What European credit crisis?

2nd quarter corporate earnings in the U.S. were better than expected. However the constant fretting about the economy has made consumers a bit more pessimistic (surprised?) and energy prices moved down so Canadian earnings were a bit less than expected.

And now the U.S. factory sector grew faster than expected in August.

"We're in the middle of what is typically a growth scare, where the economic cycle slows down after an initial run up as stimulus fades and we transition from stimulus to having the economy standing on its own," said Jason Pride, director of investment strategy at Glenmede Investment and Wealth Management in Philadelphia.  I have no idea who Jason Pride is, but a lot of my experienced friends in the oil patch have recently little trouble to get jobs. That is a sudden turn-around; just a month ago everyone felt pretty down.

So, are we going to boom suddenly? Not likely but there is light at the end of this depressing quarter's dark tunnel. Probably Ken Fisher's statement that things are always different than the masses expected will be proven right again. September and October markets may surprise us on the positive side. As Don Campbell of REIN always says: "Ah... the W" (well I paraphrased, Don never says 'Oh... and Ah... ').

Wednesday, September 1, 2010

Is there an housing bubble in Canada?

I stole this topic and the accompanying links from the REIN forum and posted my own on this topic below:
  1.  http://www.financialpost.com/news/Housing+will+banks+next+sore+spot/3466046/story.html
  2.  http://www.financialpost.com/related/topics/Report+warns+housing+bubble/3462634/story.html
Really, the question should be: If renting is cheaper than owning a house then why buy real estate?

For an investor to buy a rental property is only worthwhile when he/she makes a profit. At REIN we prefer that the rent is higher than the cost of owning the property, how else do you achieve positive cash flow?

The added profit bonus of appreciation most of us consider speculative. First priority is to have enough cash flow to hold on to the property infinitely (we can choose when to sell). As Thomas always points out there is also the mortgage paydown. So when determining when an investment is worthwhile, you may want to include this in your assesment as well. Then you should consider investing only when net income (so net cashflow plus mortgage paydown and excluding appreciation) is positive.

Real estate markets and individual deals should be considered on their own merits not on arm-waving national studies. As pointed out in other posts, don't try to time the market, only buy when the price is right!

So is it always better to invest in real estate? No! Do we have a bubble? Who cares! As long as the property(ies) we buy meet(s) OUR investment criteria and we can hold on to them for the long term.