Monday, September 26, 2011

A change in tune for older birds

Overall I am a pretty optimistic fellow, but… In today’s world of gray and black prognosticators it is hard to stay the course. The economic news is grim, oil prices and copper are trending down, consumer confidence is falling; there is a complete lack of political leadership. In the U.S. on the eve of the 2012 election, Democrats and Republicans keep on posturing rather than compromising on how to handle the fiscal environment; Europe is not much better. How come, financial experts keep on telling us that the European bail-out fund now at nearly 450 billion Euros is not sufficient and needs to be closer to 1 trillion when the entire Greek debt load is barely 200 billion? At the end of the tunnel there is fog not light!

We’re living in an oversupply of inaccurate information; we’re living in a vacuum of real information! There is no visibility! We hear more and more people forecasting doomsday and even the few optimists do not forecast a bull market for the coming year. Yes, over the long term things will work out and for young investors this is the time to look for value investments that will pay-off 3 to 5 years from now – don’t be in a hurry though. For older investors and retirees who need not only cash to buy stocks at very good prices but who also may need to live of their investment cash (flow), it may be time to sell off riskier stocks – not good dividend paying stocks though. Sell some winners and losers to stay capital gains (tax) neutral. This will give you maximum cash.

If there is another down leg to this bear market correction we will be in a position to take advantage of buying opportunities later on. On the otherhand, if the market keeps on hovering at these levels we, older investors, will at least be able to sleep through the night. This is not a panic reaction at the bottom of a bear market! This is a strategy for the mature investor, whose time horizon is short and whose 2008 scars are not yet healed. I guess, being an older bird, I have changed my tune.

Wednesday, September 21, 2011

ETF soup – time bombs

ETFs are quickly becoming a morass of obfuscation. In the Financial Post of September 20, Jonathan Chevreau writes about creating an entire risk hedged portfolio from ETFs that represent a wide range of asset classes including corporate bonds, commodities, REITs and of course normal stock market indexes. The reason for all these different ETFs that are currently flooding the Canadian investment world is obvious: profits! Profits for the issuing companies that is.

In addition to iShares and Claymore, we now can also buy ETFs from many of the banks, Horizons BetaPro, PowerShares Canada, and First Asset Management; just to mention a few. The new idea is to create not only a diversified stock portfolio but a diversified investment portfolio of ETFs comprising asset classes that do not ‘correlate well’. That is, when one asset class rises in value another may fall or does not change. Asset classes that correlate perfectly have a correlation of 1.0 and those that act exactly the opposite have a correlation of -1.0  (minus 1.0). A portfolio of assets that does not correlate well provides protection against price volatility. Of course, building on people’s greed, the next step would NOT be a diversified portfolio with less volatility. Instead, now you can buy higher risk investments with less volatility and a higher return… yeah right!

ETFs are not-actively managed and some discount brokers do not even charge a commission when buying or selling them. You may wonder how then do these brokers make money? Well, one of Jonathan’s concluding remarks may shed light on this: “I’d say 99.9% of retail investors will need professional help pulling this all off. Try going it alone and DIY will end up meaning ‘do it TO yourself’”.

My take is to stay away from this stuff. Only use simple ETF’s such as discussed earlier on this blog. Make sure, your ETFs are not derivatives but that they actually own the assets. For example, when buying a Gold ETF make sure it really owns the gold bullion. When buying an ETF representing the Dow Jones, make sure it owns the underlying stocks not some options.

In today’s markets it is hard for the money types to make money; so they’re dreaming up any scheme to make a living - usually at your expense! With every new twist they’re trying to convince you to give them your money. Now ask why that is? Because they don’t have it themselves! ETFs these days are quickly becoming a mishmash of derivatives that can only be understood by the ‘experts’ just like structured investment vehicles, default swaps and subprime mortgages. Remember how Warren Buffett sees derivatives: “I view derivatives as time bombs, both for the parties that deal in them and the economic system

Friday, September 16, 2011

Glimmers of hope

"Not all that glitters is gold", say the Doom-and-Gloomers! Economics are not without reason called the 'Dismal Science'. That becomes abundantly clear when we hear the moaning and groaning from the dismal corner and compare it with facts. ATB's Daily Bulletin (subscribe to this less than dismal economic thermometer) showed the September retail sales. You may remember last month's Personal Consumption graph when the trend was less clear! Last month it could be argued that consumer spending was about to fall off the cliff just like it did in the 3rd quarter of 2008 before the Great You-Know-What. With the negativity of August's Debt Ceiling debacle, the Japanese Earthquake fall-out and the 'crashing' stock market one may have expected the U.S. consumer to hide under a rock. But that did not happen – the pessimists are wrong once again. Yes growth in U.S. retail and food sales slowed down but sales did NOT fall.

And another tidbit was hidden below an avalanche of negative headlines! U.S. consumer sentiment inched up from 55.7 to 57.8 based on the Thomson Reuters/University of Michigan's preliminary reading. You know what the headline was? "U.S. consumer sentiment edges up, but expectations lowest in 31 years" So much for a bit of encouragement!

Once again some progress was made in Europe with the Greek debt issue. It won't be resolved overnight and yes, politicians may not take the harsh and unpopular measures the bond vigilantes demand along with their dismal brothers. But the world is not only governed by numbers and stats; there is also a human element. I bet you wouldn't be so eager to reduce the Greek deficit if your father's state pension was cut down! Furthermore, severe cut backs in government spending also cuts jobs and lowers economic output. Remember the outcry a month ago about falling GDP and rising unemployment – that was due to government cut backs and everyone was in a panic! There is a balance between debt and cuts; governments have to walk a narrow line.

Media sell fear not reality! The headlines are full of negative extrapolations and bearish forecasters. Who wants to know that things work out and that you don't have to worry that much. That you can enjoy your weekend breakfast in peace rather than reading the fear mongering newspapers back to front in order to raise media advertising revenue! Why do fund and wealth managers speak so gloomily on BNN? Well that is easy! First of all they won't be quoted by said media if they are not scary! Second, they have to show how badly you, the investor sucker, need them, the super smart wealth managers! How else can they attract new clientele! As Don Campbell of REIN says: "Look behind the curtain!"

David Chilton, in the "The Wealthy Barber" has also a little nugget for you: "It's a mathematically certainty that investors who buy market-matching index funds will outperform the majority of investors who attempt to outperform market-matching index funds." Even if all wealth managers were as good as Charlie Munger, Warren Buffett and George Soros, the total result would be average market performance with some of these managers under performing and some that will outperform. But to guess who will outperform is near impossible to guess. Even worse, if you buy the ETF, you would pay less in commissions and compensation than if you engaged these fine managers and thus : "accepting the market averages (minus a bit for costs) makes you an above average investor."

Now, this is a bit of an oversimplification because the average retail investor underperforms the stock market indexes significantly. So there must be others that outperform. Statistical analysis has shown that over the long term, investing in low valued dividend paying stocks and reinvesting those dividends does outperform the market  (see earlier postings of Dreman and Siegel). After all, the market also includes a lot of 'garbage' stocks. But it requires a lot of discipline and restraining your emotions, something most investors just cannot handle.

The consumer data shows me that we are not in recession territory and that we will continue the economic recovery. So don't give in to the scaremongering – stick to your guns.

Wednesday, September 14, 2011

My net worth did barely increase the last 5 years. Is that bad?

We seem to always focus on how much more our net worth compares to last year or five years ago. Since 2007, my net worth graph shows barely an increase. Yet is that bad?

This is the frustration many of us investors may feel. Because that is how we measure our investment success. Professional managers compare their performance with that of a benchmark index, e.g. the total performance of the S&P/TSX. This may sound like a cop out, but it is a known fact that the indexes often outperform the professionals! Hence the advance of the ETF.

But let's look at our performance in terms of valuation and cash flow. Now an entirely different picture arises. Let's look at one stock in particular to get this point across; yeah let's use Microsoft. In 2001, just before the hi-tech crash, it traded around $55 per share and today that same share trades at $26.50 Oh, that is terrible; especially when you bought at the peak, because then you lost over 50% of your portfolio value.

What are we really buying as shareholders? Earnings and Earnings growth! In 2001, Microsoft earned $0.66 per share; in 2011 its earnings are expected to reach $2.69. Wow that is a heartwarming fourfold increase or an average earnings growth of 22% per year. So it was not Microsoft, the company, that underperformed; it was the stock which traded in 2001 at a price earnings ratio (P/E) of 83 and today that same stock trades at a P/E of just below 10.

In 2001, investors paid 83 dollars for $1 of Microsoft earnings and today they pay just below $10. Now compare that to interest on a 5 year Government of Canada Bond which yields today 1.45% or so. That means the bond pays $1.41 for each $100 principal or investors pay nearly $71 to earn $1 on interest earnings (BEFORE TAX!) So what has changed? Investor perception, which is often irrational, has changed. Even better, Microsoft currently has $52 billion dollars of cash on its balance sheet or $6.11 per share. That means that if you were paid out the cash, each stock would trade at $20.50 and it still earns $2.69 that would be a P/E of 7.6 or an earnings yield of 13% compared to 1.45% on a Government of Canada Bond.

So in terms of today's valuation, a 2001 Microsoft share is worth $6.6 compared to $26.50 for today's Microsoft. Just as much as the cash holdings of one Microsoft share today! O.K. You may say that is nice, but all that earning's growth of Microsoft happened probably early on between 2001 and 2005; today its earnings grow a lot less! Wrong, in 2010 Microsoft earned $2.10 per share and a year later in 2011 it made $2.69. That is an annual earnings increase of 28%! Oh, and it pays currently a dividend of $0.64 per year or 2.4% compared to the bond's yield of 1.45%. In 2001 there were no Microsoft dividends!

So, it is investor psychology! In today's low valuation markets we're willing to pay much less for a dollar of corporate earnings than 10 years ago, or than in 2007. If markets were to return to more normal valuations a company like Microsoft would be trading around 15 times earnings or $40. Many other stocks are in a similar situation today. In terms of 'earnings yield' today's stock markets should be priced nearly 30% worth higher than they are.

It is the bearish sentiment of today's investors who discount everything that can go wrong with the economy and more. In fact, they have discounted the market prices so much that the 24% decline of the average bear market would result in a higher valuation than we have today! 40% of today's investors are bearish (think that the market will decline even more) and this is near record highs. Typically such high rates of bear sentiment indicate a nearby market bottom.

Now look again at your portfolio in terms of number of shares and the average earnings per share. Think of the dividend income from the last 5 years that you converted into additional stocks. Think of the cash in your portfolio which you can use to buy even more cheap shares. Now, how do you feel about those so-called lost years when you bought shares on sale from your dividend income and when you high graded the quality of your stock portfolio? Do you still feel that the last 5 years were for nop?

These years were not lost; these were the years where you weeded out the crap and where you created a dream portfolio the benefits of which you'll be reaping for years to come!

Monday, September 12, 2011

Did we really make that little progress?

Sometimes I scan back over past posts to see how 'good' or 'bad' my ideas were. Mostly I get red-faced when seeing all the spelling and grammar mistakes. Sometimes, I feel that I was right-on.

About a year ago I posted: How would the investment world look like with a stagnating economy? It  reads as if written for today! So little has changed, we are in a very similar market as last summer and we still worry about Europe and a double dip, though the last recession was nearly two to three years ago.

We are truly going through a stagnating economy and rereading this post may be of help.

Stop Acting Rich…

And start living like a real millionaire. That is the title of yet another book from 'The Millionaire Next Door' author Thomas J. Stanley… PhD. It is one of those books where you get its message in the first 10 pages and the rest of the book is a never ending rehash of that theme. It is terrible reading, but aside from getting to the point, it presents the true reason that people become rich.

'The Wealthy Barber Returns' is David Chilton's sequel to Canada's most successful personal investing book: 'The Wealthy Barber'. Its main theme is exactly the same as that of Thomas Stanley's books and it is a lot more fun to read. Here is the premise of David's book that is supported by Thomas Stanley's research: High Income Earners tend to be high spenders, desperate to keep up with the Joneses and typically have the hardest time to convert their earning's power into net worth. Millionaires, on the other hand, are often persons of moderate income such as teachers and down-to-earth engineers who live below their means, do not keep up with the Joneses, drive normal cars and don't live in million dollar plus homes located in trendy neighbourhoods.

According to David Chilton it all is in our genetic make-up. It is in our brain architecture and neurology. Strange how this theme of new scientific ideas from the world of neurology seems to permeate today's personal finance theory. There are whole books dedicated to reprogramming your brain. First to my mind comes "The Answer" a book loaded in my playbook's Kobo module along with 'This Time us Different' by Reinhart and Rogoff (more about that in later posts). 'The Answer' is written by John Assaraf and Murray Smith, highly successful entrepreneurs with a Canadian twist. Their book is a programming manual… for your brain written in semi-scientific fashion with some entertainment value. For some subconscious reason I am not able to finish it. Maybe I am reading too many books at once. But in spite of that, the first 30% of the book (that is where I am now) is definitely interesting reading.

So all this points into the same direction! We have little control of our spending habits; we have urges to display our wealth and status [real or aspired]. We crave for status, for 'keeping up with the Joneses'. It all goes back to the primitive urges of the reptilian part of the brain as these books state; that component of the brain that is geared to an earlier, more primitive stage of our evolution requiring instant reactions and instant gratification, i.e. survival response. The 'How can you plan for the future when you're dead?' mechanism. The latest evolved portion of our brain, called 'the executive', is the part that reasons and plans. Problem is that plans are often not implemented and behaviour engrained in our reptile brain portion is what ultimately keeps us from realizing our plans. It is a matter of not only planning but also of programming the behavior needed to execute our plans in our reptile neural pathways.

Stanley's high income earners are often people such as lawyers and doctors who live in trendy neighbourhoods, drive luxury cars, have wine collections and eat out in fancy restaurants with annual vacations in the finest resorts. Most of them spend their income rather than save it. The majority of million dollar home owners are… not millionaires but high income earning big spenders. They keep up with the Joneses and have this need to display their 'wealth' which they don't really have.

The real millionaires live below their means, don't care about Harry Rosen suites and prefer Tip Top Tailors or T-shirts from Wal-Mart. They live frugal without excess. They aim for quality and long lasting assets without debt. They don't need approval from their neighbours or society. Many are family oriented people that build their own business or are people that are good at converting their often modest earnings into assets – net worth! Assets make money; liabilities costs money! A boat is a liability; a rental property is an asset. So are savings accounts; a stock and bond portfolio, etc.

A residence can be an asset as long as you don't live in one that is more than you need! Larger houses are money pits! High energy consumption, insurance, property taxes, and excessive maintenance. Everyone NEEDS to live somewhere with a certain amount of comfort; but who needs two Jacuzzis; three car garages; 5000 sqft living space and marble topped kitchen islands the size of New York stadium?

So here is my little reprogramming exercise: rather than keeping up with the Joneses and derive pleasure from your latest leased BMW, derive pleasure from your latest investment and gloat about how much richer you are than your fast spending, near broke neighbours who recently bought a lot besides your own place for 5 times the price that you paid for your entire house 20 years ago and who are spending another cool million to break the square footage record. Now program that into your reptilian brain to become rich! Do like Warren Buffet, every time you pull out your wallet, fret about how much that dollar you spend will be worth 20 or 30 years from now. Ouch, I just spend $50 on a candy bar!

Thomas J. Stanley's title of his latest book says it all: Stop Acting Rich… And start living like a real millionaire.

Saturday, September 10, 2011

Loose Ends

Rob Carrick, personal finance columnist at the Globe and Mail interviewed David Chilton, author of the Wealthy Barber and recently of "The Wealthy Barber Returns". Rob states that for him, the Wealthy Barber is one of the most influential personal finance books in Canada. I tend to agree and just spend some hard earned money on the Return. If you want to learn more about this author, visit the Globe and Mail website:

Emotion driven investment transactions typically result in underperformance. And… it is so easy to do. I see it in myself. I know that in today's choppy scary market stocks are cheap and that this is the time to use your cash. Yet, I tend to buy on up days; the down days are too scary. I should do the opposite but in spite of all my investment experience, I still tend to run somewhat with the stampeding herds. At least, I refrain from selling. Again, don't sell in these depressed markets; once things pick up and your portfolio is recovering you're likely to make a less emotional 'sell' decision.

What to sell?

That is not easy. Once markets have fallen, risk of falling further is typically less. Risk of a falling market is highest at the peak, when most investors are euphorically buying. Over the long term, real estate and stock markets provide the best investment returns. Certainly when compared to 'safe' investments such as GICs and money market funds. So, especially during down turns and recoveries, the last thing you'd want to sell is a stock portfolio which is likely to provide you superior returns during the rest of the business cycle.

The best way to look at your portfolio is not by looking back and mourning how much you lost! That is useless and often damaging to your portfolio performance. Instead you look at how to get the best return on your current portfolio! The first thing you do is looking at your asset allocation. Recent winners or market out-performers tend to form an increasingly larger portion of your portfolio, while the proportion of losers declines. What proportions or 'weightings' you assign to your investments depends on your personal investment strategy, personality and situation in life. Typically, a stock should not make up more than 5% of your portfolio. Thus, if you own more than a 5% weighting of a particular stock in your portfolio then it is time to sell some of it and use it to buy something else – start by considering adding to the underweighted positions already in your portfolio.

Every time that you review your portfolio, ask yourself whether your current stock holdings give you the best performance. For example, Yellow Media may have fallen from $2.40 to $0.70. Don't look at the past losses! Instead ask yourself: if you sell Yellow Media today would you be able to invest that money in a more promising investment? What will give you the best potential rate of return at an acceptable risk level? If your evaluation shows that you can make a better return elsewhere, then sell Yellow Media and buy the other investment opportunity. Otherwise, hang on. Make sure that your decision is not based on stubborn emotion but that it is based strictly on the numbers. Leave emotion out of it!

In my last post, I suggested another emotion free strategy for investing. Buy a fixed dollar amount of investments, typically an index ETF, every month and once per year make with the rest of your cash savings a 'one-time' investment. This may be sounding contradictory to my earlier advice of buying an investment in steps (How to take advantage of the U.S. debt circus - II ). This doesn't have to be. Your one-time-annual investment does not have to be one 'single' transaction. You can buy in steps, and I would advise you to do so especially when you're dealing with larger amounts. As in said posting, you may decide to buy $5000 worth of DIA Spiders and buy them in smaller portions at different, preselected time points.

The same would be true for any buying in a down market. Nobody times the market perfectly, and certainly not market bottoms. So do not burn all your powder in one single purchase. Buy at regular intervals along a market bottom. For example, in the post: Bull and Bear Market Analysis we learned that the time from bottom to peak averages 2.3 years. I estimate that the bottoming process of a downturn lasts typically 1 year. Now decide to start buying from the time you reached the average decline of a bear market (24%) or from the point that you reach bear market territory (after a20% market decline) and plan over the next year to spend your available investment cash once per month, or once every two months, i.e. invest amounts of 8% or 16% of your cash respectively. That should keep the emotions away.

Corrections last shorter. Summer corrections are not uncommon and last typically one to 3 months, followed by a recovery starting in late September until January of the next year. So decide to buy your 'once-a-year' investments in three equal tranches in early October, early November and early December.

I hope these tidbits help you to tie together the loose ends of my summer postings.


Tuesday, September 6, 2011

Another recession?

Risk management is asking yourself a lot of 'What if" questions and building in the rewards of the good and the set-backs of the bad scenarios into your portfolio. Buying the Materials ETF (XMA) should let us benefit from continued growth in China and other BRIC countries without the risks of another Sino-Forest debacle and even with another potential recession in North America.

But if a recession is coming, is it with today's doom and gloom already build into the stock market or will the market fall even further? Say it falls another 20 or 30% as Gordon Pape asks himself gloomily in today's Globe Investor Gold, then what? You can wonder about all these scenarios but no-one knows for sure.

Really what are we trying to do, market timing? Have we already forgotten the lessons of our earlier analysis? The best returns come from buying at regular intervals regardless of market prices. Buy good companies at good prices or buy whole indexes and reinvest the dividends.

A large portion of our profits comes from dividends and reinvesting dividends. If you are out of the market you don't get dividends! Appreciation is important but it is unpredictable and delivers only over the long term. We learned this for real estate, but really it is also essential when investing in the stock market. You buy assets first and all for cash flow; thus you can sit out the downturns and you aren't forced to sell! Appreciation will take care of itself! If we are getting another recession there may be yet another buying opportunity during which we can boost our future profits even more! You don't want to buy at market peaks, but you cannot time the markets!

So here is the deal. Make a commitment to buy every month a fixed amount of stock, no matter what the market does. If you work through a discount broker, even buying small amounts is not going to cost you tonnes in commission. You save 10% of your gross income and you commit to buy stocks with half of your monthly savings. Someone earning $50,000 annually saves $5000 per year and invests every month $208.33 into a TSX ETF like aforementioned iShares S&P TSX60 Fund (symbol XIU). The remainder of your savings and investment income you use for one annual investment: a good solid company or ETF. Examples are Microsoft or the iShares S&P/TSX Capped Materials Index Fund (XMA). The timing for buying is up to you, but really there is only one thing that should guide you: buy a good investment at the right price! Now you're done and you can return to learning about investing at this blog, study stocks on your own, prepare yourself for an investment in real estate, or enjoy time with your family. Don't fret about the doom and gloom and sleep well at night. Voila!

Monday, September 5, 2011

Golden Opportunity?

The price chart of gold (see earlier post) has gone 'hyperbolic', a sign that suggests we're in one of those feared 'bubble markets'. You may suspect that the gold price is not in a bubble but rather that the U.S. dollar is in free-fall. However, many major investors seem now to have reached the conclusion that the devaluation of the U.S. dollar is overdone and that in spite of everything, compared to other parts of the world the U.S. is a safe haven. Many market analysts and investors have noted that the price of gold has risen dramatically but not so the price of gold producers. Here lies an opportunity.

Furthermore, the demand of a growing world population for ever increasing amounts of food have made companies such as Potash ,which mine key ingredients for fertilizer, look very attractive while the scared markets have only in part recognized their value. Finally, commodity demand will increase as long as BRIC countries keep on growing their economies. Yes China and India maybe fighting inflation, but their economies still grow between 6 and 10% annually.

Canada is sitting in a sweet spot, but we're not all experts in all those different industries. So here may be a hedge against sluggish North American economic growth, invest in an ETF that holds all the stuff mentioned above: iShares S&P/TSX Capped Materials Index Fund or XMA. Below are the top holdings.

% of Fund

The Great Recovery

These days of volatility and uncertainty seem only to spell doom and gloom. Many economists are putting a 40% probability on a double-dip recession; others think the Great Recession has never ended. It is possible that their black views are right, but, in my opinion, a second recession if it happens will likely be short lived.

In earlier posts I foresaw a significant revival of the U.S. economy despite the political impotence displayed by the Republican and Democratic parties. I pointed to the U.S. freedom to innovate; its entrepreneurial spirit and North America's relative abundance of resources as opposed to China. In this post, I want to present to you U.S.' secret weapon: Demographics!

According to Richard Dolan author of 'Life Rich Real Estate', there are four generations of Americans and Canadians waiting to buy their 'home away from home'. Recreational properties and investment properties are the targets. In addition, every year since 2008 over 1 million properties have been foreclosed upon in the U.S. According to U.S. rules, people who have been foreclosed upon 3 years ago are becoming now once again eligible for mortgages. So starting in 2012 every year 1 million previously foreclosed people may return into the real estate market.

If the U.S. was overbuild between 2000 and 2007; the pendulum has now gone to the other extreme and over the last 4 years housing starts have been far below the levels needed for U.S. population growth (9.7% over the last 10 years). European populations may be shrinking but not that of the U.S. The demand for 2nd homes or rental properties combined with the housing demand of a growing population and the annual return of 1 million potential home buyers that are once again eligible for mortgages suggest a strongly improving housing market for the U.S. in the not-too-distant future.

New housing and increased property purchases will lead to all kinds of product demands and a reinvigorated U.S. consumer. This may be the spark that the U.S. economy needs to rise from its economic doldrums. Without this spark we may continue to experience the sluggish recovery that started in 2009 but the revival of the U.S. housing market in 2012-2013 could well be the game changer that makes this the 'Great Recovery'.