Sunday, July 6, 2014

Perma-Bear or Perma-Bull? Who cares!

Anyone following this blog on a regular basis knows that my posts swing from optimistic to cautious.  This reflects my real thinking, I am neither a perma-bear nor a perma-bull.  Nobody really knows the future and so based on the continuous influx of new data, my ideas change.  In fact, you should read these posts more as likely investment scenarios and each scenario has its own assessment of risk and upside. By nature, I am optimistic – why else would I invest if I don’t believe in an ever improving and growing economy and the fact that I believe in buying (part) ownership in various good to great businesses. 
Although investor focus these days is often focused on macro-economics – really we should be focusing on buying profitable businesses at a good price.  Sometimes, when we putting on our true value investing hat, we may buy assets of an underperforming business expecting that the market will take care of bad management teams while the assets themselves are for sale at a large discount.  So we buy assets for pennies on the dollar while we expect that its underperforming management team will be disposed of by activist investors or shareholders or even creditors who demand performance. 
Of course, in buoyant or even euphoric markets, buying assets at a discount or buying good or great businesses for a good price will become more and more difficult and we will buy less and less while our cash accumulates.  In the meantime, there may be opportunities to sell some assets at crazy high prices and that will help our cash position as well. Euphoric markets are like the game of musical chairs and the higher the markets go the less chairs are available for the participants until the market crashes and many investors end up without a chair. That is why we use trailing stop losses – we hold on until a significant crash and sell. The stop loss trigger is the ultimate emergency break which allows us to have investable cash at the market bottom.
My macro-economic outlook, or my most likely general investment scenario, is simple – we likely will be in a bull market until short term interest rates exceed 4%.  Next we probably get another debt crisis; most likely a crisis in government debt. Earlier, I saw this happen in the first half of 2015; but I think now that a crash may be further out – say 2016 or 2017. But whatever the case, the crash will happen. With stocks becoming increasingly less attractive for buying and with the upside being limited, this is a time to hold on to your shares but not buy a lot more. You can increase your cash flow by trading in options but with current market volatility so low option premiums are on slim.  This is a time to be conservative.
Strangely enough, the resource sectors, in particular mining, agriculture and precious metals in general have been the market laggards; even energy companies are still on the cheap side. Many retail investors are still traumatized by 2008 and 2013; thus I still see in these market segments a lot of upside. I work in the Canadian oil patch and we still have every month layoffs. Companies are feverishly cutting operating expenses in spite of high oil prices and significantly recovered natural gas prices. Basically, they still are cutting the excesses from the 2004-2007 boom. Gold miners and other miners are in the process doing the same. So even IF commodity prices would not further increase these companies will be performing better over the coming year or two.  No wonder the TSX has taken off over the last 6 months or so.
But the dormant inflation and under-estimated GDP growth are about to change. Recently consumer price indexes have increased. U.S. unemployment rate has fallen to 6.1% and showed some surprising strength. No wonder consumer confidence is improving more rapidly. Did you notice recently price increases (hidden by decrease packaging sizes or in plain nominal price)?  Booming car sales and improved wage growth?  These are all initial inflation indicators.  Then there are the large number of world economies such as Japan and Europe that are copying the U.S. central bank in increasing money supply, by lowering interest rates, and other forms of economic stimulation. All this points to rising inflation.  During inflationary times resource stocks tend to do well especially with increased political instability such as now in the Ukraine, the Middle East and in the Japan-Vietnam-China area. So my view is that in this last leg of the bull market, which may be lasting another 12 to 24 months, you will find the best opportunities in the resource sector; in particular in precious metals. While financial sectors may start to market perform or underperform.
Remember the saying that a bull market raises all ships?  Well, one of the most liquid forms of investments are ETFs , in particular market ETFs.  So if you want to become more conservative but still stay in the stock market buy ETFs of the TSX through your discount broker which lets you sell them at the first sign of trouble for minimal commissions.  Only do so if your cash levels exceed 20% of your paper securities portfolio and use a conservative stop loss of 15% (it doesn’t cost a lot in commissions to buy back in if you sold too early).  Better use collared options on the ETFs to protect your musical chairs investment and augment your income.

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