Saturday, February 28, 2015

More thoughts on diversification - My job in the oil patch

With oil prices in the doldrums, my job security has suddenly declined big time; the Alberta’s real estate and rental real estate market may be affected as well but that is not yet that discernable. Yes there are a lot of new listings; but does that mean that properties are dumped in a panic and prices crash? I don’t know yet – it may take a while for the fog of war to lift and reveal a clearer picture.

If I owned a lot of oil stocks, in particular junior oil stocks right now things would definitely look a lot dicier. As an oil industry employee, my employment and salary are tied to oil and gas prices. Neither look great right now. I am participating in the company savings plan which is invested in shares of my employer and in cash. In spite of my employers complementary contributions, the losses in hat savings plan have been adding up. Great for off-setting capital gains elsewhere in my portfolio but not so great for my moral!
So, if my oil job salary brings in cash flow every month, just like my stock dividends and rental income add to cash flow then shouldn’t I consider my oil & gas expertise to be an asset just like my stock and real estate holdings?  If the answer is yes, than how much does my oil & gas expertise add to my net worth? Also, with maybe just a decade or so left prior to my permanent withdrawal for the oil industry would that net worth be less than that of a 25 year old, assuming there is a long career left for him or her in the oil patch?  Basically, isn’t that a matter of Net Present Value (NPV)?
Say my annual salary is $100,000 and I’ll be making that plus a 4% annual salary increase for the next 10 years, with an investment horizon of 25 years, what is the NPV of my job? Spreadsheet please!  So for an old geezer such as myself, a $100,000 job would have a NPV of $757,000 and for a 25 year old, it would be worth $1.3 million (this does not take into account the cost of living and taxes but then neither would that typically figure in your investments).
Now, when allocating your net worth to various assets, you would need quite a large portfolio without oil before $1.3 million or even $757,000 would represent the oil & gas sector's market weight of the TSX or even worse market weight of the Dow Jones or S&P500!   Add to that your oil holdings in your company savings plan and your asset allocation would require even less oil and gas holdings in your stock portfolio.
Many oil workers, contrary to the above love investing in junior oil companies and mining. But is that putting all your eggs into one basket?  I think so and as such, petroleum industry workers should – no matter how tempting – avoid investing or worse speculating in oil and gas.  The same would be true for an auto worker in Eastern Canada regarding investing in the auto industry.

Saturday, February 21, 2015

The Next Market Crash may Not be Far Away!

Today, a lot of uncertainty exists in the market and January 2015 started with an increased amount of market volatility – especially for commodity oriented investors.  Diversification into the U.S. markets should have helped mitigating the ups-and-downs of our own Canadian TSX. As discussed earlier the U.S. dollar is in rocket trajectory compared to other currencies and many commodities appear to be in free fall. The U.S. market peaked in December 2014 and today seems to be a good time to revisit the topic of market cyclicity and diversification.

Have a look at stock market patterns as described in an older post. At first sight, bull and bear markets seem to be cyclic, but the underlying fundamentals of the markets seem to change every day.  To see parallels between the 1970s and today, as many gurus have done is kind of na├»ve.  It assumes that history repeats itself and thus is cyclic.  If that was true, the world would move in circles without real progress.  That is a simplistic view – to think that life today is just like some 30 or 40 or 100 years ago is absurd. Today’s world is entirely unique– just think of our technological progress; about our life expectancy; about our lifestyle!  Think about progress in human rights and many other areas and you must admit that these gurus are comparing apples with oranges if not with strawberries.
Our productivity on earth has gone up and every step we’re taking is into a new frontier. Yet certain things seemto be somewhat repetitive, for example the ups and downs of stock markets.  In August 2011, we reviewed significant market rises and falls and noted several patterns. See Bull and Bear Market Analysis  Below, I have updated the table in that post.
Table of market peaks and lows between 1929 and today
It shows that the average market cycle lasts 3.6 years and that the longest market cycle, since 1929, lasted 7.17 years. That was during the 2nd world war when the market rose 123%.  The bull market starting in Feb 2009 has now lasted just over six years and after the 2002-2007 cycle it is the third longest on record.  So is there a trend that recent market cycles last longer?  Not really, but it shows how rare those very long cycles are. Having experienced two of the longest bull markets (except the one during World War II) in a row is probably even more unusual.

Market Cycle Duration. Vertical axis = duration of each cycle in years versus time starting in 1930 until today.
Top that off with the fact that the Dow Jones has risen close to 155% from its low in February 2009 and you may start to realize that the U.S. market is at rarified heights. The odds in favor of a bear market coming soon are high.
Here is another matter to consider: Most economies on the globe are currently not performing very well. Canada has been OK but not exactly stellar over the last number of years. This is especially so when you omit the resource sector.  The U.S. economy is currently one of the strongest in the world and that is reflected in the U.S. dollar.  Europe is quite weak, although with the European Central Bank becoming increasingly aggressive with its own version of Quantitative Easing, Europe's economy and stock markets may be ready to catch up.  The strong U.S. dollar on the other hand may lead to reduced U.S. exports and reduced profits for U.S. based multinational companies such as GM, GE, Microsoft, JNJ, Apple, etc.
While around 2008, geographical diversification did not help soften the blow by the financial crises to stock portfolios; now many countries seem to have economies that dance according to their own drum.  Compare Russia’s economy to that of Canada; the U.K. to that of the EU; etc.  This time geographic diversification may be important for protecting your stock portfolio.
How can we translate all this in a less volatile and more prosperous portfolio?  I guess, today proper diversification is very important. Both by geography; sector and by asset classes such as gold, cash, real estate and of course fixed income. Many world renowned investors over and over stress the importance of diversification, including diversification of asset classes.  However, over-diversification, or diworsification as it is referred to by Peter Lynch, is likely to result in underperformance as well.  Are we caught between a rock and a hard place? 
For the coming years, I would stop adding to your U.S. portfolio because of the earlier mentioned concerns.  I would prune that portfolio down to market dominators such as JNJ, Microsoft, Apple and other high quality, dividend paying juggernauts. De-risk this portfolio segment and then let your profits ride. What about just owning a S&P500 or Dow Jones Index ETF such as DIA or XSP (Canadian dollar hedged) as an alternative? Use a tightened stop loss of 15% and let this segment ride out the bull market. Quite often excellent profits can be made in the last stages of a bull market, but you may have to be nimble – like musical chairs – to get out in time. Hence the stop loss. I suggest to have no more that 25% of your ‘investment paper portfolio’ in U.S. markets.  Remember from other posts, that investment paper such as stocks, bonds and cash should not make up more than 50% of your total net worth.
The Canadian energy sector is, along with many other resource sectors, in bear market territory.  I am hopeful, but not certain that this market sector has bottomed. But other sectors of the Canadian market such as the financials, telecom and even real estate trusts are high if not too-high priced. Do not jump with both feet into the resource sector; wait for a clear improvement of prices. You may not catch the bottom – but it is probably better to wait until the next bull market in resources is well on its way – a technical break-out could be the buying signal. Be underweight in dividend paying large caps such as the banks or companies such as Brookfield. Alternatively, only own this market segment through an ETF that mimics the TSX60 (e.g. XIU-T). So hold 25% of your investment paper portfolio in Canadian stocks of which 15% in an XIU like index fund;7.5% (which is overweight) in high quality energy companies such as PEITO, CNRL, and Suncor and 2.5 in an Materials ETF.
Own 5-10% of your investment paper portfolio in physical gold (the global non-fiat currency) and another 15% in cash. You can build your cash by simply not reinvesting incoming dividends and other distributions, including net cash flow from your rental real estate holdings if you own those (see later on).  When you sell off stocks, do not reinvest but first build your cash position and re-invest the remainder according to the investment paper portfolio described in this post.
Now, we have close to 65-75% of your investment paper portfolio allocated.  Next we’re putting 5% in a German ETF and another 5% in a West European ETF to benefit from a recovering Europe. The remaining 15% should be going to fixed income. Possible a 3 year laddered GIC portion (5%) and a short term bond portfolio using an ETF such as XSB (10%).
Paper investments are investments that you don’t control such as stocks and bonds.  This is typically the most liquid portion of your portfolio and should not exceed 50% of your total net worth. The rest of your net worth goes, amongst other assets, towards your personal residence or home. We can write whole assays of how to buy your personal residence.  That is beyond the scope of this posting. I suggest you buy the family house you need to lead a pleasant but not an opulent life. The rest of your net worth should be invested in rental real estate.  If you don’t want to do the rental management yourself, get a good rental manager or participate in a rental pool.  Don’t invest in qualified investor joint ventures – they make often lots of money for the general partner and very little for you.
Also, if you work in a city like Calgary and you work for a local economic pillar like the oil industry, consider carefully your true diversification.  When employed by the oil industry, owning rental properties indirectly influenced by that same oil industry and investing a stock portfolio heavily weighted towards oil and gas companies does not represent a well-diversified portfolio J   The more experience I gain as an investor, the more I realize that your business or employment income ought to be considered an important part of your total net-worth portfolio. We will revisit this topic in later posts.
I think that we should fortify our portfolio for some near future volatility.  I don’t say ‘Sell everything and run for the mountains’.  However, structure your portfolio as described above. Ensure you have the cash flow to avoid any forced selling during rough markets, which in an extreme case may include the loss of your job.  Like a gardener, prune and weed your portfolio gradually until it has the portfolio structure that you desire. Never forget Asset allocation is often more important than the selection of individual stocks.  In fact, Warren Buffett suggests that rather than owning a portfolio of stocks his heirs should be better off by investing in a series stock market index ETFs.
BTW. Recently Tony Robins,  motivational speaker extraordinaire, showed another side of himself with an excellent book on personal finance that I highly recommend: 'MONEY Master the Game'.

Sunday, February 8, 2015

Calgary Real Estate is not reflected in the short term hysteria of the Globe and Mail

You may have read the Globe & Mail recently with its doom-reports on Calgary real estate because of falling oil prices. You’d think when you read these panic articles that Calgary’s real estate market has prices listed as if it were a stock market. Bollocks!

Usually sales results run 2 or 3 months behind.  Also, in winter, real estate markets in Alberta and in Calgary tend to slow dramatically as is. Yes, listings may shoot up because people are concerned about their job security in Calgary, especially those that use high leverage trying to lock in some profits or get back to more conservative debt levels. But when you do that during the slow season, you are setting yourself up and you victimize yourself just like so many retail investors have been doing in the stock market for years.
So, let’s look at some realities when investing in real estate. First of all, large numbers of Calgarians have no mortgage whatsoever on their properties and even a larger number have paid their mortgages off significantly. These people are not in a state off forced sales.
Unless people move out of the city in droves, which is very unlikely, people who sell their houses have to live somewhere else in town. So, what are they going to do, rent? In a city that just a couple of months ago had no rent vacancies?  Not likely. So do they buy another place right away?  It would not make sense for Calgarians to sell their place in a panic, just to turn around and buy another home in the same market.  Realtors would love that… yummy commissions! Real Estate lawyers would salivate too, but net worth would suffer big time.
For many Calgarians, this is not the first downturn in the oil patch. In fact, apart from the 2004 to 2008 boom, since 1980 the oil industry has never been without worries. There is always something to fret about. Since 2008, the industry has limped on one leg(oil) that has been shortened by the land locked position of the province. Think WTI discounts due to Keystone and Northern Gateway and other pipeline projects. And natural gas, the other leg, might as well have been amputated!
Sorry, Globe you are not much better in behavior than some sensationalist tabloid.Now that we had a slightly better week in oil prices ($52 per barrel rather than $45) are you announcing on your front page the next bull market in Calgary housing or yet another shortage of skilled labor?  Yeah the perpetual shortage of labor myth! 

There may be a lack of welders or carpenters from time to time, but ask many engineering students or geology graduates or more senior engineers and landman if it was so easy during the last four or five years to get a job.  Some of my older colleagues with a wealth of experience haven’t worked for several years.  And in today’s market things will be even tougher.

Yes, professionals in the right experience range 5 to 10 years are often in demand because they’re cheap and bright (but lack real experience). This has often been a hiring theme in the industry because many managements feel that technical work is not important; they only want to drill and keep the stock market happy. So, who cares about expertise, after all the suckers of the stock markets respond to every production set back with a mass exodus while any IP3 augmented production increase (some number that borders on fraud) results in jubilations by the press and short sighted oil speculators claiming to be investors will chase up the stock price.
Today’s hero is tomorrow’s villain because it is never the investor’s fault that companies become over-levered and pay exorbitant prices for land and services. But if your BOEs per day don’t go up every quarter (regardless of long term profits) the stock market punishes you with a vengeance. No wonder that the oil patch is a boom and bust game!
So, ignore the Globe and Mail. Ignore the hype. Don’t sell or buy Calgary real estate like speculative stocks. Over the long term, real estate prices appreciate here between 4 to 6% per year. Oil and gas prices always recover while oil service prices retrench until profitability returns and the game starts over – often in a matter of a few quarters or a few years.
What you should avoid buying in Calgary is new, unproven, real estate. This is the most speculative portion of the market. Inexperienced buyers buy those glossed-up, often down-sized, properties at inflated prices with way too much leverage. It is like all those guys and gals buying leased BMWs and Mercedes which get repossessed at the first sign of economic weakness. Not only are those new properties often financially unstable, but nobody knows how many issues were created during construction and have to be ironed out during the first three to five years of operation. This often results in massive special assessments or other large surprise out-of-pocket expenses.
Since Calgary real estate, except for the newest stuff, was recently quite reasonably priced (especially older condominium complexes), the market will likely get past the current hysteria and will do very well over the long term – thank you very much. So do not join the crowd of panicked speculators and keep on investing for the long term.

Peak Oil is real in that we have run out of light oil from easy reservoirs.  The new technologies are right now producing from semi-depleted and poor reservoir quality plays that cannot be produced at today’s prices. Also, don’t forget that nobody knows exactly what the Saudi production capacity is, nor that of many other OPEC countries, because they have always massaged the numbers and kept them close to their chest. How much higher can their production go? Especially since larger and larger volumes of their oil are consumed domestically.
Not only has the technology and oil play quality changed, but also the supply quality has changed. Think about it, in the olden days, oil and gas wells produced for decades, today we produce large volumes from wells that produce not much longer than 2 to 4 years; close to 60% of the oil is produced in the first year! If you don’t think that this has changed the oil and gas game big time then you’d better think again.
Don’t be so sure that the ‘experts’ know where the price of oil is heading. There are no experts, just a bunch of deluded simpletons that lead you down the garden path. It is sad to see that these days many claim to be experts on everything because so much data is available at our fingertips.  The problem is that nobody knows exactly how to interpret this deluge of data properly and how good the data is. This turns every short-term investment decision into not much more than a casino gamble.
Keep your head cool and think what is good for the long term. That strategy is always important when investing but never as important as today!


Sunday, February 1, 2015

Time to sharpen your stop loss triggers

We’re now in the 7th year of the Bull Market if you count from the market bottom of Mar 2009. According to market valuations we’re not super expensive; but coming from the March low of 6000 to today’s 17,000, the Dow has risen nearly 300%.  I remember buying Microsoft for around 18 dollars and recently it traded close to U.S. $50!  This bull market is getting old and don’t forget our adage that the higher a market goes; the higher the risk!

Well, if you read the headlines today, you’d think we’re in a bear market.  Combined with the collapse in most commodity prices, of which oil is the latest one, it is no wonder our own TSX is so wobbly. Worldwide, economic growth is wobbly and unimpressive as well.  There are positive things happening as well: Europe’s latest QE imitations bode well for the EU markets but their economy is far behind the U.S. recovery with the Greek jitters only enforcing overall investor uncertainty.  Now the Canadian banks are in the eyesight of investor temper tantrums.  
Look at the price chart of TD bank shown below for the last 12 months.  It is trading now below its 200-day average and its price trends towards lower lows and lower highs. Technical analysis suggest this is bearish and many fundamental gurus also are less than optimistic about TD’s prospects.  Oh, many forecasters go, that is because of the falling oil prices and its impact on Canada’s economy!  “Oh yeah?” is my response, “Is that why the Dow Jones does exactly the same thing?” (See the other chart below). 

Figure 1 TD 12 year chart shows that it is trading below its 200-day average (yellow line) and the prices go from lower lows to lower highs. Technical analysis suggests this does not bode well.

Oops, the 30 industrials should benefit from low commodity prices!  But many of those industrials are also getting a large portion of their profits from outside the U.S. Those profits are in foreign currencies that have to be converted into a super strong U.S. Dollar when included in the company profits.
The price of oil maybe down due to some oversupply. But all commodities are priced in U.S. dollars and it is that strong dollar that drives these prices down even more, just like it reduces the value of the foreign profits of the Dow Industrials when expressed in U.S. dollars!.  In figure 3 you see the U.S. Dollar plotted against a basket of currencies going back to 2009. You see, the U.S. dollar has gone ballistic.  Recently, only gold has kept up – isn’t that amazing?  So, the U.S. dollar is in bull market territory and nobody sees it coming down. The U.S. dollar market is in a state of euphoria – close to a peak maybe? 

Figure 2 Dow Jones Ondistrials price chart over the last 12 months.

Figure 3. U.S. dollar versus a currency basket (EUR, JPY, GBP, CAD, CHF and SEK) between 2009 and today. Source:
Well maybe! Considering that other countries are cutting their interest rates against a 5% U.S. GDP growth in the 3rd quarter of 2014 and a Central Federal Bank that may raise its short term interest rates later in the year, it is no wonder that the U.S. dollar is in nose-bleed territory! 

So these are indeed uncertain times. Uncertain times are volatile and risky, especially this late in the U.S. stock market bull market.  Here at home things are uncertain as well. This combined with the bearish price trends in Canadian banks AND the Dow makes me very cautious.  I suggest that we all should be cautious and raise our cash position by taking some profits from our biggest winners and offset the gains by selling our biggest and most hopeless losers. This will neutralize our tax burden and fortify our portfolio. I suggest that you raise cash positions in your paper portfolio to between 15 and 30%.  If you own real estate in your overall investment portfolio and this real estate is located in Western Canada, then maybe hold off on buying new properties and make sure that your leverage is not too high! There is a good chance that rental revenue flattens or even falls as a lot of Alberta and Saskatchewan’s economy depends on commodities - in particular on oil and gas.
Finally, rather than using a 25% trailing stop loss, start using a 15% trailing stop loss. This alone may already trigger sales and raise your cash level which, in turn, will fortify you portfolio for rougher times ahead. This is not a time to buy lots of stock; first weather the storm; then when there is light at the end of the dark tunnel start thinking about buying bargains. That time, as said, is not now.

(Self) Education is the foundation of a wealthy life

I didn’t respond to the comment made on a post on this blog a while ago – but now I am ready to do so: I wanted to ask you; if you could advise someone on a career path or a specific job-related skill to learn, what would it be?”
Before giving you my two cents worth, here is a word of caution.  I am not professing to know the right answer on questions of life; I am groping myself and often what may be the right answer today is no longer right tomorrow.  Such is life! Life is truly very dynamic: yesterday energy supply was limited and expensive – today there is abundance and energy is cheap!
Someone’s career path depends on the lifestyle that person wants and where that person’s interest lie. Whether you are 5 or 100 years old, your life is too short to fill your days with things you hate. That doesn’t mean that you always do what is pleasant, it means that you follow the goal(s) you think are worthwhile pursuing and you do what it takes to get there. If it takes a good grade in school to go on a dream trip to Disney land, than do it.  If it takes living below your means to get rich and you want to be rich; just do it.
In today’s world, most people will live into their eighties.  In the 1930’s, North Americans had a life expectancy of 62 years. Google's Ray Kurzweil thinks “The Business Of Extending Human Life Is Going Into "High Gear". So expect to grow really old: 100 years; what about a 120 year life expectancy?  What about that immortality is within our reach unless you’re hit by a bus? J
In fact, the longer our life expectancy, the less important it is what career you chose; the more important it is to learn how to educate yourself. Use the first twenty to thirty years of your life to learn what life is about (not that I have figured that out at 60; but at least give it a good try!). Learn during the first 30 years of your life how to educate yourself and learn about the joy of learning every day; of learning something new every project that you take. Life at 200 years may become pretty boring if you don’t! J
We’re arising from an era of cookie cutters; from a time where square pegs that didn’t fit in round holes weren’t considered useful. However, often the opposite is true! – After you have learned the self-discipline to study by yourself then educate yourself. In the 1950s until the 1980s, having a university degree was your ticket to above average wages and a secure career.  If you were smart and had the self-discipline to shave yourself from a square peg into a round one, you did very well.  That is why parents always encouraged their kids to do their best at school. “Do your homework; go to university and college and you will make a lot of money” they said and still say. However, it is no longer true!
The demand for this cookie cutter education rose so exponentially that today we have an oversupply of graduates; we have a world where every basket weaver has a university degree and that many of these graduates have horrendous student loans. Yet, they are no longer shaved square pegs; now graduates are cookie cutter products that have not learned to think out-of-the-box; instead they are well trained corporate drones. Now you need a degree for becoming a secretary, sorry… administrative assistant; for becoming a bank teller or store manager at 7-eleven. Strangely enough, now the demand is high for craftsman: plumbers; electricians; and welders. Five years from now DNA-engineers maybe the flavor of the day!
Read Tony Robbins’ book Money - Master The Games – it is a bit long but it has many valuable ideas. It contains many of the ideas to building a happy and prosperous life that are being advocated on this blog. In fact, many books on building a life of abundance (no matter how you describe such a life) always come back to the same themes.  It is not a secret that only the rich know – the difficulty of building a happy and abundant life all boil down to converting your dreams into goals (ever moving targets) and having the self –discipline plus perseverance to achieve it. Many people don’t define their goals (their Belize) and even less have the self-discipline and perseverance to reach their goals. So make sure you are one of the few to make your dreams real!
I think that it is important to learn math and language(s), including computer programming languages.  Languages are not just about words; they are about seeing life from different perspectives. Learning how others may see things is one of the most important skills to create win-win situations. Win-win is constructive; ‘I win-you-lose’ or ‘you-win-I-lose’ is not. You and I lose is destructive. You need those basic skills; you need the skill of deductive reasoning but you need even more so the skills of dealing with people.  You learn the good; bad and ugly at elementary school; in private or public. You learn a lot about raw emotions and herd mentality at high school during your crazy-years or teenage years. For a lot of people, those teenage years are the most dramatic years in their lives and in that of their parents.  When kids are toddlers and under ten they are often sweet and charming. During their teenage years, life is raw emotion while they’re supposed to learn to become a reasonable adult. How impossible!
Once you’ve overcome – I mean it: overcome – those years then there is the time of real education: starting with learning to live on your own; it is time to educate yourself and that education depends on what your personality, your lifestyle and interests are. I am not saying that a university education is bad – it depends.  Many people adore having a high IQ; which is in my books more about having an academic talent rather than being really smart.  Many professors may have high IQs but are entirely weltfremd (if you don’t know what that means educate yourself on Google or Bing).
Many kids hate school and thus weren’t the round pegs that fit in today’s education system. That does not mean they are dumb! Often the evidence points to the contrary. Many of these kids educate themselves and don’t have the glossy certificates of well-behavior. They’re headstrong; often unpleasant; and listen to no advice.  But in the end, many end up defeating their demons and being super successful. They’re fighters of the establishment and they are finding their own way often via harsh lessons. I am not saying that they are lazy and don’t do anything; many of those people have a lot of energy – energy frequently stymied in the school system which may have made them aggressive.  But once they learned how to release their energy to building a better life they are unstoppable.  Nobody will tell you that Steve Jobs was a pleasant person neither was Bill Gates but they had drive!  Not academic drive; they had a lot more in them than a high SAT score!
So learn to educate yourself; learn to use your educational and experimental skills to build the life you want and then throw everything upside down and start building an even more rewarding life; and so on and so on until you reach the ripe age of 1500 years.