Tuesday, January 15, 2019

Most predictions are wrong

Once again, we try to make predictions for the new year, but it is a known fact that most predictions are wrong. In fact, the market often goes in a different direction than the consensus prediction. Also, markets are driven by institutions rather than mom & pop or retail investors so to accuse the small investor to make the emotional decisions that create bull and bear markets is ridiculous. It seems that a lot of the market volatility is caused by institutional investors with programs that either perpetuate technical market trends or just momentum trends. This is what I recently read about commodity trading houses and their trading programs:
The case with Commodity Trading Advisors or CTAs.
For anyone unfamiliar with CTAs, they are a class of asset managers whose investing models are based on momentum algorithms. Their investment style is driven by "trigger" levels in the stock markets. So, when the market is rallying, it sends their models signals to buy stocks, and, when the market is falling, it sends the same models signals to sell stocks.   From Stansberry Newswire, January 14, 2019
Guess what, this technique perpetuates existing trends until a dramatic ‘trigger’ switches the model direction. No wonder that when ‘experts’ forecast the price trend for oil you hear things like “the market will fall further” or “the rising price will continue”. Or… “we foresee oil prices to remain within the trading range it has been in during the last six months”.  Really, it is an extreme form of ‘recency effect’ where recent ‘calamities’ will be the future calamity.  How many prognosticators have not told us that the next crash will be even worse than 2008 (the most recent major crash)? Now how is that for salesman ship!
Other than our optimistic view is the investor’s inherent expectation that the economy will grow over the long term and so will the stock market. For the rest, we really don’t have a clue as to what comes next.
Thus, for any investment we must look at the cashflow it throws off where dividends are most predictable while appreciation is a mug’s game. Overall prices go up with earnings and as compensation for inflation, i.e. the loss of purchasing power of the currency in which you bought your investment. No wonder that  investment returns are mostly generated from dividends and to a lesser degree from rents and interest (we talked about that before).
If you buy a stock, you pay commissions. When you sell a stock, you pay commissions and you must pay capital gains taxes. Not selling basically means you defer your capital gains taxes, nearly comparable to an interest free loan from your friendly neighbor the government. If it is so though to make profits then at least reduce your costs – i.e. transaction friction… oh what a fancy name for such an ugly game! 
Although many look down on ownership of a residence, as I showed in a recent post, it is often your best investment over a lifetime, except for those who often change residences. Isn’t that amazing, the same pattern as when owning stocks. Anyone here who has seen a Canadian Bank going bankrupt? BMO, Royal Bank or TD? So why do some many buy and sell these stocks rather than collecting the growing dividends year-in and year-out.  Typically, you collect dividends at a better tax rate than interest and over time the share price has gone up at least 4 or 6% per year!  Thus just like your residence, see stocks as long term investments in businesses not as some short term speculation.
Now there were in the early 1980s several years when banks were doing poorly but that is now forgotten by most. Ignore the gurus just buy at a reasonable price and avoid market peaks. Buy stable long-lived companies and just like your house don’t sell them.  Buy the banks, communication companies like Roger or BCE, and other ‘bluechips’ like the ones in my recent $50,000 per year tax-free portfolio’ post. Check on them from time to time since no company lasts forever.
There is another type of stocks – highly cyclical but being cyclical they are predictable. Commodity producing stocks are very volatile but especially well-established producers like Cameco for uranium, or Barrick for gold or Suncor or Shell for oil and gas; or forestry companies like Canfor or West Fraser they all go through big down turns with oversupply and big booms when there is a shortage of the commodity they produce. Keep a close look on the balance sheet, because many resource stocks bite the dust because of too much debt. Buy them when they are in the ‘sh.t house’; ride them high and sell them when everyone else wants to buy them.
I have made some of my largest profits with oil and gas investments. There were also some big misses but over all they worked very well for me. But… there is a lot of frustration while holding these investments.  They may go a lot lower than you would have expected upon purchase so be careful and only jump in a tiny bit each time. Also, don’t have a large position size! 10 to 15% of your total stock portfolio for the entire resource sector is plenty. When resources are booming it is OK to hold none (you sold them all at great prices).
Two types of stocks with very different investment styles and… you ignore all that market noise and sleep well at night. If you want to diversify more then use ETFs as often discussed on this blog: market index ETFs for a number of countries: Canada, U.S., Europe and a bit of emerging markets. Have insurance through owning a bit of gold. It is better than trying to speculate in currencies just look on a chart how the value of gold has grown between the 1970s and today!
Combine your stock and bond portfolio with portfolios of other asset classes as mentioned on this blog numerous times. Then, try to enjoy the ride. Most asset classes have their day in the sun and a time in hell. By holding multiple asset classes there is always somewhere a bull market. Some investments work right away but many take their time (and possibly a lot of work) before they pay off. Sometimes you may have to give up on an investment and that I will discuss in a future post.

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