Rational Advisor

Hey, I am back from out East. It was a wonderful trip.

Got to sit down with the Dartmouth/Halifax branch met a bunch of new guys.

This was a trip for the Kevins – Kevin S from Bedford NS, and Kevin P from St Margaret’s Bay in NS, and Kevin D out of St John’s New Foundland.

Kevin P’s son is part of an amazing band called Faded Blue, and we were taken to a gig at a bar in Halifax called the Seahorse. What can I say, I was totally WOW’d. This is an amazingly talented band, and I just couldn’t believe that they were not discovered yet. I have become a huge fan of them. You can expect me to be at any concerts in the Toronto region. Thanks a lot Kevin P.

Here’s some links for them

www.fadedblue.ca

just watch the you tube link to see how great they were. http://www.youtube.com/watch?v=MICQGQM5ZxA

Then after that we went to do a presentation for Kevin S and his clients, and again I really enjoyed it. Kevin S is my fly fishing buddy (he taught me how to NOT catch fish!). It’s always good to see the investor’s faces, and answer their concerns. Most of the concerns are not about returns, but really volatility. They are afraid when they don’t know the downside of their investments. Many people get caught up in comparisomitis, that’s always thinking it’s better on the other side, or some other investment. However once the risks of these other investments are outlined, and they are shown what measures have been taken to reduce the risk, they realize that obtaining a return that meets their criteria is better than rolling the dice on the markets.

We also met with Mark L and his friend Elle who I was really impressed with. Elle’s a Harvard professor of engineering and we had a great discussion on the investment world, and the BS that’s in there. The problem with Investing and Engineering is that unlike Engineering the numbers do not have a static meaning. We place far too much reliance on a past number or performance, and try to think that its better because it had a better past number. This may be true for Engineering, but not for investing. Unlike Engineering the investment world is fluid. Sometimes it’s not in the numbers but more in the structure of management.

Elle’s done well, by reducing the risk in his investment choices. We do the same, by trying to counter the obvious risks. However in the markets, all risk cannot be mitigated, they can however be reduced.

From there we went on to luverly St. John’s NF. A gorgeous place. I once thought Kelowna was the place to be in Canada, well now, we have two great tourist sites, Kelowna in BC and St. John’s in NF. St. John’s is the oldest city in North America founded in 1497. http://en.wikipedia.org/wiki/St._John’s,_Newfoundland_and_Labrador

We had an amazing Seafood meal. I met Calvin and Kevin and hiked upto their offices (not recommended for the weak of heart). The next day we presented to Kevin’s clients, and it was great. Cal’s going to be a great planner, he has the right mentality – calm and thinking. There were a couple of challenges, where I had to explain that just because a return is high, does not make it a better investment. What has to be considered is the risk taken to achieve that return.

With that I now bring you back to the regularly scheduled program – the markets

Just as some intestinal fortitude was needed, Mr, Bernanke has a bowel collapse The US Federal Reserve cut a key interest rate by a half point on Tuesday - the first cut in over four years - and left the door open to further relief to prevent a painful housing slump and a credit crunch from driving the US into recession.

Was it the right move? Hard to say.

The market’s initial response is ‘Thank you, Ben. The markets loved it, propelling stocks up 335.97 points in the US - its biggest one-day point jump in nearly five years.

“Today’s action is intended to help forestall some adverse effects on the economy that might otherwise arise from disruptions in financial markets and to promote moderate growth over time,” the Fed said in a statement released after its closed-door meeting.

The rate decrease increases the chance that the US economy will be able to avoid a recession and consumers will keep spending.

I however believe that the situation for the Fed could become tricky. . This does nothing to solve the underlying problem. Interest rates were too low for too long, bad loans were made, those were repackaged into instruments that made the risk seem negligible, and now, no one wants to hold the bag. After months of being the inflation hawk, Benny has thrown all of that up at the first sign of trouble because the markets wanted him to bail them out of a problem that they created. The Fed’s response to this summer’s market volatility may eventually lead investors to worry more about how bad the current credit climate is, and how vulnerable the U.S. economy might be to it. The big rate cut had downsides, too. It raises the risk of inflation. And it does little to correct the biggest problem of the moment: the paralysis in certain debt markets owing to fear about the quality of loan collateral such as mortgage backed securities. I fail to see how dropping rates, makes the Asset Backed Securities more safer – those assets still have their risks and problems. Dispelling that fear requires improved disclosures about the real value of those securities – not necessary lower short-term rates.

Dundee Wealth sale

We’ve just experienced in Canada a change in equity ownership due to asset backed securities. Apparently Dundee was one of the wealth management arms that used a lot of Asset Backed securities to make it’s returns look better. Now that the proverbial crap has hit the fan, they will have a new equity partner – Bank of No Service. No matter what they call it – this was a bailout. The Bank of Nova Scotia has struck a $348 million deal to acquire 18% of Dundee Wealth Inc., with an option to increase its stake to 20%… and beyond that to take control of the financial advisory enterprise. The Bank will also pay $260 million to acquire Dundee Bank of Canada, an unprofitable business that some say Scotiabank never really wanted. The higher banking rates offered by Dundee were attractive, and gathered over $2 Billion, however it had difficulty in finding ways to invest the deposits at higher returns. And what’s more Canada’s banking regulators demanded that increasing amounts of capital be set aside to cover the growing depositor base. Dundee had invested more than $380 million in asset (crappy)-backed commercial paper. Dundee had to extend their line of credit with Scotia bank to $500 million. So chasing crappy paper just because it looked good, eventually meant you had to sell a part of your firm. I am skeptical of business leaders that try to put a rosy tone to “we got screwed, we made a boo-boo” statements. Be careful, be very careful… This could very well have been like the British Northern Rock banking fiasco! Where the bank ran out of money to lend and people pulled out their money like crazy, causing a bank run. So when investing in companies that provide higher than normal interest rates for savings chequing accounts, you have to wonder what risks are they taking! This includes foreign banks coming into Canada.

Meanwhile, thanks to Benny Baby dropping rates, the US dollar fell to a new all-time low against the Canadian dollar, and euro after the rate cut, because lower rates make a currency a less attractive investment. Crude oil futures also increased, and gold prices rallied to a multi-decade high.

These factors could add up to trouble for the consumer. Though the Fed tends to measure inflation after stripping out volatile food and energy prices, high commodity costs trickle down to average Americans and can dampen their spending power.

If they were concerned about inflation before, they should be more concerned now. This half-point rate slash maybe considered as “overkill.”

Gold

Thanks to the falling US$ gold has also had a remarkable run. Investors are afraid that their US$ will be worthless, and that’s why they are purchasing gold. What we are seeing is a bubble in gold thanks to Bubble Ben Bernanke. So, if you want to know when gold will finish increasing look to the US$.

As the US$ falls, the export trade numbers increase and the GDP of the US increases – more people buy cheaper US goods. As the GDP increases the economy gets stronger and investors come in. As investors start buying up US shares with foreign monies, they have to buy them with US$, which means it would need to go higher. US$ also goes higher because fo a regime change in 2008. US$ higher means Gold will then fall.

A lot of people quote China and India as large purchasers of gold, and they are, but no more than previous years – they didn’t all of a sudden decide lets put more money into gold! Gold after all give you no interest, and costs you for storage. What’s prompted the increase has also been the slowdown in central banks selling of gold.

Gold was at a high of $850 an ounce in January 1980, as high inflation linked to strong Oil prices, Soviet intervention in Afghanistan and the impact of the Iranian revolution prompted investors to buy the precious metals. Similar events are in the news today – Oil, Afghanistan, Iran! And remember Gold fell sharply after that period. Once Russia left Afghanistan, Oil prices came down, and Iran became boring news.

I am concerned that many Gold bugs are saying “It’s different this time” – just like it was when technology went up, and people said the same thing!

C$

The Canadian dollar has seen some steep ebbs and flows in its history. In 1864, the greenback traded at $2.78, an all-time low for the U.S. currency. In 2002, by contrast, the loonie traded as low as 62 cents.
From recent numbers on inflation it seems like Dodge has beaten inflation. From Statistics Canada, the inflation rate hit an 8 month low in August as consumers paid less at the pumps. CPI rose at a 1.7% annual rate, a sharp drop from 2.2% in July.

The drop in US rates also led to a fall in the US$ against the Cdn$, allowing it to hit parity. And don’t we know it, almost every paper had that as their main headline news. Most of the reason for the loonie’s rise is the US$ demise, but also remember our country is commodity based, oil, gas, wheat etc which all have also risen over the years. I heard a few reports that say once the Americans get their financial house in order the loonie will drop back. Right now, I think what we’re seeing is speculators pushing the loonie to par, rather than underlying economic forces. Parity is just a number! This entire obsession with parity is unfounded. The exchange rate for the dollar is not a good indicator of how strong the economy is. The important measures of economic strength are employment growth, GDP and inflation. No real significance for the average Canadian other than the reduced spending power of Canadian NHL players who are paid in US$. Could we just get a life now!

We are no way as rich as the Americans by every economic yardstick, from standard of living to personal income. For sure we can go into a US store and buy goods with the same power as an American, but the fact is their counterpart in the states still earns about 20% more than the Canadian does.

I think what we are seeing now in the US dollar is similar to what happened with Canada in the 1990s. We had way too much debt. And deficits were WAAYYY too large. We were basically forced into devaluation scenario to pull out of this nosedive. The US is attempting the very same thing now. Just as Canada got out of its debt problems, by dropping its currency and increasing its trade, so will the US.

It is hilarious how Canadian cheer this news. Canadians have such envy, Obsession-Compulsion and fixation of the Good old USA that reaching parity is watched with baited breath. For an export based economy such as Canada’s, this is very, very bad news.

Remember the Media’s prime directive is not to ‘educate and inform’. It is ‘to bring the audience to the advertiser’. Content is operational expense between the revenue generating advertisements. As such it is easier to bring stories like Britney, Beckham, Lindsay, Paris, and the exciting dollar parity!

The loonie versus the Euro has stayed the same the last couple of years:
Today its worth 0.70442 Sept 20, 2007
A year ago 0.70343 Sept 20, 2006
Two years ago 0.70664 Sept 20, 2005

See, it’s only against the US$ and only because they wanted to!

Is it unfair to lay this at Mr. Bush’s feet? Yes and no. Currencies are complicated beasts and their gyrations are not driven solely, or even primarily, by government policy. The five major countries whose currencies have appreciated the most in the past year — Norway, Brazil, Australia, Canada and New Zealand — are each prolific producers of natural resources. As commodity prices rise, so does the value of their exports, and their currencies. The U.S., as a huge importer of oil and other raw materials, pays the price. Those are macroeconomic forces.

Yet, when it comes to the U.S. dollar, the question of confidence still lingers. Would oil cost $80 (U.S. or Canadian) a barrel if not for the misadventure in Iraq? Would the US dollar have fallen so rapidly against the euro — 30 per cent in the past five years — if not for the Bush administration’s free-spirited approach to fiscal policy? U.S. federal spending rose nearly 7 per cent a year from 2000 to 2006, directed by a Republican president and a Republican Congress. It’s hard to know if Mr. Kerry would have managed things very differently — but harder still to imagine he could have done any worse.

Today, the United States is running a deficit of 1.3% of GDP — hardly a disaster, but still twice the size of the deficit of the euro area, according to forecasts published by The Economist. The trade deficit, at 5.7% of GDP, is a bigger overhang for its currency. Small wonder the traders and reserve banks of the world have been selling greenbacks.

What next?

The US Fed might pause after this cut, having gotten all of its cutting out of the way at once.

In the long run, it’s always foolish to bet against America, which did not become the world’s wealthiest nation by accident. It will rebound; it always does. The mortgage crisis, and the resulting economic slowdown, will shrink the trade deficit. And Mr. Bush is now a lame-duck president whose party might well lose in 2008. Anyone remember how the U.S. economy — and the currency — performed during the last four years of Clintonomics?

For Canada there is a good chance that we could see Canadian interest rates come down – Our dollar is too high, and inflation is low. The Canadian dollar may have overshot its fair value is trading at a level above what the country’s economic fundamentals justify. There is probably about 5 cents of headlines movement that is speculative.
Bank of Canada Governor David Dodge has said that speculative gains in the currency would cause “monetary policy to be more stimulative than it otherwise would have been” — in other words, lower interest rates.

History shows the outlook for stocks is promising after fed rate cuts. In the 11 times the US Fed has started to cut rates since 1945, the S&P 500 has gained 12% in the six months flowing, on average according to Standard & Poor’s.

But don’t get too excited. After four of the 11 initial rate cuts stocks fell, including in 1990, when the S&P 500 index fell 14% as the economy struggled with a bear marketing housing that led to the S&L crisis, and junk bond meltdown – a situation eerily similar to today’s housing problems in the US and credit crunch.

And don’t forget the last time the US Fed went on a rate cutting binge: In January 2001, nearly ten months into what turn into a devastating bear market, stock prices continued to fall for 21 more months.

And for those who think that when there is a recession in the US stocks prices go down. History is against you.

When you look at all the recessions over the past 150 years, as identified by the US National Bureau of Economic Research (NBER), the unofficial arbiter in the US of when recessions start and finish.

Over the last six decades, the stock market more often than not was higher when a recession came to an end than when ii began. Just the opposite is the case over the century before that.

During the 11 NBER identified recessions from 1945 onwards, the stock market rose 7 times and fell 4 times. The average stock market gain over the 11 was 3%. The average before 1945 was -13%. Why the difference, because recession shave been much shorter after 1945.

The average recession since 1945 has averaged 10 months, prior to 1945 the average was 12 years.

A bubble is forming in Emerging markets, and commodities, all because of a dropping US interest rate and thereby its currency. I find it hard to bet against the US, after all they control almost half of the world’s wealth. The US didn’t become the world’s wealthiest nation by accident. It will rebound, it always does. The mortgage crisis, and the resulting economic slowdown, will shrink the trade deficit. And Mr. Bush is now a lame-duck president whose party might well lose in 2008. Think of all of the world class companies that they have – Wal-mart, Proctor & Gamble, General Mills, etc.

As about Gold, there are just too many bulls, and that alone worries me. Nobody thinks it’s going down!!

What’s an investor to do? Investors can expect more big swings in the stock markets in the coming weeks as traders react to each and every nugget of economic news.

Try to remain rational. Predicting where to invest based on which countries and sectors are likely to perform best is a little like predicting the Soccer World Cup winners for the next five years. We can make educated guesses based on current lineups, future draft picks, coaching personnel and the financial stability of the team, but there are a host of possible events to turn a potential World Cup Cup contender into a playoff wannabe. Same goes for investing.

In 2004 and 2005, emerging markets such as India and Latin America, were excellent choices, producing group returns of 16.8 per cent and 31.2 per cent respectively. Much like China and precious metals are doing today

But in 2000 emerging markets were at the bottom of the heap, losing 28.2 per cent as a group. In 1999, they were up 57.2 per cent.

Whew! That is a roller coaster ride and some might say it is exactly what you would expect from a volatile investment.

Not so fast. Let’s take global income, i.e. global government bonds. While the gain/loss swings are not so large, the place where global income sits in returns is also all over the map. In 2002, one of the worst years for equity performance, global bonds, not surprisingly, offered the best returns at 18.1 per cent.

One year later, global income was in the basement with a loss of 6.3 per cent. Two years earlier, 2000, the sector was in third spot with a gain of 5.9 per cent. But in 1999 global income was a cellar dweller with a loss of 10.3 per cent, which follows a fourth place finish in 1998 with a gain of 23.8 per cent.

Now let’s open the dressing room door of Team Large Cap Canada. This laggard club only won the return race once between 1986 and 2005. That was in 1996 when domestic large caps gained 28.4 per cent, the best returning of the broader global market indices.

Interestingly, Team Large Cap U.S. ranks roughly the same among the global indices between 1985 and 2005. The difference lies in degree – at least on the gain end. In 1997, right after the gold medal performance of Canadian large companies, the U.S. big cap stocks were winners, turning in a whopping 39.1 per cent gain for the year.

Diversifying, across borders, sectors and company size, is a brilliant strategy. However, forget trying to predict which geographical area, size or type of company is going to be on top in a given year.

In fact, of 10 major global market indices, every single one has put in at least one gold, silver or bronze performance between 1985 and 2005 and every single one has suffered a bottom three finish as well.

The lesson is quite simple. Spreading your investments more broadly will increase your performance over time but, more importantly, the strategy will reduce risk.

Thanks

Rational - I used to be indecisive. Now I’m not sure.

I have learned that if you upset your wife she nags you…..
If you upset her even more you get the silent treatment.

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