Rational Advisor

These are some ruminations based on my trip to Greece and Italy

One of the fascinating things about Greece and Italy was the stories of their warriors and their Gladiators.

Gladiators were those athletes that would excite the population with their fights and battles in the public arena. They were front and center in the media of the times, and cities were identified by their winning gladiators.

We know of them also from our movies “The Gladiator”, “300″, “Spartacus” and a whole bunch of others.

Yet, when I got to think about things, I realized it was the Farmers who were the most successful. Greece and Italy are known for their fruits, wines and olives.

Also the Farmers were the ones who provided for their families and looked after the future.

Being a gladiator means thinking about the next fight, the next opponent, today.

Being a farmer means thinking about the future, planning for the future, caring for the seeds you put into the ground that will look after your community and your family.

So, if I was to choose, I’d rather be a farmer than a gladiator.

We have the same mentality today

Gladiators - we get caught up in what is exciting in the markets, we want to see the blood, we enjoy or commiserate about the theatrics in this coliseum called the stock market. Too many of us get caught up with these gladiator managers who have had a streak of winnings. And we look for the one that’s had the most kills – not realizing that they can also be killed.

What we need to do is look for good farmers, and be good farmers. We need to look for managers that treat their investments like they would a farm. Knowing when to seed the right crop, giving time for the crop to work, adding the right soil, water and sun combination. And not pulling out the plants every week to check if they are on track.

If we become or are seduced by gladiators, all we will be remembered for is crumbling coliseums, crumbling arches, a ghost like Olympic stadium, and stories…

Instead if we act like farmers, we will still see lush field, still producing food and wine that keeps on providing. Fields that have stayed around for centuries.

You have a simple question to answer – Are you a gladiator or a Farmer

I know what I am.

Traits of a gladiator (irrational speculator)
- focused on the next fight, (always looking for the next thing!)
- wants to make a quick kill (quick profits)
- enjoys today for their might not be a tomorrow (only want to know about what’s hot today!)
- Hatred for the enemies (everyone else is wrong except for me)
- Weapons are swords, knives and other instruments of harm (technical analysis, charts and other goobeldygook)
- Has a short life span (Ah, I lost all of my money in day-trading)

Traits of the farmer (rational investor)
- focused on the future
- Plans for fruits and crops to continue to provide for ever
- Thinks about the future genrations that will reap rewards from todays seeds
- Loves the community. Always willing to help others
- Tools are ploughs, shovels, oxen, horses, sheep, goats, chickens
- Has a long life with family and friends and leaves a legacy

Need I say more…

So just like a Farmer, you have to think of your investments,
- make sure they have the right soil,
- Make sure they are tilled, and get enough sun, water and nutrients.
- Make sure they are given enough time to grow
- Don’t pull the stalks out each week to check how they are doing
- Replant
- Rotate the crops
- Have a discipline
- Take advantages of new mthods to improve the success of your crop
- Have Patience

Remain Rational

This last quarter Pfizer’s wonder drug Viagra turned 10 years old. Although much has been written about the little blue pill, it’s not caused much rise in Pfizers price which remains lower than it was ten years ago.

Conditions being assessed for treatment with Viagra include jet lag, heart failure, premature ejaculation, diabetes symptoms, multiple sclerosis, pain, premature birth, chronic pelvic pain, memory loss, Reynaud’s phenomenon, and strokes.

In Egypt, Viagra has been used to save unconsummated marriages; in Argentina, it has been investigated as a new therapy for jet lag; in Israel, researchers have found that it can help cut flowers survive for longer.

I think Oil’s been on a bit of a Viagra run!

Rational

“Order and simplification are the first steps toward the mastery of a subject.”
— Thomas Mann, Nobel Prize winning novelist

Mastering investments is also about keeping Order and being simple. Too many times we over complicate our investment world. And we do not retain any order, in fact, it’s just a jumble of investment ideas.

Order - means having a process, and orderly method of doing something. Knowing where things are supposed to be, and why they are there, and then maintaining that order - also known as rebalancing

Simplification - uncomplicating your portfolio. Too many times we want to over diversfiy something, and continue to tinker with it, by adding this and that. All this leads to is DI-WORSE-IFICATION. Having too many Canadian Funds, all doing the same thing or holding similar investments is not diversification. Simplification means having few investments, knowing what they are, understanding their downsides, and volatility, and holding them for an appropriate length of time for them to work through their process. You don’t have to follow the latest trends, the latest fads. You don’t have to keep on adding to your portfolios.

So, there it is - Order and Simplify

KISS - Keep It Simple, Stupid
.
Rational

Markets correct. Each correction feels different and bad. But that’s what markets do. We’ll get through this one as well. And unfortunately, it won’t be the last one.

You can’t put a time stamp on it. The market will be in better shape once we’re through the situation we’re in, because transparency will be better and leverage will be down.

We say, have a plan and understand the plan with a reasonable expectation for market returns over the long haul, and then, very importantly, do a gut check. If you can’t sleep at night, be less aggressive, but recognize the trade-off. Will stocks do better over the next two, three years? Who knows, but you need to take risk to get reward over time.

If you are in your prime savings years — and the median baby boomer is 52, I believe — you want the markets to be flat to down, then rally as you work your way toward needing to consume your capital, because you are putting the money to work at lower prices.

Patience

Patience is the greatest of all virtues.
Cato the Elder (234 BC - 149 BC)

Much of the lack of problems with investors is their impatience with their investments. The revered investors such as Warren Buffett, David Dreman, Tom Marsico, Gerald Cooper-Key, Bob Tattersall, George Fraser, Philip Fisher, Benjamin Graham all succeeded because they had one good common quality – patience with their investments.

The worlds religions preach the value of patience

In Christianity, its one of the fruits of the spirit.
In Judaism, it part of wisdom.
In Buddhism, it’s an avenue on the journey to enlightenment. And so on.

Why is it so universally regarded as important, and so universally ignored – simply, it’s our human nature.

That same nature that is fueled by consumerism, materialism, self-absoprtion – all wrapped around short term instant gratification.

We make our decisions lickety-split, we want to see results now, or sooner.

However Patience is good.

“If you are patient in one moment of anger, you will escape a hundred days of sorrow” – Chinese proverb

“To lose patience is to lose the battle” – Mahatma Gandhi

How do we teach patience

- Don’t overload our schedules, encourage downtime
- Go watch-free on evenings and weekends. People hurry up when they see a clock, which is why stores typically don’t have clocks – they want us to linger

http://www.wikihow.com/Be-Patient

I have always said one of the best books ever on investing, and a MUST read for all those that do anything with investments, or even think they are doing something with investments is “Contrarian Investment Strategies” by David Dreman. David was recently included in Bloombergs list as one of the best 6 investment managers in investment history.

This book is a classic, and I woudl encourage you to devour anything ever said, written or spoken by David.

Here is a list of contrarian investment rules. from the book - for mor ein depth discussion on the rules - get the book.

“Rule 1

Do not use market-timing or technical analysis. These techniques can only cost you money.

Rule 2

Respect the difficulty of working with a mass of information. Few of us can use it successfully. In-depth information does not translate into in­-depth profits.

Rule 3

Do not make an investment decision based on correlations. All correla­tions in the market, whether real or illusory, will shift and soon disappear.

Rule 4

Tread carefully with current investment methods. Our limitations in processing complex information correctly prevent their successful use by most of us.

Rule 5

There are no highly predictable industries in which you can count on an­alysts’ forecasts. Relying on these estimates will lead to trouble.

Rule 6

Analysts’ forecasts are usually optimistic. Make the appropriate down­ward adjustment to your earnings estimate.

Rule 7

Most current security analysis requires a precision in analysts’ estimates that is impossible to provide. Avoid methods that demand this level of accuracy.

Rule 8

It is impossible, in a dynamic economy with constantly changing polit­ical, economic, industrial, and competitive conditions, to use the past accurately to estimate the future. The past gives some frame of reference but cannot be exact.

Rule 9 (my favorite rule)

Be realistic about the downside of an investment, recognizing our hu­man tendency to be both overly optimistic and overly confident. Expect the worst to be much more severe than your initial projection.

Rule 10

Take advantage of the high rate of analyst forecast error by simply in­vesting in out-of-favor stocks.

Rule 11

Positive and negative surprises affect “best” and “worst” stocks in a di­ametricaI1y opposite manner.

Rule 12

Surprises, as a group, improve the performance of out-of-favor stocks, while impairing the performance of favorites.
Positive surprises result in major appreciation for out-of-favor stocks, while having minimal impact on favorites.
Negative surprises result in major drops in the price of favorites, while having virtually no impact on out-of-favor stocks. The effect of an earnings surprise continues for an extended pe­riod of time.

Rule 13

Favored stocks under-perform the market, while out-of-favor companies outperform the market, but the reappraisal often happens slowly, even glacially.

Rule 14

Buy solid companies currently cut of market favor, as measured by their low price-to-earnings, price-to-cash flow or price-to-book value ratios, or by their high yields.

Rule 15

Don’t speculate on highly priced concept stocks to make above-average returns. The blue chip stocks that widows and orphans traditionally choose are equally valuable for the more aggressive businessman or woman.

Rule 16

Avoid unnecessary trading. The costs can significantly lower your re­turns over time. Low price-to-value strategies provide well above mar­ket returns for years, and are an excellent means of eliminating excessive transaction costs.

Rule 17

Buy only contrarian stocks because of their superior performance char­acteristics.

Rule 18

Invest equally in 20 to 30 stocks, diversified among 15 or more indus­tries (if your assets are of sufficient size).

Rule 19

Buy medium-or large-sized stocks listed on the New York Stock Ex­change, or only larger companies on Nasdaq or the American Stock Ex­change. (Obviously american centric here)

Rule 20

Buy the least expensive stocks within an industry, as determined by the four contrarian strategies, regardless of how high or low the general price of the industry group.

Rule 21

Sell a stock when its P/E ratio (or other contrarian indicator) approaches that of the overall market, regardless of how favorable prospects may appear. Replace it with another contrarian stock.

Rule 22

Look beyond obvious similarities between a current investment situa­tion and one that appears equivalent in the past. Consider other impor­tant factors that may result in a markedly different outcome.

Rule 23

Don’t be influenced by the short-term (3 or five year) record of a money manager, bro­ker, analyst or advisor, no matter how impressive; don’t accept cursory economic or investment news without significant substantiation.

Rule 24

Don’t rely solely on the “case rate.” Take into account the “base rate “­the prior probabilities of profit or loss.

Rule 25

Don’t be seduced by recent rates of return for individual stocks or the market when they deviate sharply from past norms (the “case rate”). Long term returns of stocks (the “base rate”) are far more likely to be established again. If returns are particularly high or low, they are likely to be abnormal.

Rule 26 - Patience

Don’t expect the strategy you adopt will prove a quick success in the market; give it a reasonable time to work out.

Rule 27 - Reversion to the mean

The push toward an average rate of return is a fundamental principle of competitive markets.

Rule 28

It is far safer to project a continuation of the psychological reactions of investors than it is to project the visibility of the companies themselves.

Rule 29

Political and financial crises lead investors to sell stocks. This is pre­cisely the wrong reaction. Buy during a panic, don’t sell.

Rule 30

In a crisis, carefully analyze the reasons put forward to support lower: stock prices-more often than not they will disintegrate under scrutiny

Rule 31 - Diversify

Diversify extensively. No matter how cheap a group of stocks looks, you never know for sure that you aren’t getting a clinker.

Use the value lifelines as explained. In a crisis, these criteria get dramatically better as prices plummet, markedly improving your chances of a big score.

Rule 32

Volatility is not risk. Avoid investment advice based on volatility.

Rule 33

Small-cap investing: Buy companies that are strong financially (nor­mally no more than 60% debt in the capital structure for a manufacturing firm).

Rule 34

Small-cap investing: Buy companies with increasing and well-protected dividends that also provide an above-market yield.

Rule 35

Small-cap investing: Pick companies with above-average earnings growth rates.

Rule 36

Small-cap investing: Diversify widely, particularly in small companies, because these issues have far less liquidity. A good portfolio should contain about twice as many stocks as an equivalent large-cap one.

Rule 37

Small-cap investing: Be patient. Nothing works every year, but when smaller caps click, returns are often tremendous.

Rule 38

Small-company trading (e.g., Nasdaq): Don’t trade thin issues with large spreads unless you are almost certain you have a big winner.

Rule 39

When making a trade in small, illiquid stocks, consider not only com­missions, but also the bid /ask spread to see how large your total cost will be.

Rule 40 - Hot investments

Avoid the small, fast-track mutual funds. The track often ends at the bottom of a cliff.

Rule 41

A given in markets is that perceptions change rapidly.

Davids succesfully used these rules, if you find it hard to follow these rules, then it’s probably smarter to let David do it

Rational

Many people think that a mutual fund is passé. There is a negative connotation to having a mutual fund.

In essence everything in the world is a mutual fund

A mutual fund is a grouping of investments.

So, if you have a single stock like Royal Bank, what you have is a company with multiple business lines, - Retail banking, investment management, discount brokerage, investment lending, etc. What you have is a group of businesses (mutual) already wrapped up into one company (fund) - a mutual fund concentrated on financial services, that mutual fund happens to be called RBC. And yes, they do charge a fee, because they have to do audits of their books, they have to pay taxes, lawyers, custodians etc.

If you hold Berkshire Hathaway, you actually hold a group of companies (mutual) , Insurance (GEICO), soft drinks (Coka Cola), consumer products (Procter and Gamble) , candies (See’s Candy’s), weapons systems (Level 3), Bonds etc all wrapped up into one company (fund), managed by a manager Warren Buffett, aged 78. – You hold a diversified mutual Fund, with bonds and equities in it.

So, this whole thinking about “I don’t want mutual funds” needs to be revisited - virtually everything in the investment universe is a mutual fund.

These discretionary managers, like to play on the illusion, that they are different - “we don’t put you into mutual funds” - Well, if they put you into investments that have more than one stock in it, they have you in a mutual fund - multiple positions in one account. You can call it whatever you want – pooled, segregated, models etc. But, guess what they DID put you into a mutual fund!

Smart investors, don’t get caught up in mutual fund or not. What they want is to make sure they have an appropriate investment vehicle that will meet their financial objectives with the amount of volatility they can tolerate over the length of time they are intending to have it working.

What is important is
1. Financial objective
2. Time period of investment
3. Volatility and Risk toleration.

Whether it is a mutual fund or not does not matter.

So, get over it - Everything is a mutual Fund!

Rational

From May 15, Globe and Mails Social Studies section

Soft drinks can be used to kill mice and rats, contends Janet Ford on the website eHow.com. It sounds very unlikely to us, but she continues
- Mice and rats lack the ability to burp
- Pour a cola drink into a shallow dish and place it where mice or rats are found
- the rodents will drink the sweet soft drink and later, when thei can’t burp, they will die.

So, there you go COke to the rescue

People always seem to buy otday what they should have bought about five years earlier; they hated tech stocks in 1994 when prices were low and loved them in 1999 when prices were high, they hated bonds in 1999 when prices were low and loved them when prices are high, they hated oil in 1999 at $12 a barrel but love it now at $126. Plus ca change as the french say.

Sometimes the best things to buy are those that are out of favor - how do you know what is out of favour - it’s all the stuff the newspapers are telling you are doing terrible. It’s the funds that are not doing “hot” right now.

Rationality is a choice. People are not forced to act rationally.

Back from the Big Apple

Had excellent meeting there, primarily with Credit Suisse, Citigroup and David Dreman

Most of the managers were in agreement that the first half of the year would be tougher than the second half. This was a correction waiting to happen. Also that the media and general investors are a bit too pessimistic.

Credit Suisse - prefers Canada to the US, and Europe to Japan. Concerned that there are more problems to come out of Japan.

- Global growth weakness is still not finished but inflation risks have not gotten worse
- The inflation threat is real. The Fed will ignore it to stimulate growth. THe ECB (European Central Bank) will be much more disciplined
- Growth data coming fromt eh US have disappointed again. Credit Suisse’ss expectations are weak growth for 1H 2008 followed by a pick up in the 3rd and 4th quarter.
- Markets are pricing in negative earnings growth - too pessimistic in our opinion
- Canadian stocks look attractive in comparison to Canadian Bonds
- Japan stays weak and consumer sentiment has collapsed. The good news is that inflation is in positive territory.
- Growth in Europe (Eurozone and the UK) have surprised positively.

Citigroup - Real Estate is offering great opportunities fro future long term income streams in the US. The financial markets maybe a little to distressed.

From a conversation with David Dreman

They believe that the first quarter may prove to be the worst of the year. The second quarter will be less volatile due to a bottoming in housing activity. By the second half, economic activity should start to exhibit stronger life as the impact of massive economic policy stimulus (lowering of interest rates) begins to surface.

The slope of the yield curve was slightly inverted a year ago, and is again solidly positively sloped. There’s been a tonne of money that’s been put into money market funds at an annual growth rate in excess of 30%.

Money markets are not really an investment vehicle just a parking spot, so eventually this capital will come out and positively affect the markets.

There’s been a lot of “economic medicine” that’s been applied to this patient, and every policy official is focused on “job one” - getting the economy moving again!

Every financial crisis comprises of two components - fundamental balance sheet/Income statement problems and “fear”.

What we have here is pervasive and widespread fear - collapse of the housing market, auto industry, and subprime mortgage loan losses.

Yes, housing in the US is a mess and many bad subprime loans do exist.

However the fundamentals are still strong - good balance sheets and income statements. Today 95 percent of all who want a job have one. Household networths are near all-time highs, and household liquidity growth has risen close to 10 percent in the last year. Non-financial companies have been making good profits for a record-setting string of quarters. Non-financials balance sheets are stronger today than at any time in the last four decades with capital cash flow to capital spending ratios near record highs with inventory levels near record lows.

So this crisis appears more fear based than fundamentals based. This crisis is because of fear! Even though many investors have the wherewithal to “buy”., they simply won’t buy because they fear the prices will go lower. Fear, not of credit defaults due to bad fundamental balance sheets or poor income statements, but fear of catching a falling knife.

The good news is that crisis such as these don’t last, because eventually the fundamentals shine through. The most important impact of recent interest rate drops might not be what they ultimately do for the economy, but rather the reminder that are a protection for investors. For those investors that have parked their monies in Money market funds their rate of return is going lower with the interest rates, and they’ll eventually need to move to better opportunities. No true capitalist system will sit idly by in Money markets for a long while. No self-respecting investor will ignore equity values on non-financial companies which have declined while their earnings have increased at double digit pace.

Finally, how long will the “fire sale” on US financial stocks last once “write downs” become “write ups”? The financial markets seem to be looking forward to an eventual economic recovery.

Rational