Rational Advisor

One of the sad things that have happened to investments over the last decade is the tendendancy of a growing number of investors to be trend followers., buying on upward momentum, without any regard to valuations (eg late 1990’s - techs, 2006 - Oils and energy), and then selling when stocks are falling, again regardless of valuations (summer of 2002, and now). What this does is create a scenario where markets overshoot on the upside and downside.

And that’s the reality of now. And it doesn’t matter how you were correlated, becasue when sanity leaves the markets for stupidity to enter. All correlations and asset allocations designed to insulate investors don’t help.

I’ve watched in dismay as solid companies, with great balance sheets, lots of cash, and sound businesses get decimated and increasing number of investors run to cash, as if that’s going to earn a better return in the future.

One thing I’ve learnt through going through so many gyrations in the markets in the past, is that every one feels like the worst ever at the time. The market crash of 1982, when I came to Canada, had a recession to it, and stocks fell like no tomorrow, in 1987, it felt like the end of the world in one day!, the S&L Crisis of 1990’s was when we faced the multiple threats of government uselessness, and a looming war with Iraq, as well as more than 1,000 bank failures, and then the late 1990s when we had the Asian Flu, and finally the ground shaking tech wreck of 2000. Each of them was supposed to be the show stopper. The it’s-never-been-like-this-one.

But as we all know, that these events were exceptional times to move out of cash and into stocks that had good businesses.

So, is this what we are going through worse than those in the past. will the markets come back from this mess. Will the markets be stronger?

Just a few months ago the media was feasting on, nay egging on “High Oil prices”, with some analyst saying $200 Barrel, and more… It was the Oil peak scenario, we’ll never see it come down again… And just like idiots we believed them.

Now, the media has fcused on “economic distress”. Of course, the emdia will spin all this stuff into another reason why we are headed for a modern-day end-of-the-world..

What the media doesn’t focus on is the good news
- the non-financial corporations record amounts of cash
- the low non-financiasl corporate debt level compared to the last two recessions
- Or that the GDP per capita in “bankrupt” USA is the highest in teh world, 35% greater than Germany
- and other good stuff!

No, that would make people see the real side of the world. That would make people happy! And happiness doesn’t sell Ads, only misery does.

So, just be careful who’s telling you what. Realize that there are good companies out there.

And there are good people out there, and we’ll get through this calamity as well.

Rational

It’s been an tough few weeks for investors around the world, especially those Canadians with resource heavy or US financials heavy portfolios.

When you hear all the terrible news in the markets or how much the markets have gone down - this is not YOU. Yes, you will see some ripples affect our good companies.

Our philosophy has always been to be diversified among Canadian Bonds and Equities. The Bond side of the portfolios is doing very well, since it is not part of the equity markets. It’s the equity side that is showing some mild affects of the markets rumblings. Be assured our equities are strong.

Who else is down - Billionaire investor and value investment guru Warren Buffett’s Berkshire Hathaway is down too. So are many (most) of the “market neutral” hedge funds that promise steady returns through market dips. Trend-following momentum funds are down and precious metals funds (sometimes considered the “safe-zone” in rough markets) are down roughly 40%.

Higher uncertainty in the markets causes firms and investors to temporarily pause their investment. According to Stanford University assistant economics professor, Nicholas Bloom, in his September 2007 paper, recently updated “The Impact of Uncertainty Shocks”. Bloom shows that, based on his measure of stock market volatility, the recent credit-crunch-related uncertainty is quite comparable to the last such shock, associated with 9/11.

In the 9/11 case, the uncertainty slowly began to lift as the months proceeded, and the economy began to right itself. In this case, the rescue packages that central bankers are providing do create some light at the end of the tunnel.

Every time we think the sky is falling in, we think it’s something new. In fact, there’s nothing new about Financial Crisis
- Russia had it in the late 1990’s
- Argentina had it in 2000/2001
- The US had it in the S&L crisis of 1989/1990

Banks have been in bank-rupture mode periodically ever since they started in Italy 600 years ago.

The one consistent theme, around every miserable financial crisis is that they have recovered strongly. Although, at the time, everyone thought it was the end of the world.

What’s fortunate is to look at to the upside of all the recent panicked selling. The market has entered the phase of the bear market where participants feel compelled to dump what had been their best stocks. That is not the beginning of a decline. But more like the end - a capitulation of all those investors who should not have held risky investments, such as resource stocks, emerging market stocks etc.

Another good point to consider is that the ratio of cash to equities in the US market surged to 31%, topping the 30% seen after the tech bubble burst.

That hoarded cash will be deployed when the credit convulsion subsides, and when concerted global policies and mergers begin to repair confidence.

Mutual fund redemptions in Canada hit an all time high last month as investors redeemed an estimated $4.6 billion in assets. The last time fund redemptions peaked was April 2003, coincidentally marking the end of that cycle’s correction. Many of the remaining investors went on to experience the best 24 months of returns in recent history following all that cashing out. As a group, mutual fund investors have had an uncanny knack in the past for perfectly mistiming the markets ups and downs. It is no different now. All the people exiting will look back on this in five years, with regret!

So….what’s the plan? Surely, the volatility and collapse of the markets is a call for a change in direction. To be sure, some of the markets gyrations have left us as breathless. That said this is no time to change strategy or abandon one’s investment discipline. In fact, following a set of rules and procedures forged from ore based on market history is key in separating the noise (best ignored) from the fundamental changes that call for adjustment.

We manage risk and set policy primarily on asset allocation - the division between safety of cash and bonds and the risk and opportunity of equities. This is the cornerstone of our process, and it’s stood us good through even tougher times than now.

Opportunities like this do not come about too often, perhaps once every 15 to 20 years - the last one was in 1991. You have to be disciplined and courageous enough to take advantage of this turmoil.

The one point I want to leave you with is that although these are uncertain times, the issues are working their way through the financial system. The weak companies are going into stronger hands. And this will lead to a more stable and stronger financial system. The demand for financial services will increase not decrease after this.

There are incredible opportunities amidst the doom and gloom, but I think the worst thing people can do right now is redeem and get out of the markets, because history over the last few hundreds of years has shown very, very consistently that significant downdrafts are followed by sharp bounce backs, and if you’re out of the market you’re going to miss that opportunity.

None of us knows the future, but I do know, that if these are not unusual events, which we believe they are not, then we will come out of this just fine, just like all the other similar “earth shattering, collapsing, End-of-the-world, catastrophic’ crisis that have happened over the past few hundred years. And we will come out if well.

As Jim Rogers one of the Worlds most famous investor says

“Just about every time you go against Panic, you will be right if you can stick it out”

Hi Rational,

Can you tell me why it is taking so long for this thing to hit bottom? Besides the fear factor, there is an incredible amount of anger from our clients that ” experts” in the industry didn’t see this coming and why portfolios weren’t better positioned.

Anonymous person from Nova Scotia

Here is my reply

Hi Anonymous from Nova Scotia

It’s been a pretty tough week in the markets. And I share your pain in the markets, but I don’t share the massive amount of depression thoughts out there. It’s not the “end of the world”, and we’ve been through much tougher things. Investments are being priced as if the whole solar system is going out of business. What I believe has happened this week in particular, just from looking at the pattern of sells in the markets is that margin clerks at the world’s largest brokers are clearing out huge positions also program trading is going on, because much of the markets drops are within the last hour of the day. We need this kind of cleansing, even though it is very disturbing, because it flushes out all the speculators. And we had a lot of them. This flushing of assets, takes them of investment companies books, but they’ll have to eventually buy them back again, once prices have gone up - because that’s their business.

Experts can’t see the future, much like we can’t see the future. All the managers can do is make sure that the companies they are holding are sound have good business models and balance sheets. Of course they try to do as much as they can to assess future events, but in reality it’s still a difficult thing to do. They cannot control what the sentiments of the markets will do to good companies. All they can do is take advantage of opportunities of attractive prices for sound companies, and sometiems these good companies keep on getting cheaper, and it seems like these investment managers have lost their mind. Not really, they understand what’s in the companies, and recognize that eventually the rest of the world will as well at a higher price..

it’s not as much just “Fear”, as “uncertainty” that’s rocking the markets.

The uncertainty is
- Will the Banks recover - They will or they’ll be gobbled up by stronger banks - survival of the fittest - Darwinian economics
- Whose running the country - in Canada and the US. The leaders are so focused on their elections that they can’t put legislation into place. it’s just talk - When will this be over - November 4th. Bush is not running the US, because he knows he’s on the way out, with a job at Dad’s company - The Carlyle Group (Biggest Defense company in the world - and you wonder why they went to Iraq)
- Is my money safe - every government has said they will insure deposits.
- What about earnings - sure some of those companies with high debt will be affected, but there are many companies that have nothing to do with this slowdown, that will do well, and even profit from lower oil - Fed Ex, Proctor & Gamble, Pfizer, and Canadian Banks!

When will it be over, none of us knows for sure, and it will be a surprise, which the market is not expecting. Everyone and their uncles have said this will be looonnggg. This is what makes me optimistic. If everyone is saying that it’s going to take a long time, they’ll plan their investments that way, and when we do get a surprise, they’ll rapidly change their minds and add to the markets - it happens everytime. This is why investors such as David Dreman and Warren Buffett are so successful, because they don’t listen to everybody and their uncles (the media).

What we need is some major acquisitions to come from cash rich companies to buy out their competitors. There’s a lot of cash sitting on the balance sheets. as an example Pfizer, which has fallen around 33% in a year has $20 Billion in cash, pays a 7% dividend, and needs to grow its earnings (they could do with buying a competitor that has a good drug pipeline - Note, this is NOT a stock recommendation)

The next few days could bring an historic effort from the G7 leaders to work together to stabilize credit markets.

The G7 finance ministers are meeting in Washington this weekend to discuss the current financial crisis. There will also be bilateral talks that will include Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke.

This could include some form of guarantees for interbank lending, new initiatives to support the stronger institutions (Canadian banks) in buying the weaker ones (US Banks) and having some form of guarantee backing any surprise bad assets that come along in the package etc. Look for news on this to break late Sunday.

According the World Economic Forum, Canadian Banks are ranked as the soundest financial institutions in the world. The World Economic Forum’s Global Competitiveness Report based its findings on survey responses of 12,000 executives in 134 countries who awarded banks a score between 1.0 (insolvent and possibly requiring a government bailout) and 7.0 (healthy, with sound balance sheets). Just behind Canada in the ranking came Sweden, Luxembourg, Australia, Denmark and the Netherlands. US Banks ranked 40th in the poll.

Canada’s Finance Minister Jim Flaherty appeared to spend as much time as he could get in front of the news cameras trying to reassure Canadians that the banking system remains sound and that bank deposits are not in jeopardy. And i agree with him.

There are a lot of things that have been put in place
- global governments efforts to support the financials system
- lower oil prices
- lowering of interest rates

All of these things take time to have an effect, it’s not like switching on a light. But these are the right things. Had they of done these things in the 1929 depression, we would never of had a depression. so, yes, they are doing their job, and eventually it will work. How long that eventually will be… that’s the tough one. But if I had to guess I’d say it’s be sooner than most expect, and it’s probably not going to be in years!

Here’s what may need to happen

- US elections over with, new admin comes in (Bush is gone)
- Regulations in place to stop it from happening again
- Banks or someone to start lending out money again
- Companies to spend their money on buying out their competition

Remember all Bear Markets end with the beginning of a Bull market, and that now just temporarily, the inmates are running the asylum

All I can say, is listen to the sound file linked to above, and read the notes.

I am confident of getting through this. I am confident of taking advantae of these attractive prices. I am confident of five years from now, looking back and saying “I’m glad I didn’t make no drastic decisions and added to my portfolio”

Now go out and on the 17th October watch the new movie “W” - The story of George W Bush!

Rationally yours - Have a happy Thanksgiving

Rational (who wishes he was in beautiful Nova Scotia)