Rational Advisor

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”

Comments RSS