Rational Advisor

Santa didn’t bring much in the way of good cheer to the markets in 2008.

Financial markets have, of course, been very bad this year, so investors knew ahead of time that there’d be coal under the tree. But even a lump of carbon actually has some value, and stocks have lost around 40% of theirs this year.

Let’s face it. This bear market started as the perfect storm of popping bubbles—commodities, emerging markets, hedge funds, and real estate.

The S&P 500 is on track to finish the year down 41%.

Meanwhile, the Dow Jones Industrial Average down about 36% for 2008.
The Nasdaq down 42% so far this year.

The TSX of almost 40 per cent from the beginning of 2008, led by steep declines in resource stocks as demand tanked for oil and metals. Adding to the carnage, financial stocks tumbled as banks and insurance companies scrambled to deal with a string of write downs connected to the collapsing U.S. housing sector.

From its high in June when it was all about Potash Corp and RIM, the TSX is down almost 50 per cent from high to low in 2008. So do you really want those ETF’s and index funds now? How abou tthose lower MERs did they help when the markets came down. At least balance funds didn’t fall as much. many only as half as these ETFs.

Losses accelerated in the final quarter of 2008 after U.S. investment bank Lehman Bros. was allowed to fail, making banks even more hesitant to lend, instead focusing on boosting their own capital levels.

Tougher credit conditions helped pushing the big North American auto companies to the brink of bankruptcy by year end.

But the downturn also affected the so-called safe or defensive sectors that investors have turned to in the past to ride out severe downturns.

For example, utilities fell almost 30 per cent while consumer staples lost more than 10 per cent on the year.

There really was almost nowhere to hide,

The best companies were those that sold things cheap - In the US, like Walmart- discount retailer, Family Dollar Store-discount retailers, General Mills - Cereal, Autozone- Capr parts (people preferred to repair their cars instead of buying new ones), Biotech- Amgen, Celgene.

The Losers were primarily financials with the biggest exposure to mortgages.

What we are seeing is the downside of globalization, a synchronized recession in the developed economies, so we’re seeing that the U.S., Europe, the U.K. - they’re all deep into recession leading to other economies being impacted China, India etc. So much for the advantageous of globalization! You’d almost wish there was no globalization, and that each economy was segregated from the others.

Selling pressure could continue in January if, for example, more hedge funds are revealed to have invested with Madoff (Made-off) and skittish investors pull their money from those funds, Day says. In Canada, we have a mini-Madoff type hedge fund scenario in Sextant hedge funds. They seem to have about $90 million missing - I got concerned about this fund when it showed up on top performing charts at Paltraks, Morningstars and in the papers.

Even Cerebus, the hedge fund that bought 80% of Chrysler and lost 16% for the year, has announced that it will at a certain time stop people from withdrawing their money

Even more reason to NOT deal with Hedge funds until the appropriate legislation and rules are in place. I am pretty sick and tired of hearing about these IED
s (Improvised Explosive Devices) of the investment world killing innocent people. Yes, the are IEDs.

Both jobs and consumer spending have been a particular concern for investors. The more people lose their jobs – or fear they will lose their jobs – the more they close their wallets. And consumer spending accounts for more than two-thirds of U.S. economic activity.

The hope now is that forward-looking stock markets will sense an end to the downturn around mid-2009, after big stimulus packages pre-emptively announced by U.S. president-elect Barack Obama take hold.

We may well see the first glimmer of a recovery come from the US. The world needs the US to recover to feel better. US Consumers consume the worlds goods.

Sector wise the recovery may not come from resources, as typically resources don’t lead in the recovery, they’re late cycle performers.

Sectors that are early cycle are typically tech and financials

Techs have had the most cash on their balance sheets, they went through the last crash got all beaten up and had their major lay offs 10 years ago, so they have been a lot more defensive than careful.

They weren’t caught up in the commodity bubble and now they’re leaner, wiser and have some cash in the bank. And when companies need to grow in a challenging market, they don’t do it by hiring a bunch of people, they try to upgrade their technology at the outset.

Financials will be the other key group to watch.

There’s not too much risk of a dividend cut. The strong one’s aren’t going out of business. The banks have an incredibly profitable business model. They just charge higher fees to get out of their messes

Recently we’ve seen a lot of sparring between the Canadian Banks and the Canadian government. The government saying that the banks are not lending as much. I’m on the banks side in this sparring. Banks have demonstrated that they have increased their lending, and yes they are charging more for it - notice RRSP loans are now at Prime and Prime plus one, also variable rate mortgages are prime plus. The real issue, is not their lending, but that demand for loans has come down. Because of this slowdown, less people are buying large items that require financing - like houses and cars. So, it really isn’t the banks fault. If the government wants the banking sector to get better, they had better make it conducive for employers (lower property taxes, incentives etc) to come into Canada and provide more jobs.

Another good thing for investors is that because of a miserable 2008, many people will not want to be in equities, the fear of a repeat is to great for them, they’ll run to GICs etc paying 2%. This is great for investors because it means there is less volume and competition to buy good sound businesses

“Financial markets, however gingerly, are starting to look ahead to a better, if not yet glorious, summer,” CIBC World Markets economist Avery Shenfeld wrote in a recent note to clients.

Fear and uncertainty might lead investors to sell their investments during tough times, putting downward pressure on prices. Trading based on these emotions can be detrimental to a portfolio’s value. By selling during downward price pressures, investors might realize short-term losses. This is compounded as investors wait and hesitate to get back into the market, possibly missing some or all of the potential recovery. The lesson here is that patience can pay dividends. And also Diversification is always important.

One of the main advantages of diversification is reducing risk, not necessarily increasing return, over the long run. While stocks offer the potential for higher returns, the downside risk can also be extreme. A diversified portfolio can help mitigate such extreme swings in value.

Where do we go from here? Probably not lower, in our opinion. We are beginning to see some calm in the markets, as more and more bad news has less and less affect on the markets.

This is the 16th bear market since 1929. Its more-than-50% decline makes it the worst bear since 1945, and the third worst since 1929. But when this bear market finally ends, history says be prepared for a fast and furious partial recovery. In the first 40 days after establishing a bear-market bottom, the S&P 500 has traditionally recovered an average 33% of the point loss experienced during the just-ended bear market.

(source: S&P Analysis) Since November 20th the low, the S&P 500 is up 21% from that point - only once since 1939 has an increase of 20% from a low gone back down (2001-2002, because of 9/11 following the tech crash).

Should Nov. 20 end up being the low for this bear market, S&P Analysis team believes 2009 may end up being a fairly good year for stock returns, if history is any guide. During the first year of a new bull market since 1932, the S&P 500 rose an average 46%. What’s more, the “500″ recovered more than 82% of the prior bear market’s loss, on average, in that first year. They can’t guarantee that the market will respond the same way this time around, but successful investors look at history—and history points to a sharp advance in the first year of a new bull market.

The magnitude of the decline is one of the reasons they believe a bear-market low may have been put in place. The 52% decline is within earshot of the 54% falloff recorded in the 1937-38 bear market—the second worst since 1929. The largest peak to trough decline was 89% recorded from 1929-32.

The S&P 500 fell by more than 20% eight times since 1900. It rose in six of the subsequent years, posting an average advance of 10.4% in all occasions. You have to look to 1931 and 1932 for the exceptions.

This bear market retraced 103% of the advance during the 2002-07 bull market. Traditionally, bear markets retrace an average 73% of prior bull-market gains. And those that retrace more than 60% of the prior bull run have taken back an average 110%. The current 103% retracement is close enough.

The S&P 500 was trading at a P/E ratio on trailing operating earnings per share (EPS) of 11.5 times, equal to the lowest operating P/E ratio in the 20 years that S&P has been tracking operating results. It is also a 40% discount to the average operating P/E ratio of 19.3 times since 1988.

Finally, on Dec. 8, the S&P 500 closed at 909.70, or 20.9% above the Nov. 20 closing low of 752.44. Technically, that’s a new bull market. Even though they would prefer to see this level successfully retested before admitting that they are in the beginning of a new bull market, history indicates that only once since World War II (September 2001-January 2002) did the S&P 500 experience a bear-market rise in excess of 20% that was subsequently followed by an even lower low. All other 20% advances were eventually proven to have been the ultimate bear-market low. Again, you have to go back to the 1930s to find exceptions to this rule.

Of course, these are unprecedented times and the rules are being rewritten every day. In all, however, I believe the abundance of positive precedents will likely have some impact on the rational investors

Merry Christmas and a Happy 2009

In a truly historic market, a cliche best describes it all: What a difference a year makes.

Few people have lived through a market as wrenching as the one we’ve seen in the past year. Prices have fallen, while previously stalwart companies such as Lehman Bros went bankrupt, Bear Stearns was purchased by JP Morgan, companies like Merrill Lynch was forced to sell itself to Bank of America.

2008 was a year of remarkable headlines and events. Market volatility reached new levels, while industries went through dramatic changes. Investors have rightly become concerned about the long standing viability of previously sound companies.

There are lessons to be learnt from the series of events that happened in 2008, not least of which is how smart money (hedge funds, resource based funds, and emerging market funds) got it so wrong, and how supposedly “dumb” investments like Balanced funds, bonds and somewhat dividends funds got it fundamentally right. Even though they were impacted, they still were less affected than smart investors.

Even great investors like Warren Buffett have taken a big beating,Berkshire Hathaway A is down 31.09% for 1 year. Here is the greatest investor of our lifetime, and even he was not able to steer clear of the market issues in 2008.

Let’s begin with the trouble in global finance. The failings of modern Wall Street and Bay street can be summed up in three ideas; crazy leverage, poor credit risk, and not understanding low probability risks.

If there was one lesson to be learned about financial risk from the Great depression, it was this: Leverage in combination with volatile assets is a poisonous brew. Much of these volatile assets were in Hedge funds that previously had stupendous returns, mostly leveraged on the back of commodity prices. Another reason not to look at past great performance funds and managers.

My views are that much of the commodity price increase had to do more with speculation and leverage than real demand and supply issues. And this speculation was fuelled by the entry of the US led by Bush and Cheney into Iraq (the 2nd largest proven reserves of Oil in the world (http://www.brookings.edu/papers/2003/0512globalenvironment_luft.aspx).
Prices of Oil shot up from $60 from March 2003 to $147 on July 11th
2008. This led to concerns around inflation, increases in interest rates in 2006, housing and sub-prime crash following due to higher rates to fight the inflation issue, lack of purchases of Big gas-guzzling auto car sales (mostly US), currency increases in Canada, due to Canada’s higher content of Oil, which led to less jobs in manufacturing, slowdowns which meant that lenders such as banks were less willing to lend - just in case. All trickled down from one major event - is this too simplistic, maybe. But, it’s harder to dispute when you take a look at the timeline of events. Pre-2003 we never had any of these issues, sure there were bubbles etc - but the pin that pricked the balloon wasn’t there yet (that pin that pricked the ballon is meant to reference the outgoing US adminsitration)

Just before July 11th, it was announced that the democratic candidate for the US president would be Obama and not Clinton. Suddenly the end of Bush and Cheney’s Oil love affair began to come in sight. It faded even further when in November McCain, a Bush wanna-be lost the election for the US president. And so, we’ve seen a dramatic decrease in the supply of Oil, which has led to failures in companies that were caught on the wrong end of oil speculation - Bear Stearns, Amaranth, Lehman Bros and others.

The temptation to take ever greater risks rose in the past five years, with interest rates at low levels not seen since the 1960s. People forgot about credit risk, and they decided to forget about diversification and instead concentrate on what was doing well, commodities, Energy, India and China.

Combine leverage and inattention to risk and the third failing, the failure to anticipate low-probability risks and the story was complete.

I’ve had many concerns around the “great” contribution of modern finance, and its assumption that the world is based around statistics and mathematical formulas. The propeller heads. PhDs and math wiz’s followed these new techniques of quantitative investing, correlation, sortinos, betas. standard deviations and better risk management tools. One of the great failings of the smart money was to focus unduly on the central tendency, and ignore the low-chance events (Black Swan events). there may well be a 98% probability that your capital position is secure, but once in a great while, say, in 1929 or 2008 - a 2% event comes along. I am absolutely, not a fan of the propeller heads and computer based models to protect assets. Investing is not as much mathematics as a combination of mathematics, art and a larger amount of psychology. It’s interesting that teh greatest investors in the world the likes of Warren Buffett, David Dreman etc are not Math Wiz’s.

What lesson should we investors draw from the decline of the smart money?

During times of crisis, it’s easy to shut down and avoid asking yourself and your advisor the right questions. But, it’s crucial to take a deep breath, take a step back and assess where you are now. The crisis will pass and you’ll still be faced with planning for your future. Are you committed for the long haul or looking to make short term changes?

The next important question to ask yourself is “How am I doing today?” Are you feeling confident or anxious? have recent events brought up strong emotions such as anger and resentment? If so, talk to your advisor.

The classic response to stress has often be described as “Fight or Flight”.

Fight mode means that you may be displacing your negativity onto others, such as snapping at your spouse and others. If you feel that’s happening, take a break, walk around the block and cut the negative circuit. This is not a Fight you will lose, of you keep a cool head and realize that strong companies will come out smelling like roses,
and that they will continue to increase their revenues and cash flows, as their weaker competitors get decimated and removed.

Flight mode means that you may be trying to escape from the crisis by locking yourself in your office or avoiding talking to your advisor. If you’re going into flight mode, take the initiative. Schedule an appointment with your advisor, and make sure you are staying connected.

We need to look at the millions of North Americans who did the right thing financially: diversify, make sure bonds are part of a portfolio, understand their risk tolerance, understand what they are invested in, not get caught up in the high returns of the past investments, not get deluded by past performance numbers, keep a focus on their longer term.

Successful investors display great emotional intelligence during moments of crisis. They’re forward looking, and rationally optimistic, Crisis like the one in 2008 take almost everyone by surprise, including myself.

2008’s volatility is not new, it’s only that daily and intra-day swings of two, three or four percent

Remember it’s not the event, but your reactions to the event that’s really critical. If you think rational thoughts, you’re going to feel rational. you’re going to have more appropriate judgement and more appropriate feelings, And in the end you’re going to behave more rationally. During times of crisis, emotional intelligence is as
important as financial intelligence.

When the air clears, there will be renewed interest in economic fundamentals. Financial institutions will need to be better capitalized, less leverage on their balance sheets, and better built to withstand low-probability events. This all makes for stronger companies in the future, something that I, looking forward, find
particularly exciting.

One of the unexpected consequences of the financial crisis, I anticipate, with be the rise of stronger dividend paying companies, and better managed funds. The markets will continue to evolve, creating new challenges and opportunities. Downturns don’t last forever

Meanwhile, take a step back and focus on what matters the most. Play with your children, talk to your spouse, reconnect with your friends and identify with what keeps you grounded. Take a deep breath and take fear out of the equation. Stay true to yourself and your values.

I promise to stay true to my values of having portfolios constructed with Bonds and Dividends of strong companies, and managers who have demonstrated the ability to succesfully weather crisis in the past. I have an even greater faith in this process now!

“All financial crises end-and when they end, they end in ways that create spectacular opportunity.”
- Larry Summers, incoming head of the Obama administration’s National Economic Council

With that I leave you with some very special words from Ben Stein

“And let me close with another thought. I am far from glib about the economy. It has a lot of pitfalls facing it. As workers and investors, we know that many dangers lurk in our paths.

But so far, these things have always worked themselves out and this one will, too. In the meantime, they say that falling in love is wonderful, and that the best is falling in love with what you have.”

Please copy and paste the link below as my New Years gift to you

http://www.nytimes.com/2008/07/13/business/13every.html?_r=1&em&ex=1216440000&en=a9a6d3e97f11545f&ei=5087%0A

Remain Rational

Dance
as though no one is watching you

Love
as though you have never been hurt before

Sing
as though no one can hear you

Live
as though heaven is on earth

- Souza

It’s amazing how each bear market is so similar.

Each and every bear market’s end term is identified by someone going to Jail

2008 - We have Madoff with a $50 Billion scandal and Marc Dreier going to Jail

http://en.wikipedia.org/wiki/Bernard_Madoff

http://www.nytimes.com/2008/12/14/nyregion/14lawyer.html?em

2002 - Bernie Ebbers Worldcom arrested for fraud - marked the end of the technology crash

http://en.wikipedia.org/wiki/Bernard_Ebbers

2001 - Jeffrrey Skilling, Enron - marked the end of 2000 stock market crash
2001 - Martha Stewart

1995 - Nick Leeson, rogue trader with ING Barings - marked the end of the peso crisis

http://en.wikipedia.org/wiki/Nick_Leeson

1990 - Michael Milken arrested for junk bound fraud at Drexel Lambert - marking the end of the 1990 recession

1986/7 - Ivan Boesky - insider trading - marked the end and short liviedness of 1987 crash

Arrests usually mark the last period of any bear market

Deutsche bank may be giving a signal about concerns in European banks (Not Canadian).

They recently surprised the markets when they announced they will not redeem $1 Billion of callable Bonds. These bonds do not mature till 2014, but they did have a callable date of Jan 2009.

Why is all of this important! Why does it give me some concerns - and why am i Thankful not to have European banks

When the bonds are called in early the debt is retired, the debt is paid back to the bond holders, and the banks now don’t have to pay out the income. It’s industry practise for banks to redeem the bonds at the earliest possible date, this is usually proof of the soundness of the banks balance sheet. The fact that they can pay back their loans earlier.

Deutsch Banks decision caused me concern that there may be more problems at this European Financial Services Giant. Perhaps they need to shore up their capital base, and thsi was the best way of doing it, anyways you look at it, I don’t think it was normal.

I don’t think the Canadian Banks have much to worry about, they had stricter capital requirements, and also didn’t get involved in as much silly loans. Nevertheless I will keep an eye on Canadian Banks $3 Billion worth of callabel notes that come due in the next few months.

Week ended Dec 21st

Here are some of the interesting things that happened in the markets that should make us think

MARKETS

It’s Christmas week on the markets, only three days of market activity in the week.

The Canadian market has lost more than 40 per cent of its value since hitting a high above 15,000 in mid-June and market watchers are looking for any sign of a market bottom and eventual turnaround.

TSX CLOSED DOWN

The Toronto Stock Exchange, shut down for the entire day Wednesday, sidelined by a technology glitch, driving business to rival exchanges and into New York. The TSX would have lost in the area of $800,000 in transaction fees, based on the daily average in the last quarter.

And guess what it was probably the best thing for investors at this time. They were forced to look at their investments as long term holdings (more than a day). What would be great is if it could be closed for five years!

Autos

Soon-to-be ex-prez George Bush outlined his plan to funnel a total of $17.4-billion (U.S.) towards General Motors Corp. and Chrysler LLC, in an effort to keep them out of bankruptcy in the near term and prevent a wave of auto-related layoffs. (The longer-term fix is for the next administration.). He said a collapse of the car industry could send the suffering economy into a deeper and longer recession.

Where will that $17.4 Billion come from – why you the US taxpayer, through the $700-billion (U.S.) banking rescue package approved earlier this year. $13.4-billion will be given now, with another $4-billion in February, with a number of conditions attached. Key among them: The car companies have just three months to restructure. The companies must also provide the government with warrants for non-voting stock. Under the terms of the agreement, if the companies do not demonstrate they are financially viable by March 31, 2009, the money must be returned. (if they are not viable, How will they be able to return the money?) For GM, Ford and Chrysler, the lights are still on but the clock (I think it’s a clock that can be heard, but it may be a bomb) is ticking. If that doesn’t work, the loans will allow an orderly bankruptcy, Mr. Bush said, so that Americans can continue to buy U.S.-made cars. Uhmm, isn’t that the whole problems – Americans NOT buying American cars – shouldn’t that be the focus. Cars that are needed, instead of cars that only the execs think the Americans need. Americans and Canadian auto workers were paid very richly, Car companies to sustain these pay stubs had to produce larger and larger cars and sell them at higher and higher prices – to maintain the pay stubs! Had they had more equivalent wages as the Japanese and the Koreans, there would not have been a push for such large and consumer unfriendly cars. They could have made smaller cars with less profit but more sales – So, don’t just blame the executives, also blame the workers and unions for asking for more, when there wasn’t more to be had.

It’s the same in every industry, including the financial industry – Product is made that is not suitable to the end user. Things that do not disclose the risks, but sound exciting. Things that supposedly provide guarantees and protection, without identify the costs and assumptions e.g. PPNs (Principle Protected Notes) offering principal protection and returns now having to convert to Bonds with the fees of an equity fund No wonder, the public has lost trust with the product providers – they’ll bring stupid things out, and fool everyone with their marketing and gimmicks. As always it’s the simple things that work, and keeping a focus on the publics needs – not the company’s wants..

And with everything else, as soon as Bush opens his mouth – the world ignores him. We got a ho-hum response from investors.

Canadian Stimulus Package

And in Canada, Prime Minister Stephen Harper said that a federal stimulus package could total as much as $30-billion (Canadian) in an effort to prevent the deteriorating economy from spinning out of control.

This will probably mean that Canada will be in a deficit for a few years.

Personally, I don’t think Canada needs a stimulus package, we need to have things take their course. By bailing out the US companies we don’t get more jobs. It would be better to offer the money to other auto companies to provide more stable jobs and take over the US plants.

In tough times, at the household, you don’t go around spending more money – you go around cutting costs and fat. You stay within a budget, and you battle through the tough times. What we need is a Margaret Thatcher!

BANKS

Ottawa this week pressed the country’s banks to ensure adequate credit is available. On Wednesday, Bank of Canada Governor Mark Carney, said the major banks should not sit on capital but instead should lend more. A day later, Finance Minister Jim Flaherty said he and Mr. Carney would meet the bank chiefs in January, and he expects them to prove they are making adequate credit available.

US INTEREST RATES

The U.S. Federal Reserve cut its benchmark Fed funds rate Tuesday to a record low range of just zero to one-quarter of a percentage point, and promised to keep it there for an extended period. Central banks around the world have been slashing rates to battle the mounting crisis.

RIM

A bright spot was Research In Motion Ltd. 14 per cent to $53.32 after the BlackBerry maker posted a 66 per cent surge in quarterly revenue to US$2.78 billion despite a jerky rollout of new smartphones. RIM also issued a jolly outlook for the holiday season and beyond.

Potash

Potash Corp. after the fertilizer giant lowered its 2008 profit guidance due to wilting demand for crop nutrients in a blighted global economy. PotashCorp also issued layoff notices to more than 900 employees.

Oil

The more the price of crude oil falls, the more the previous highs look like a bubble. Oil traded at just over $34 a barrel on Friday morning, down about 76 per cent from its high in the summer, when some analysts believed it was headed for $200.

Bespoke Investment Group pointed out that oil would only have to fall another $2 a barrel to make the round trip as disastrous as the pop of the Nasdaq technology bubble.

“The only difference is that it took years for the Nasdaq to reach its lows, while oil has declined by almost as much in just a few months,” Bespoke said on its blog, Think B.I.G. Indeed, oil’s precipitous fall make it look like one of the most extreme bubble bursts in history.

Bespoke also pointed out that bubbles tend to deflate a lot faster than they inflate, noting that it took 1600 trading days for oil to hit its peak but only 100 trading days to move back down close to its lows.

Some things to consider about bear markets

What we have to realize is that bear markets are scary when you are in them, but they are also necessary. They bring back to rationality any insanity that’s creeped into asset prices. Unfortunately, the correction of the insanely valued assets also leads to the mis-pricing of otherwise fundamentally sound businesses. Meaning that the babies get dumped out with the bath water. And it’s this belief in those sound companies revenue and cash flows that gives us greater opportunity for the future. If you want to achieve above average future returns, you have to invest in below average prices. And this is what we are experiencing, the painful process of below average prices.

Some truths about Bear markets

1. Realize that the below average prices – the bear market are common.

Canada has seen about six bear markets in the last 39 years. That’s one every 6.5 years or so. U.S. stocks have seen 15 bear markets over the last 137 years - an average of one every nine years. The average is closer to six years if you include bears within a bear (i.e. where a 20-per-cent decline is followed by a further 30-per-cent loss before recovering). So, rougky every six to 6.5 years we will see a bear market – next one will be around 2014/15. This wasn’t the first asset bubble and it likely won’t be the last,

In a bear market even the savviest investors (including Warren Buffet) have get hurt. Shares of Buffett’s Berkshire Hathaway have lost a about 30% to 40% of their value this year.

2. Diversification works..

The reason you have diversification is to reduce the impact and focus of particular risks. There are always surprises in the markets, diversification just helps to reduce the impacts of those surprises.

The best place to hide has been in government cash and bonds. In the Great Depression, for instance, U.S. stocks fell nearly 90 per cent and spent 15 years under water. But a portfolio of 60 per cent U.S. stocks and 40 per cent U.S. government bonds spent just over six years in the red. Here’s why:

First, a portfolio of bonds and stocks lost a lot less than the all stocks portfolio. Second, deflation dominated the 1930s and government bonds do well in deflationary times, which helped the balanced portfolio recover quickly. The interest from the bonds was used to buy lower priced stocks.

3. Like every other bear market, this one will also finish there’s no such thing as a permanent going-on-forever bear market.

The average U.S. bear market spent nearly three years recovering from its lows. Perhaps this bear market is worse than average and may take longer to recover, the economic news may even worsen from here but stock prices appear to be assuming the worst. Unless you believe that the economy will shrink over the next decade, that people will stop buying things, that companies will cease to grow - stocks are cheap. And when fear begins to subside, this bear will slip back into hibernation.

Peak volatility is rarely sustained over time. In a market where a deep recession has become rooted as consensus, where central banks are flailing very publicly in their fight to fend off disaster, bad news ultimately loses its ability to shock. Bad news seems to be everywhere, so any new bad news is just normal – what is the surprise is some small piece of good news. It is interesting to see how equities have recently shrugged off some very negative corporate developments and economic data (Madoff scandal, retail slowdown, high unemployment).

Monetary stimulus - The U.S. government is pulling out all of the stops to ensure this financial crisis does not spiral out of control. The Fed, Treasury and FDIC collectively have cut the overnight lending rate to zero, provided numerous lending facilities to financial and some non-financial institutions, injected capital directly into financial institutions, guaranteed debt and increased deposit insurance.

Other governments are also tackling the issue and Canada is doing its part by lowering interest rates and providing additional liquidity into the financial system.

Fiscal stimulus is the next step and packages are likely to be very large. Expect the budgets to provide some good benefits.

It will take time for these measures to work but in the end they should achieve their desired effect.

This may be the richest environment of low-hanging fruit I’ve seen in my career. And you would have to go back to 1973, 1974 or even, in some markets, to the Great Depression to find markets priced as attractively as now. This is not a time to be hunkering down in the safety and comfort of the Treasury curve and GICs. There are tremendous opportunities right now. It is so tempting in a bear market to focus on the glass being half-empty and on how much has been lost. But the glass being half full side is largely ignored. There are a lot of absolutely wonderful companies making great revenue, even in these tough markets, that are going for a song.

The TSX Composite Index and S&P 500 Index offer dividend yields that are higher than the yields on 10-year government bonds. The S&P 500 also yields more than a 30-year Treasury bond. This is not normal. At every time through history that these occurred investors who took hold of the opportunity were well rewarded in the years that followed.

It is interesting so many felt so confident buying stocks when they were 40%, 50% or 60% higher but can’t muster the courage to wade back into the shallow end of the pool. Great opportunity arises during periods of crisis.

Almost everybody, retail investors and institutional investors alike, invests with their eyes in the rearview mirror, favoring what has worked best in the past. But there is a very powerful pattern of mean-reversion in the markets. What has done spectacularly well often takes a rest or it takes a bear market to get back to normal. So the notion of looking at markets and asking what has been hit really hard and, as a consequence, may be priced at really attractive levels is alien to most investors. This temptation to buy what has done well is the single greatest pitfall in investing, and it is the single reason that a disciplined approach to asset allocation can actually work very, very well.

There is a silver lining to all of this madness. Financial discipline will make financial institutions, consumers and the economy stronger in the long run.

Bob Olstein was a manager that I’ve tracked since our selection for Dreman, since that time I have kept an informal communication with him. He was not chosen because he is an all-cap and not just a Large Cap value manager

Here is some of his views on some of the issues we are facing, with respect to his letters.

I re-read his comments in his shareholders letters and here are the gems…

In 1998, Robert Olstein wrote an important letter to his shareholders, on the underperformance of his fund. Robert had stayed true to his discipline and not invested in Technology, when technology had been doing well for the previous three years. After the tech crash, he beat the index by 20% margins, and recovered all of his underperformance and more. He was ranked as one of the top Value managers in the US

Here is Bob’s comments from the June 30, 1998 shareholder letter

“It is our opinion that everyone in the securities business eventually goes through periods of disappointing performance. If you do not understand this basic fact, you are probably not dealing with your investments realistically. Unrealistic investment expectations can create panic and lead to decisions that could be detrimental to your financial health. We believe that long term objectives are only reached by portfolio managers who stick to a successful long-term discipline even when it is out of favor and not working [during the] short-term. No discipline works all of the time… After 30 years of experience, each time the portfolio declines, my stomach still feels some pain. However I manage the portfolio with my head and not my stomach.”
- Robert Olstein June 30, 1998

In September 1998, Bob’s fund had a -21% decline in 6 months. Here is his notes to his shareholders on Sept 1998

“False expectations are dangerous to your investment health. Although disdained, volatility is a necessary evil that must be tolerated when committing to a diversified, long-term equity portfolio. While this volatility can create anxiety, it creates potential opportunities for future long-term appreciation. A portfolio must be managed with one’s head, not with one’s emotions. .. Market psychology goes through schizophrenic changes in reaction to the latest crisis or economic event, resulting in short-term price fluctuations that have no correlation to our long-term views. Investors are usually consumed by the events of the moment and rarely look beyond their current feelings of fear or jubilation. Sound investments need time to emerge. Patience is the greatest virtue an investor can adopt”
- Robert Olstein, September 30, 1998

In his February 28, 1999 shareholder letter, Bob writes..

“Many mutual funds that invest in large capitalization internet-related stocks are currently receiving a lot of press coverage extolling their metoeoric returns. Yet, there is little coverage of the risks taken in order to achieve such high returns. There is also very little press coverage as to what happened to the followers of previous manias that have since proven to be only short term fads. Human nature tends to be attracted to what is currently working, trendy and getting media coverage. Returns on investments currently in the in the investment spotlight are driven higher and higher by additional investors seeking their fortune, with little regard for the underlying fundamentals or for the risks taken. As always, when conclusions are reached that a particular investment discipline is the only way to go (e.g. indexing, technology, and internet companies), the mass acceptance of that conclusion leads to classic cases of overvaluation which can eventually result in serious corrections and investor disenchantment.”
- Robert Olstein, Feb 28, 1999

Then in March 2000, the Technology bubble burst, and everything that Bob had talked about came to fruition. His portfolios recovered well, and investors that had left him because he was not “hot” enough came back

Here’s notes from Bob’s July 15 2000 shareholder letter.

“Although lucky with our timing, our philosophy indicated to us that the speculative bubble could not be sustained for much longer. Assuming that a hot sector or group that is currently appreciating rapidly will continue forever is dangerous to your financial health. Wall Street’s history is littered with bubbles that have burst, and I am sure that this is not the last. This phenomenon plays on human nature, which tells us to ignore risk and seek instant gratification.”

Bobs fund to date has an 3.49% ten year number and has beaten the S&P 500 by a 4.42% margin over that period. Even after suffering three disappointing years because he did not jump on a “hot” sector.

His since inception performance is 7.63%

Yes he is currently down -46% for the year, and he’s been adding to a lot of financials, which he believes are way undervalued

IN his recent letter he wrote

“As in real life, the tide eventually turns and comes back in and so will the negative emotions of investors”

“The markets need to differentiate between prices based on future cash flows of businesses that have been hit hard, but still have great revenue, rather than reacting to the latest write down or press coverage of repeated sensational events that have been repeatedly in price declines. We have to look at the future expectations and see if they are realistic or not. Prices of many stocks are priced as if they will never prosper again, ever.”

“we disagree with the majority of investors who dwell on the headlines”

“the Credit crisis will end, the housing prices will trough, and the market will stop falling, and return to normal”

We should all learn from Bob’s discipline and patience.

Here are my notes from recent trip to Nova Scotia.

This is a wonderful part of our country, and I encourage all of you to see it, just not in winter!

These notes are based on discussions we have been having with advisors and their clients

Stock markets are anticipatory and currently they seem to be making a floor and waiting to go up.

Even though we’ve had a lot of bad news, as an example $50 Billion fraud by Madoff, the markets still moved higher.

We’ve had
bad news in autos
bad news in economics
bad news in bailouts and banks

and yet still the markets managed to be mostly up. We’ve actually been in a range, and this is normal and part of the markets bottoming process. Bad news is now Old news.

We may well be seeing the bottoms. When the market begins to shrug off the bad news, and it starts to go up, despite the bad news. It’s really saying that anyone who had wanted to sell has already sold out. So there are less sellers on the bad news.

The uncertainty in the markets may well have ended, and on Jan 20th it will be a new guy and has already started to do things.

Even in Canada the news of a coalition government does not seem to faze the markets. Ten years ago, the news of the coalition government would have brought the markets seriously down.

Let’s face it, the US auto companies are bankrupt, they’ve as much as admitted it. They got up in front of congress and said here are the dates that we will run out of money. If that isn’t an admission of bankruptcy, I don’t know what is.

Here are some of the questions I have received on the Nova Scotia trip

Q – Are things truly going to get better? the US keeps on printing dollars, they’re debt keeps on getting higher. Are we not heading inot a bigger disaster?

A – It’s a mistake to think that the printing presses for currency are on. Yes, they are borrowing more money from China,. But China and other nations need to lend to them, if they want their own economies to survive. Because a dead US is a dead US consumer, which is a death to these nations.

If they did not lend to the US, it would be much worse, there would be much more unemployment.

The uniform response from governments around the world has been for them to bail out the risk takers – this I don’t like. A lot of this borrowing will be eventually inflationary, but it may be years down the road, and we’ll have to deal with it then. Now, we have to deal with this recession.

We think incorrectly that governments control interest rate movements. That’s not true – they react to market forces. It’s the markets that force the banks to raise or drop interest rates. The current rate reflects the price of money, and the supply and demand of that money dictates the current rate. Because nobody is willing to borrow at the higher rates, the rates have to go lower.

And right now, the US dollar has been going up, and that’s because globally countries are willing to lend to the US, globally they increase their demand for US dollar. Because they have greater faith in the US government ability to pay back the loan, than they do in the Euro etc. They are thinking that the US will get through this mess and be stronger afterwards.

Q – Is this a buyers market?

A – We are seeing the most intense deleveraging cycle since the 1930s. But, yes, this is a buyers market. Investors who are selling are selling because they are panicking or they are desperate for capital. These are some of the cheapest markets I have ever seen in my life and probably most of the people livings lives. Only 1929 were cheaper. These prices cheap prices should not exist, they do not make sense. Recently in the Wall Street Journal they commented on the fact that there were around 2200 companies that were trading below their net cash positions. And that’s not normal, its an aberration.

One or two companies trading below net cash is normal, but bloody 2200, that’s beyond an aberration, its twilight zone stuff, beyond rationality.

The most companies below net cash recorded in past downturns was around 300 companies. So we have somewhere around 8 times as many of those. And some of these companies are quite large companies, with no debt. If you bought them, and the day after they go belly up, you actually make money after settlement.

Something strange is happening in the markets – too many companies that are good are selling for way to cheap a price.

There are no bells or whistles that signal the markets have changed direction. We have to study previous market cycles to get some sense of when things could happen, although it may not be exactly the same, it does offer some outlook. Again, when markets move higher on bad news, one can reasonably argue that the bad news was already priced into the markets are discounted. Most people are expecting more bad news, and that’s been priced in. The surprise will be the good news, and that could reverse the markets sharply and quickly.

We’ve now been told that the recession that the US is in, officially began in December last year, therefore it’s a year old and if it were to equal the longest post-war contraction, we’d only have four months to go. However, this may be longer, thanks to the lack of consumer confidence. However even if we assumed that it would take two years, ehich would represent a whopping 50% longer than norm. We are about halfway through that scenario. And this may be encouraging. It’s just past the recessions half way mark that share prices begin to anticpate a recovery. Stocks in 1974 and 1982 (the last time they were two standard deviations below their mean), stocks began to turn up as the recession was still in force. In the great depression, stocks hit their lows in 1932 stillin the middle of their recession.

History has shown that on average, bear markets last 12 months while bull markets last 41 months. Winning markets outlast losing markets.

Q – We think it’s different this time, Lehman Bros has failed, ear Stearns has failed, interest rates are dropping to unprecedented lows.

A – yes, I hear that, and I’ve heard similar things at every peak or bottom on the markets. When markets are going up it’s different, because or such things as the world has changed because internet will change the way we do business (2000), or when markets are going down, because of the failure of US banks of a whole county in the US (1990), or because of te failure of a country’s currency (1997 – Peso). When I hear these magic words “it’s different this time” I know we are somewhere near a turning point in the market, either a top or a bottom. Markets do rise over time, but they don’t go up continuously, and this decline is a natural and common event. What seems different is that this time it wasn’t down to technology, but due to stupid bank lending practices – both of these vents were based on the publics increase in greed. There are in fact, very few downturns that were due to banks. But, it has happened before in 1991

Takeovers will start to happen at some time, as the strong companies wanting to increase their revenue, find it cheaper to buy their competitors than build more business. Right now, companies are sitting on a lot of cash

A strong case can be made that that the pendulum has swung to the point of excess gloom. There has always been good news and bad news out there. Only two things vary at any given point in time; First, the balance between good and bad news, and second, what people focus on. The tech mania of 1999 was a classic period in which the public only focused on the good news and ignored the bad news; arguable we’re seeing the exact opposite now, as all we hear are the negatives.

Q – Should we be borrowing to invest.

A – If you are ever going to borrow to invest, the first thing you must think about is “Can I carry the debt?”. “Can I make the interest payments without relying on the income from the investment?” Your personal cash flow should be good, the rate of borrowing should be good, and the time frame for the investment period must be a minimum of five years. Your age also matters, and if you are going to leverage, the investments should not be overly risky for your tolerance.

Q – How can you protect against another Nortel, Enron, Worldcom or something else

A – This is why we have diversification. This is why it is much more risky to own individual stocks. If you have 40 to 50 stocks, if one or two go bankrupt it is only a small percentage of the whole. We have to remember that there is no such investment that is perfect, there is no sure thing. Prudent diversification helps you reduce your risk.

Q – a lot of your managers have been buying into banks, are Canadian banks strong

A – We first have to understand that our managers are diversified. I do prefer funds over individual stocks. However, our managers are saying that banks have beaten beyond reason. They are still making excellent revenue, and it doesn’t look like they will have to reduce their dividends.

Q – What should be done about our funds, a lot of people are concerned about them

A – One of the best things you can do, is understand them better – Review them again. Don’t make the portfolios too confusing. I prefer to have a balanced type investment, almost always – if there is a recovery, it will also happen to balanced type investments. This may e the cheapest time to look at them. Ultimately, this is the truest sense of the public’s assessment of risk, this is the risk that needs to be addressed.

Remember nobody really knows the future, the future of the stock market is not based on any science or mathematics – if that was the case, then the richest people would be the Maths and Science PhDs. The markets are based on the collection of opinions of what businesses are worth. Sometimes these opinions are completely irrational – like now.

The stock market only acts as an intermediary in helping us to own a parts of businesses in which we choose to invest our equity. The markets act as a matrimonial website, Giving you innumerable number of best fits, but leaves the trigger for you to pull.

The most common mistake that investors make is thinking that the market prices on the companies are a true reflection of the value of the company. They are not, they are just the collective opinion of those in the markets of what that company will do. And if there are more panicked investors, they will make more panicked decisions.

Think about it, would we ever stop shaving, using paints to color our houses, consuming salt or for that matter enjoying a good chocolate if the value of these companies fell. Would we stop using or eating them. No amount of change in the interest rates will slow down the underlying fundamentals of these businesses. Just one bad result or quarter or worse a year should not affect our investment decision in that company but should be accepted as a buying opportunity to average out your low cost. If, like other speculators we sell our company because its having a bad year, it would be similar to throwing out our brilliant son for having a bad year, forgetting his capability through his previous brilliant years. In the investing world we usually are not presented with buying opportunities like these again and hence nicely owned businesses are being sold for peanuts.

To manage wealth, huge amounts of emotional stability and a whole lot of Common sense is required. And unfortunately common sense is in short supply.

Investors will eventually move from the phase of thinking about stability to thinking about recovery, and why they don’t want to miss the recovery phase of the markets. And when this happens, we will begin to see the massive amount of cash on the sidelines come back in rapidly.

To get above average results, you have to invest at below average prices.

Could Obama have been involved in sub-prime - No, you say.

Well, let’s think about things,

One of Obama’s first jobs, was to be a social worker in South Side Chicago. That job involved pressing the government and oprganizations such as Fannie Mae to lend mortgages to low-income people who coudl not really afford them. (Subprime candidates).

Barack Obama blamed the economic policies for the economic crisis. This economic crisis was brought on by the fact that so many subprime mortgages were sold to people who simply could not afford them. It’s organizations like ACORN and activists like Barack Obama. Who used race and votes to force companies that did not want to lend to sub-prime candidates to lend. To by pass the strict rules they had.

Obama was the board chair of the Chicago Annenberg Challenge. Through both funding and personal-leadership training, Obama supported ACORN. Let’s begin with Obama’s pre-law school days as a community organizer in Chicago.

ACORN sounds like a good organization that is just trying to help people get equal rights and treatment from banks and mortgage companies, but in reality, it used intimidation to force financial institutions into loaning money to bad credit risks, all in the name of fair treatment. It didn’t seem to matter that they couldn’t afford to pay the money back and that is what got this entire mess started.

Using provisions of a 1977 law called the Community Reinvestment Act (CRA), Chicago ACORN was able to delay and halt the efforts of banks to merge or expand until they had agreed to lower their credit standards.

On July 6, 1994, a lawsuit was filed against Citibank and on June 30, 1995, Judge Ruben Castillo certified it as a class action in the case of Buycks-Roberson v. Citibank Fed. Sav. Bank, 162 F.R.D. 322 (N.D. Ill. 1995). This lawsuit was file by ACORN and despite his denial of involvement, Barack Obama was one of ACORN’s lawyers on this case. See http://clearinghouse.wustl.edu/detail.php?id=10112 for records.

Think about it, he sued Citigroup (that same bank that is in so much trouble now) because they weren’t willing to lend to people with bad credit. Which is the reason that we had a lot of the crisis.

So, perhaps the new US president is not as clean as we may have been led to believe.

This is why I prefer to remain skeptical about politicians and their decisions.

Let’s see what else the new prez does, but please keep a healthy amount of skepticism out there.

From G&M Dec 8, 2008

If you like to write your daily to-do list on a small card or piece of paper, you misght enjoy shifting it to your desktop with MiniTask (www.minitask.org), which allows you to check of tasks that are done (or have them dissapear), group tasks by themes, add new tasks through the day and shift them around.

You can also paste them to excel word and your email system

It’s much easier to use than outlook etc.

So, your first task is to install it