Rational Advisor

“The further backwards you can look, the farther forwards you can see” - Winston Churchill

“Many an optimist has become rich by buying out a pessimist” - Robert Allan

I know, the comment usually comes to these are uncharted times; no one has seen anything like this before.

True, but every crisis is unique. In the case of this event, we have never seen such a decline in house prices and have never seen such a policy response either. The US market downturn is approximately -52% and the average decline in the last 11 bear markets (spanning 70 years) is about -32%. In the 1970s we saw a decline of -48%, and the bursting of the tech stock bubble took markets down -49%, each of these had unique drivers as well.

Selling equities after they are at a near 10-year low and buying them back later is a sure way to lock in losses and minimize participation in a rally. This is only the third time since the crash of 1987, what happened after investors en-mass withdrew to cash, in 1987, a 12-year bull market. When was the next time? 2002. What happened after that? a 5-year bull market. This is the third time. And the past may repeat itself.

Truly extraordinary years (up and down) are by definition hard to predict. However, they do happen, and history provides us some lessons. Let’s look at recent major rallies (we’ll use the DJIA because it has the history):

1. 1933 +57% - Franklin Roosevelt re-flated the economy and stocks moved up sharply after the great Depression sell-off

2. 1935 +47% - Confidence returned to the banking system, credit lending returned and the auto sector led the market higher.

3. 1954 +52% - A shift from the US Federal Reserve to easing (after an inflation scare) to avoid fears of another depression altered expectations in the markets.

4. 1958 +43% - Corporate Confidence fell after the Soviet Union successfully launched the world’s first satellite, Sputnik, but the combination of heavy federal spending and the US Federal Reserve moderating rates drove institutional investors back into stocks.

5. 1975 +37% - Stocks rallied after reaching a post-1929 low in P/E when a sharp rise in bank failures caused the Fed to ease credit sharply, following the collapse of the Bretton Woods system and the 1973 oil crisis.

6. 1995 +36% - Chairman Greenspan’s abrupt tightening in 1994 depressed equity markets and 1995 was a rebound rally, with shares soaring as Japan cut rates and led global re-liquefaction

In reviewing these we do see a pattern - Bounce Back from a drop and Easing of Credit does help.

Bounce Backs

It’s clear that when the world seems to be coming to an end and markets fall sharply, large recoveries do happen. Most of them were not expected by the pessimists of the day.

- The 1908 boom (+45%) followed the panic of 1907
- The Great Crash of 1929 was followed by the largest rally of the century in 1933 (+53%) and was followed by the fourth largest rally in 1935 (+47%)
- In 1954 (+52%) a rally followed a -11% decline in 1953 as capacity utilization and consumer spending fell at such a rate that the fear of depression gripped the markets.
- In 1958 (+43%), was preceded by 1 -13% decline of the Dow in 1957
- In 1975 (+37%), after fears of recession, inflation and disastrous governmental action drove P/Es to their lowest since 1929

Easing of Credit is another common theme that helped foster large rallies.

- The end of the “Panic of 1907” would not have led to the boom in 1908, is JP Morgan has not stopped the US banking crisis
- Expansion of bank credit was key to the boom of 1935
- The mid-year 1954 easing was key to that year’s performance, while the Federal Reserve unexpectedly reversed its course to an easing in late 1957 helped produce the 1958 rally, which was fuelled by further rate cuts throughout the year.
- As recently as 1995, The Greenspan Federal Reserve surprised markets by reversing a previous tightening bias and easing as a result of the Mexican financial crisis.

The pattern from these major rallies in history is clear. Rallies start from stocks in depressed levels, and a sudden exogenous event puts fears of inflation on the back burners of the Feds. As they help re-liquify the stock markets with cash.

The once consistency we have to large rallies in the stock markets since 1900 in all but one case (1928) is the combination of depressed prices and an easing of credit availability.

From the Long Term Capital Management/Asian Contagion meltdown in 1998 to the war/recession/layoffs/savings & loan crisis of 1990-91 to the greatest one-day stock market crash of all time in 1987. One thing has remained constant the markets have recovered strongly from all of these. I don’t know how it’s going to end, but I’m confident that it is going to end.

It’s also true that in every case pessimistic forecasts based on drops in the markets have repeatedly proven to be an expensive error. At the start of every strong year, the press is almost universally negative and almost universally wrong.

We’ve found the best tool in a chaotic environment has been a solid framework for making decisions. When least expected a spark may touch off the greatest buying panic any of us has ever seen.

When I think about romance, the last thing on my mind is a short, chubby toddler coming at me with a weapon!

and how come you never see Cupid with a girlfriend? [I really don’t understand why Cupid was chosen to represent Valentine’s Day]

Asset Allocaton Summit, Toronto Feb 4 2009

Here are my notes from the Asset Allocation Summit in Toronto. attended by large pension funds.

Over all a great summit, to discuss the problems and issues facing pension funds.

Some disappointments were in that I was not impressed with most of their structures.

For example, one Crown Corporation Pension fund for Canadian equities has its own group of managers internally - employees. Their rational was it kept costs down. When quizzed later about pension short falls, they’re comment was “we are a Crown corporation, we never have short falls, tax payers help us”

I was also not impressed with the consultants, and their justifications for their modelling, prodcuts and risk reductions. The big product push was around Infrastructure investing - wonder if Obama had anything to do with that! The infrastructure players there - second largest in the world Maquarie, did admit that there is no history on this asset class!

The greatest surprise was the amount of pension short falls. The fac that they did not have as much money to pay the employees.

Anyways here are some of the more important notes.

- No one saw the tail risk as a reality. Tail risks are a definite reality. A tail risk is the part of the bell curve of investment returns at the very edge - the lowest and the highest. Mostly financial engineers talk about 2 standard deviations, the most common returns (66%) etc. Now Pension Funds are including the whole returns - NOT just the most common, to get a perspective of the worst possible one time event, even if it only happens once every a hundred years.

- What will it take to go back to being offensive investors, instead of the current defensive mindset? - A couple of years of low returns and time to forget the current panic.

- How do determine what asset class to incorporate in to your asset mix? The excitement and newness of adding alternative asset classes and new asset classes is dangerous. We forgot the Tickle-Me-Elmo lesson. Grandmas used to line up for ages to pick that doll for Christmas, only six months later it was in the bargain bin section. We always have to remember Risk and NOT theory, keep an eye on cash flow requirements, and determine asset classes by them. It’s the theories of portfolio management with their backward bias of correlation, standard deviation, efficient frontier, modern portfolio theory that has got us into the current problem. Pension funds are now realizing that the science and mathematics does not measure up to reality - this has been a rude awakening.

- Are alternative asset classes appropriate? Defined contribution plans have higher fees, and to justify these fees, pension companies have jumped on alternatives, such as, hedge funds, real estate and infrastructure and this has really hurt them. Not just companies but investment advisers and consultants have got fee hungry and to justify
these fees and to add to the complexity have jumped on these derivative based products. Many alternatives are less liquid and hard to monitor. Real Estate is not priced daily, and neither is infrastructure or hedge funds. If everyone wants their money out at the same time, this illiquidity could lead to drastic results, as we are witnessing. Long/short hedge funds are highly correlated to small cap growth. And small cap growth is much cheaper.

- What mistakes have you made in benchmarking? The mistake has been to ask managers to beat a benchmark over short periods of time such as a year. This has forced good managers to become index huggers, and this has led to greater volatility, as more and more managers copy the index securities. Afraid of underperforming it for a year. The best thing is to not measure over a year, but measure over 3 and 6 years. This will allow the managers to take their focus on the index over a year.

- Statistics in pension plans that use overlay managers to reduce risk, shows that they did not add much value. Risk management was not improved. Theoretically they should have, but practically they did not. There was no overlay manager that showed a benefit over a simple balanced portfolio - Not one.

- What has current markets done to emerging markets and hedge funds? Hedge funds and emerging markets have been decimated, and are a difficult class to justify. Now we are seeing real value in public markets over private markets. Public markets (public stocks) also have lower fees than private companies. Last year we saw a plot of deals of private equity fall apart. Because of the drops in these deals, and the less frequent valuation dates on these, the weights ran up of poor private equity positions. And this was dangerous. A lot of the private equity deals were created by the financial engineers and investment bankers. We’ve now realized that financial engineering is NOT the way to go. Thankfully the investment bankers have now been thinned because of their own mis-handling.

- Pension funds are now eating into their liquidity due to their love affair with emerging markets, hedge funds and private equity deals.

- The most appropriate way forward because of the dramatic shift in demographics is to focus on the basics of income generation requirements. The more we have gone away from this, the more we have put the risk of capital at risk.

- LDI (Liability Driven Investing) How will it impact asset allocation? This will drive future asset allocation strategies. This is really key. You cannot consider an Asset allocation without understanding LDI. You need to monitor it year over year and
understand the mismatch risk. For retail fund companies, they need to identify the typical client for their portfolios and watch year to year that clients liabilities. Create liability benchmarks.

- How can Asset allocation aid pension plans facing shortfalls? Increasing risk can increase the shortfalls. CP rail recently issued stock to fund the pension short fall of their pension plan - incredibly, the markets took this negative as a positive. They didn’t raise capital to increase profitability or increase machinery etc!

- Remember you don’t need to shoot the lights out, it’s this shooting that’s led to the pension short fall.

- Are there any asset class strategies that have emerged due to recent financial turmoil? Yes, Patience Cash, and Corporate debt. Tactical moves have been more popular now. Most pension plans have not made many changes. But, they plan to as their demographics of plan member’s change. And the need to derive income becomes a greater need than deriving growth.

- What are the latest trends in Asset Allocation Policy? The new Fund objectives are 1) Security of benefits 2) Income management instead of Maximization of Long Term investment returns 3) Managing short term volatility of funding.

- Concerns around traditional Asset Allocation strategies? Efficient frontier is structured on PAST 40 years and is NOT useful now. The past correlations are not the same as present, mainly because of the presence of mire hyper active players in the markets, like hedge funds that need to derive a return every month, also because of the growth in index huggers. The traditional efficient frontier curve is now lower on the chart, due to inflation and bond yields being lower, and it’s also moved to the right because of Risk tolerance has decreased. Assets have become far more correlated, such that traditional statistics for correlation and risk are now quite meaningless.

- Our Risk tolerance now is much lower. Why? Because of declining interest rates increase the sensitivity to interest rate moves. Also many plans are now maturing having to pay income to retirees. Demographics have now changed plans horizons. Maturation of plans means less positive cash flow coming into plans, and less cash coming in to cover the short falls - this is the biggest risk. So, pension plans are running to income based products, and as the largest affecter on investment markets we will see the impact there. Pension plans that do not have short falls are happy to hold lower yielding bonds as long as they can continue to provide a yield to cover needs. They do not want to be sued for short falls - and are happy to have low yielding bonds. They are not sellers of these.

- Most pension funds have large embedded deficits. means that they have lots of losses and short falls.

- Cash flows from plan sponsors (the companies) is becoming larger and larger to cover the short falls, the coverage typically came from plan members, because of retirement, there are less of them. This larger and larger contribution is now affecting the operational cash flows of the sponsors.

- The next risk is Cash drag. The higher levels of cash in portfolios will not help in a recovery phase, It won’t be able to pick up the appreciation. Cash has never been a great long term asset performer. Cash drag could severely impact retirement and pensions.

- Optimizers and other tools that make it seem like there is a science to this, have been proven ineffectual, they do not increase alpha or reduce risk. They just make you think we have.

- The new products coming out will be Specialist Beta Funds (another derivation of hedge funds).

Predictions for 2009

- Hedging will be much lower

- Investment risk will remain

- Equity multiples are at “unsustainably” low levels. These technical lows are due to forced liquidations of bank portfolios redeeming cash to fund losses in their hedge programs. Deleveraging portfolios were for operational and not investment reasons.

- Cash is king is an illusion, it could easily turn into the joker. The new term will be “Cash Drag”. How much it will drag down the performance of a portfolio, becasue there is too much in cash.

- Regulatory friction will slow and disrupt market and increase prices of investments. The reason Canada has higher expenses than the rest of the world is because of our higher regulation, we have too many bodies to pay fees to, too many securities regulators etc.

What has changed

- Investment banks greatly reduced so financial engineering activity will be lower

- Deflation fears are now coupled with massive government spending programs

- Equity swaps and other leverage is now more expensive

- Credit spreads are stratospheric

- Commercial banks have been minimized but are still strong

What has NOT changed

- Still need diversification

- Still need reliable income and gains

- Still need better governance

- Still need planning

Should people continue to invest

The No argument
- Once burnt, twice shy
- Most of the investments were negative last year
- Future returns are highly uncertain

The YES argument
- Returns following a downturn exceed the average
- People are anxious for returns. You will still need to invest to fnd a retirement - Cash and GICS will not provide enough money.
- Future returns are ALWAYS highly uncertain - nothing has changed.
- Exceptional opportunities will overwhelm the costs.

I believe it is critical not to be part of the herd when investing in financial markets. Just because most investors are moving in a particular direction doesn’t make it the best direction. In fact, often it has meant the opposite – Jeffrey Vinik

The best time to invest is when it is extremely difficult to summon up the courage to do so. This is usually when the market is relatively low and the outlook is murky – James D. Slater

There is still widespread pessimism and a good deal of fear. The ‘08 panic has left policy officials filled with doubts and wondering if anything will work. Reducing interest rates to stimulate the economy is like pushing on a string. Businesses about the globe are hunkered down, preparing for some widely anticipated extended winter economy.

We’ve enter 2009 shocked, scared and uncertain, aimlessly walking, seeing no direction. Investors are suffering from post traumatic stress disorder (PTSD). Therefore it’s understandable why most are cautious, outlooks are reserved, all that’s visible is a depression outlook, and this makes them hesitant to do anything.

Whenever the consensus in the investment world starts to pronounce something, you can be sure the opposite is about to happen – David Roche

History is full of examples of periods of financial troubles being quickly followed by spectacular investment opportunities, than they are with examples of ongoing economic ruin. There’s never been a bear market that’s not ended in a bull market. If you look at any chart of the markets it’s upwards and to the right. Not downwards to zero!

Most of the current economic collapse is due to fear frozen healthy consumers who have jobs but nonetheless have chosen to postpone spending plans until they “see where this is going”. It’s due to relatively healthy companies which are still making money, but have decided to temporarily freeze hiring until “things clear up”. Only widespread paralyzing “fear” can explain why the economy seems to be collapsing.

There are certainly issues in the economy which will take time to fully solve. High household debt can’t be made to disappear overnight. Housing prices won’t jump up immediately. And yes, we may see higher employment around the world.

If fear begins to ease, healthy households and businesses (which far outnumber those that are sick) will begin to spend again, which means less employment. There’ll be employment again.

The policy response to this crisis has been gigantic, more diverse and more preemptive than any other recessionary cycle in history. I think they’ll beat this beast into submission. With so many people around the globe trying, how could they fail.

I think we may see a surprise sharp rally in the markets some time this year. Why, because history suggests stock markets which fall hard and fast, typically recover hard and fast.

Since 1900, the US market has experienced six panics which resulted in price declines of at least 40 per cent. One of these was the Great depression stock market collapse which forced prices down 90 per cent and had 25 per cent unemployment it took 25 years before recovering to pre-crisis levels. Another was in the middle of the depression era 1937, when the stock market fell by 50 per cent. It took eight years to fully recover the losses; nearly 75 per cent of this collapse was recovered within a year of its crisis low

The other four non-depression stock market panics were the Rich Mans panic of 1903, the Panic of 1907, a panic in early 1920s during prohibition and the Nifty Fifty collapse in 1973-74. These four historic panics exhibit remarkable similarities to the current panic. They all suffered similar top to bottom percentage declines, they each displayed sharp and short bear market rallies on the way down, they each ended in a late collapse larger than any previous sell-off during the panic and they all exhibited nearly identical durations. Most importantly, in five of the six major stock market panics since 1900 (The Great Depression being the only exception), the entire stock market collapse was regained within 18 months of the crisis low. even though most seem to believe recovery from contemporary stock market collapse will take years, unless this si the second coming of the Great Depression, history suggests a sharp and quick stock market recovery is more likely!

Since “perceived risk” is so high today, so that means “actual risk” is probably quite low. This is the opposite when markets are peaking “perceived risk” is low, and “actual risk” is high. Look at stock dividend yields they are above bond yields for the first time in 50 years! I find this just incredible!

Further downside seems quite limited. Yes, the stock market could again revisit November 2008 lows, but I doubt it will be able to sustain it.

Fear is already too elevated; most of the nervous Nellies have already sold. Stock values have been restored, interest rates are low, there’s too much unspent cash on the sidelines.

One of the safest times to invest is when the news is a awful and markets are depressed: the Time of Deepest Gloom – John Train

Remain rational. Invest when it’s the hardest thing to do, not the easiest.

For months, the global downturn has been compared to the worst economic slumps of the past century: the drawn-out recession of 1982 and even the Great Depression. And yes, I know it feels like it. But you know, even with all those comparisons, just remember the markets recovered from each of those.

Our greatest oversight was not recognizing the speed with which the breakdown in the US financial system would undermine not only shallow investor confidence and equity prices, but also the entire global economy.

Our lower allocation to commodities, cost us at the beginning of 2008, and then eventually came to help us outperform the indexes. Another thing that helped was our ample weighting to Bonds and Cash - in our Canadian Bonds and Candian dividends portfolio, Canadian Bonds and Canadian Dividends was 33% cash, and then an additional 35% in Bonds above that. However, outperformance doesn’t sound good when it’s still negative. So, we don’t take little solace in this outcome.

What we saw in the last quarter of 2008 was selling now migrating from what “should” be sold to what “could” be sold. Investors fears, margin calls and the unwinding of hedge funds and other vehicles pushed the prices of good liquid names down sharply, with dividend paying stocks at low relative valuations included in the carnage.

Despite the turmoil in the markets, most Canadian stocks with attractive yields continue to pay their expected dividends and at last check more than 100 companies have increased their dividends in the recent quarter. Notable standouts from our most widely held names include Bombardier, Husky Energy, Encana, Shoppers Drug Mart and Power Financial to name but a few. Adding itself to the list was CN Rail. Despite lower sales and profits, the company raised its dividend by an impressive 10%.

Market historians oftentimes observe the close relationship between long-term out performance of stocks that consistently raise their dividends.

And currently the entire Canadian financial sector is also being painted “with a very wide brush,” just as it was in the fall when it largely escaped the troubles that torpedoed several major American and European banks. Canadian Banks are NOT US or European Banks - we are conservative.

We know we’re in a recession but dividends are still there, the dividends haven’t been cut, they’re still being paid.

And given the most recent take on the recession by the Bank of Canada, it looks increasingly unlikely that anything will happen to those bank dividends.

Most of the banks have also remained steadfast on their dividend payments, with some choosing to raise capital rather than slash dividends.

In a period when stock prices are under pressure, dividends are especially important. First they allow us to be “paid while we wait” for a recovery and second, when reinvested, dividend income imparts a “gearing” effect on portfolios. Buying more units at a lower price, to give us better yields in the future.

Just how bad has it been in the stock market?

Few are even bothering to answer this question, since it appears utterly obvious to almost everyone that what the stock market has been experiencing is unprecedented, at least in modern financial history. Don’t we have to go back to the Great Depression to find anything remotely similar?

Well, no.

These are the surprising implications of a fascinating study published by Ned Davis Research, the Venice, Fla.-based quantitative research firm.

Pat Tschosik, a senior equity analyst at the firm, took a sober and data-driven look in comparing the popping of the financial sector’s bubble over the last 18 months compares to the bust of the Internet bubble in 2000-2002.

In several significant ways, believe it or not, the tech experience early this decade was even more traumatic than what has transpired since mid-2007.

Since its peak in 2007, for example, the financial stocks in the S&P 500 index have dropped 78.7%–slightly less than the 82.5% by which the information technology stocks in that index dropped in the 2000-2002 bear market.

Not so fast, you might object: Surely the financials in 2007 constituted a more important sector than technology did in 2000, right?

Not necessarily.

According to Tschosik, the information technology sector represented about 35% of the S&P 500 at its March 2000 peak, in contrast to the 22% weight that the financials sector represented at its peak in 2007. As a result, a greater amount of total market capitalization was destroyed by the tech sector’s decline in the 2000-2002 bear market ($3.6 trillion) than by the financial sector’s decline since 2007 ($2.2 trillion).

To be sure, these historical comparisons provide little solace to investors who have lost huge amounts over the last 18 months. But they do provide a reality check on excessive pessimism and despair.

Just as it’s dangerous at the top of a bull market to think that “this time is different” — and that the old rules no longer apply — the same is true when we’re at the depths of a bear market. Just as trees don’t grow to the sky, as John Maynard Keynes famously once remarked, those trees’ roots won’t continue descending until they get to China either.

The stock market did finally recover from the Internet bust, and so will the current bear market eventually give way to a new bull market.

In this time of turmoil and complexity, investing will return back to the basics. Fewer hedge funds, less private equity, and an implementation of old fashioned truths will re-emerge.

It is our belief that selling momentum has overshot the actual falloff in business prospects for some of the world’s best companies.

To say that my team and I have been holding a few hands over recent months is kind of like saying the new US president has some challenging times ahead of him. We’ve been in hyper-drive to make sure that investors understand what has been occurring. And focus on the opportunities amidst the carnage. One point, I have tried to make is that if it weren’t for this global clearance sale, we wouldn’t have the chance to acquire additional good companies with extraordinarily high dividend yields. In other words, we are better off in the long run because fo the trauma we’ve gone through. Of course, in the middle of the meltdown, it’s hard to fully appreciate the element of cheap companies at high dividends, and I admit there were times that I even questioned it. That is until I got smacked around the head with our managers sanity. “Rana, we’ve been here before, and you’re an idiot to think we won’t recover ever”

Regular Investment Advisors have no control over events like … Nortel, Bre-X, SARS, 9-11, Enron and the current subprime mortgage mess and there’ll be other future financial fiasco. Every year, you read about a “Bernie Madoff” type of story and there’ll be more. What we do have control over is our rationality and emotions.

My sense is the surprise will be just how quickly we come out of this. In the meantime, I can get high dividend yields on stocks 50 per cent off their high prices.

The markets in 2008 functioned like it’s being run by Jim Morrison i.e. it suffered from major bouts of alcohol based insanity.

The TSX ended down 35 per cent or about $700 billion, the second-worst year ever, compared with a 37 per cent decline in 1931.(So much for index investors and ETF investors, most Canadian equity mutual funds did not have that kind of loss)

The US Dow Jones industrial average was down 33.8 per cent.
The S&P 500 was down 38.5 per cent
The Nasdaq composite index, fell 40.5 per cent

Crude oil ended a six-year winning run and fell 53.5%, while gold gained 5.8%.

It was a year when Canada’s benchmark index soared to a record high only to collapse in spectacular fashion, destroying almost everything we thought we knew about investing. Diversfication didn’t really work, neither did buying on the dips etc.

People were told, for example, that the global food shortage would push fertilizer prices up forever as farmers tried to squeeze as much production out of their land as possible. So they bought Potash Corp. of Saskatchewan.

People were told that the price of oil was going to $200 (U.S.) a barrel because China and India were industrializing at a time when the world was running out of crude. So they bought oil sands producer Suncor Energy.

And they were told that BlackBerry sales would rocket ever higher as consumers around the world discovered the joys of sending e-mail from a bathroom stall. So they placed a large bet on Research In Motion.

And for a while, they felt smug, because you were getting rich as the stock market kept going higher, hitting a record 15,073.13 on June 18.

Well, RIM, Potash and Suncor – three stocks that seemed to have such a bright future – suffered colossal comedowns? In fact, no other stocks made a bigger contribution to the S&P/TSX’s 35-per-cent loss for the year – the worst performance for the index since 1931, when it fell 37 per cent.

What’s even more scary is that both RIM and Potash not long ago were vying for the title of Canada’s biggest company by market capitalization. That was before the credit crisis steamrolled everything in its path, paying particular attention to companies trading at obscene price-to-earnings multiples.

But they didn’t bring the market to its knees all by themselves. Base metal miners, banks and insurance companies all made their own generous contributions to the Great Stock Market Collapse of 2008.

Millions of terrified investors also did their part. With oil prices plunging, bank writeoffs mounting and central banks in a mad scramble to keep the global economy from sinking into a deflationary spiral, investors were quite happy to yank their money out of equity funds and park it in low-yielding bonds or guaranteed investment certificates. Which put even more downward pressure on stock prices.

But at least Canadian investors can take comfort that it could have been worse. They could have lived in China, for example, where the stock market plunged about 66 per cent. Or in India, where it fell 51.9 per cent. Or in Iceland, where the index plummeted 94.4 per cent.

Looking ahead to 2009, investors can also take comfort that back-to-back losses on the Canadian market are rare. Over the past 20 years, the S&P/TSX has only fallen in two consecutive years once – in 2001 and 2002. And each
of those declines was about 14 per cent, which is a mere paper cut compared to the shredding of investors’ portfolios that took place this year.

The two worst-performing sectors were metals and mining, which fell 68.4 per cent, and information technology, which was cut almost in half. Nortel Networks, down 98 per cent on the year, has almost been wiped out. The
energy sector fell 38.2 per cent and financials 38.3 per cent; together they account for more than half of the composite index.

But consumer staples was also that sector that endured one of the softest drops on the TSX, down roughly 12 per cent on the year.

Indeed they showed their defensive qualities this year, although because there was no hiding place they went down less than the market as a whole. It’s things that everybody needs and will continue to buy like food, beverages and medication.

Twenty-three of the 24 equity fund indices Morningstar Research tracks posted losses of more than 20 per cent last year, and 20 of them had their worst year in at least a quarter-century, the company said.

The mutual fund analysis company said its natural resources equity index was the worst-performing of the group, with a drop of 48.5 per cent.

“Oil and commodity prices tumbled in 2008 as a result of dwindling global demand,” said Jordan Benincasa, fund analyst with Morningstar Canada.

“Natural resource stocks took a beating as oil went from more than $145 US per barrel to less than $40, while other commodities like natural gas, aluminum and copper followed a similar path.”

The best-performing indices were the health-care equity index — off 8.4 per cent — and the Japanese equity index, which dropped 20 per cent.

A basic principle of sound investing is that you can reduce the risk of investing in stocks by diversifying across various economic sectors and countries. But the panic conditions of 2008 proved that that there are limits to what diversification can do for you.

“Diversification works 99 per cent of the time. But when there’s a panic, it doesn’t matter what you own very much. We never thought that could happen, at least to this extent.”

The one diversifier that did work in 2008: government bonds or Treasury bills.

Morningstar said fixed income fund indices were the only ones to finish in positive territory last year.

What’s keeping investors on edge now is the uncertainty about how long the economic contraction will continue and what depths it might plumb.

for most of 2008 – a year studded with economic catastrophes of near-biblical proportions – has already been factored into everything from consumer buying habits to corporate expansion strategy. Consumers and bankers are tight-fisted as seldom before, hoarding cash rather than spending or lending it. Business has been curtailing expansion, closing operations and engaging in “pre-emptive” layoffs, bracing for worst-case scenarios.

And here’s the result. Banks are remarkably flush, thanks in no small degree to unprecedented billions of government dollars pumped into their reserves to revive a paralyzed system. They’re poised to resume lending at reasonable rates when demand reasserts itself – that is, when the consumer and business confidence essential to a robust economy is restored.

All the monetary easing in the world — with interest rates in the U.S. at zero and the Bank of England reducing rates to the lowest levels in its 315-year history — isn’t translating into meaningful borrowing by consumers. In fact, U.S. consumer borrowing fell by $7.6 billion in November, the biggest drop in the 65 years that the measure has been tracked. They’re all scareed “in case” it gets worse.

The amount of money stashed in money-market mutual funds had surpassed that in stock mutual funds as of the end of November, according to the US Investment Company Institute, a national association of investment companies. In contrast, money-market funds were just 48% of stock funds when 2008 began. “If all the money currently sitting in U.S. money-market funds left and went into buying shares of the Standard & Poor’s 500 index, it would absorb 42%” of that benchmark’s market value — the highest in at least 25 years, says Jason Goepfert of sentimentrader.com.

“Never before have these investors allocated as much or more to cash as they have to stocks,” Goepfert says.

Luring that cash and winning investors over won’t be easy. The economy will worsen before it begins to show the benefit of aggressive government stimuli, And investors will only return to equities well after they have appreciated, as they always do.

The fear is too widespread and deeply ingrained for that. But the run of astonishing bad news that has sapped confidence has largely run its course. For the most part, the banks and big businesses that were going to fail have done so. Meanwhile, the fundamentals that drove up energy and agricultural demand are unchanged, conspicuously the overnight industrial revolutions occurring in China and India and to a lesser extent other rapidly growing developing world economies.

even a modest economic recovery this year could yield dramatically good results. Right now, companies, even if they’re doing well, are saying, `Hey, wait a minute. Let’s not hire anybody for a while. They could change their minds quickly.

Certainly in Canada, economic recovery may come sooner than expected. With its strong federal budgetary system and decade of strong GDP and job growth, Canada slipped into recession late last year, but is still in better shape than its G8 peers.

Canada can expect to lose about 200,000 jobs this year, as the unemployment rate rises from its current 6.3 per cent to 8 per cent. But that’s a far cry from the 13 per cent jobless rate of the 1980-81 recession and the 10 per
cent unemployment rate of the most recent downturn, in the early 1990s.

The market is always discounting where it will be six to nine months out. We’re getting close to the point if people believe that things are getting better it will be reflected shortly in the market.

What Billionaires Think Will Happen In 2009

Nearly all believe the economy will regain strength in late 2009 or early 2010.

Asked about the most alarming trend facing the economy, many believe it is fear. “The entire economy has lost confidence in its jump shot,” said Mark Cuban, the outspoken owner of pro-basketball’s Dallas Mavericks. “As a result, money will sit on the sidelines longer than we would like, and when it is put to work, it will be in very conservative instruments.”

Members of the Forbes 400 had strong opinions on what the Obama administration’s first fiscal policy decision should be. Cuban said “transparency of any and all government funding” should be the new president’s top priority.

Mark Cuban
Net Worth: $2.6 billion
Source of Wealth: Broadcast.com

What is the most alarming trend facing the economy today?

The entire economy has lost confidence in its jump shot. Investors who had complete confidence in their methods no longer do. As a result money will stay on the sidelines longer than we would like, and when it is put to work, it will be in very conservative instruments

John Paul DeJoria
Net Worth: $3.5 billion
Source of Wealth: Hair products, tequila

When will the economy return to positive growth?

The latter part of ‘09

Alexander Rovt
Net Worth: $1.6 billion
Source of Wealth: Fertilizer

What is the most alarming trend facing the economy today?

Wild daily fluctuations in the stock market.

What is your bold prediction for 2009?

When the recession turns, economic improvements will be faster than anticipated.

Mort Zuckerman
Net Worth: $2.8 billion
Source of Wealth: Real estate, media

What is the most alarming trend facing the economy today?

The continuing decline in confidence

Randal J. Kirk
Net Worth: $1.6 billion
Source of Wealth: Pharmaceuticals

What is your bold prediction for 2009?

I think it is going to be a pretty good year for most people.

Leon Charney
Net Worth: $1.5 billion
Source of Wealth: Real estate

What is the most alarming trend facing the economy today?

Lack of confidence in the financial markets

What’s the 800-pound financial gorilla in the room?

Lack of consumer confidence

John Catsimatidis
Net Worth: $2.1 billion
Source of Wealth: Oil, real estate, supermarkets

What is the most alarming trend facing the economy today?

The loss of credibility and lack of transparency in financial institutions. Inability of bond market to function normally.

What will a barrel of oil cost next December?

Oil will range between $60 to $70 per barrel.

Dr. Thomas Frist Jr.
Net Worth: $1.9 billion
Source of Wealth: HCA Healthcare

What will a barrel of oil cost next December?

$54

What level will the Dow bottom out at? When will this happen?

It bottomed in November

What’s the 800-pound financial gorilla in the room?

Frozen capital markets.

Allen Stanford
Net Worth: $2.2 billion
Source of Wealth: Stanford Financial Group

What is the most alarming trend facing the economy today?

It is not a trend it is a reaction to the unprecedented flow of problems and negative news about the economy. Loss of investor confidence, fear, and outright panic has gripped the U.S. like nothing I have ever seen in my lifetime. Hopefully when Mr. Obama takes office on Jan. 20 an era of hope and confidence in our nation’s future will be ushered in as well.

What will a barrel of oil cost next December?

Less then $55

What level will the Dow bottom out at? When will this happen?

I believe we are very close to the bottom now, but if you want a forecast I would say between end of first quarter to end of second quarter of 2009 the DOW will have stabilized and a long recovery period will begin.

What is your bold prediction for 2009?

I predict that 2009 will be the catalyst year for a decade of change. Although we are currently in a very difficult global economic environment I believe we will see a bottom in the US economy by latest end of second quarter 2009 and that a very long economic recovery will see industries and the global economy reshaped in ways that are necessary and good for future generations.

James Dinan
Net Worth: $1.7 billion
Source of Wealth: Hedge funds

What is the most alarming trend facing the economy today?

Consumer funk

What will a barrel of oil cost next December?

$58

What level will the Dow bottom out at? When will this happen?

Already bottomed

When will the economy return to positive growth?

Fourth quarter 2009

What is your bold prediction for 2009?

World doesn’t come to an end.