lil' wayne & buy & hold

"If 'buy & hold' is dead, then I am the embalming fluid"

Once again, I am using the world of rap music to derive my quotations about money and investing. Rapper, Lil' Wayne was talking about hip hop when he uttered this line in his single 'A Milli'. Lil' Wayne may wear his pants below his a$$, but he is a wise poet indeed.

The recent stock market collapse has certainly been an experience in observing perspective shifts from everyone from analysts, advisers, advertisers, to individual investors. Below are some of those new perspectives that have more than likely come from several sources over the last year or so. Whether it was an ING Direct commercial or your local politician you've likely heard some of these views lately:

• Capitalism is dead, and no longer works as an economic system
• More regulation, and less leverage is always better.
• Everyone took on too much debt, and the recent crash will cause everyone to be very debt averse forever; let the de-leveraging begin.
• The right thing to do with your money all along was to play it safe, and sock it all away in a savings account; assets with risk associated with them should be avoided at all costs.
• Don't speculate, don't invest in stocks, don't buy real estate, don't take risks in starting a new business venture or making any kind of investment where loss is a possibility

...and my personal favourite:

• 'Buy & Hold' as an investment strategy is dead.

All of these new postulations are the result of the human instinct to remember the most recent painful experience and alter one's thoughts and habits to correct for this. What has happened is akin to falling of your bicycle and breaking your arm. Perhaps walking is a better idea. Maybe you can't get places faster on your bicycle. The government should ban biking. Better yet, perhaps we should all stay in our houses. Do you want to buy a video game that simulates riding a bicycle? The real thing is far too risky and provides no real benefits to anyone.

Of course people are now saying that 'buy & hold' is dead. It's easy to think that buy & hold is a bad idea when the current 'hold' experience involves watching your investments fall by 40%. That hurts, for some probably more so than falling off of that bike. Does this in itself mean that buy & hold dead? I think not. Equities have been the best asset class to own over the long term, and I don't believe that will change. Try not to do all of your buying at the peaks and all of your selling in the valleys, and buy & hold will probably work out for you the longer you hold shares of quality firms that provide the goods and services that people want.

The best time to draw inferences about what works is probably not during and post a large market crash. Ask yourself, what biases are those making these calls prone to? For the vast majority of us, the market crash will turn out to have been a good thing long term. That is if we avoid buying into the inferences drawn by those with broken arms.

For those interested, my other financial advisor is Kanye West.

psychology & Wells Fargo @ $7.80/share

It’s funny how emotions and psychology influence us all as investors. Depending on one’s personality type, investment time horizon, future outlook, and current general state of mind, one can be desperately bearish or exuberantly bullish in the same stock market environment.

What investor’s have been through over the past 2 years is nothing short of one of the steepest, gut wrenching stock market declines ever. The S&P 500 index plunged from an all time high of around 1,562 in October of 2007 down an astonishing 57% to around 666 in early March of 2009. Most of this precipitous decline came after September 15, 2008 when global financial services firm, Lehman Brothers Holdings Inc., which was founded in 1850, filed for Chapter 11 bankruptcy marking the largest bankruptcy in U.S. history.

Since early March a fairly significant relief rally has been built on the back of optimism for economic stabilization, and mild recovery. The market seems to be telling us that the next great depression and other worst case scenarios have been ruled out. The financial system is not collapsing, and some sparse ‘green shoots’ of recovery are starting to poke through the dirt and dead matter that toxic debt and upside down mortgages have left strewn around the world. The S&P is now up a full 30% from the depths of March. Some financial stocks like Wells Fargo, General Electric, and Manulife Financial are up as much as 156% from their single digit lows. If that wasn’t the bottom, this is a ride that investor’s will probably want to get off of.

For long term investors that were buying stocks as they fell, or maybe well into the market bottom they took heart in the fact they were buying when pessimism was abound and stocks were surely cheaper than they were at any time over the past decade. How those same long term investors are feeling now that stocks are 30% to 156% more expensive in the case of Wells Fargo is how psychology really wrestles with us as investors. I would imagine that many investors are now feeling frozen, and their appetite for buying into this market has waned. It is a little bit like a deer in the headlights, or better yet a deer that just got hit by a semi and survived.

two sides of the coin

One of the reasons why stocks change hands a million times over everyday is because no matter how great or dire the economic/corporate earnings outlook is, there is always two sides to the story. Optimists and pessimists will always disagree, and each side can usually make a compelling case to either leverage yourself to the hilt and buy stocks with all your resources, or to sell everything stash most of your cash underneath your mattress and use the rest to build a bomb shelter. I think most would agree that it feels like we are on a very bad footing right now economically, but yet stocks are still finding bids, and the sun continues to rise every morning. Here are some reasons to be optimistic or pessimistic about the near-mid term economic/corporate earnings outlook:

Pessimists

• Consumers and businesses are buckling down for a number of reasons which include economic uncertainty, rising unemployment, recessions, falling home prices, and trouble obtaining credit.
• The U.S. government is building a massive debt load, and recent actions that they've taken shake the very foundations of capitalism and promise more risk aversion, and government regulation, of industries and markets in the future.
• The former 'BIG 3' automakers are in trouble, putting millions of more jobs at risk.
• The growth within emerging markets like China and India is slowing and recent terrorist acts add to the fear and uncertainty in these markets.
• Deflation is now taking over from inflation as a worry because the price of goods are declining quickly.

Optimists

• Fuel and other commodities are much more affordable than they were just months ago. This allows consumers and businesses to cut costs and leave room for consumption and investment.
• The S&P 500 index has fallen over 40% since the start of 2008. Shares of many companies can be bought for significantly less now versus in 2007. Severe declines in forward earnings have been priced into many stocks making them less risky investments.
• Interest rates around the world are coming down making credit and mortgages cheaper for many.
• Emerging markets like China and India are still growing at very high rates and demographic, and lifestyle trends indicate that they will require the rest of the world's goods and services in a big way for years to come.
• In a Darwinian type of way, plenty of the inefficiencies, mismanagement, redundancy, greed, and waste is being washed from the system. Most of the issues which have been dealt with and are being dealt with right now will come out the other side cleaner, leaner, and more stable. (ie Big 3, Financial sector, credit markets, consumer debt)

Feel free to comment on which camp you are in and why.

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the price of clarity

If anyone ever tells you that investing is 100% safe, they are lying to you. There are risks present in every investment, and you are taking a risk every time you buy something. Whether you fashion yourself a stock picker, an indexer, or some combination of these investing styles, chances are that you are going to have to make a decision as to when to buy. You could be choosing when you should buy a particular Exchange Traded Fund (ETF), or choosing when to buy a stock that you believe is beaten down or undervalued in some way, relative to where the price should go in the future. Either way you are placing a bet as to the future of that particular security.

The sandbox that I've decided to play in consists of financially stable, established companies with strong brands, favourable demographics, and histories of swift earnings and dividend growth. I believe by making this choice I have inherently taken some of the risk out of the equation. Therefore after I chose the companies that I would focus on, I was stuck with the conundrum of when to buy them. In creating a modelling process where I use a discounted model to determine reasonable prices that stocks should be worth, I have established a framework in order to value firms. I don't expect my models to tell me when a stock is dirt cheap, and therefore guarantee the success of an investment. The purpose my models do serve is to provide a kind of framework in order to prevent me from overpaying for a stock. They also show me what type of earnings growth the market is pricing in for a particular company, so at the very least they tell me what is expected from the company at it's current price. Put another way, how does the market feel about the prospects of this company going forward?

Often times the uncertainty around an industry or a particular company is the key driver that causes bad stock prices to stick to good companies. The more I follow investing and the market, the more I have discovered that bad news often hurts stocks much less than uncertainty (or the expectation or possibility of bad news). I've noticed that many investors take the attitude that during these periods of uncertainly it is always a wiser and more efficient call to wait for the dark clouds to part before buying. It is my opinion though that for a long term investor, uncertainty is a blessing in disguise. Often times if you truly want to obtain the lowest cost on an investment you need to buy during that awful period of uncertainty. Sure, you will always get a chance to buy the stock or ETF after it is discovered where all of the bodies are buried; however, usually by that time much of the market has beaten you to it, with the same information, or they dive into the stock earlier with a little less knowledge than would be ideal.

Personally in a lot of cases, with the type of stocks I follow, I feel that if you are long term you might be better off diving in with less knowledge than ideal, instead of waiting for the perfect moment of clarity. See, because when you wait, that perfect clarity is always reflected in the stock price, whereas dark clouds usually come on the cheap.

This type of strategy won't work all the time; nothing does. Sometimes you are better off waiting for some degree of clarity based on your personal thoughts and analysis of the stock.

Here are some examples right now where I believe there is high uncertainty, and thus low prices...

Home Depot (HD), Lowes (LOW), Masco (MAS), Reitmans (RET.A)
Citigroup (C), CIBC (CM), Bank of America (BAC)

fear the bear?

Bear Market: A market condition in which the prices of securities are falling or are expected to fall. Although figures can vary, a downturn of 15-20% or more in multiple indexes (Dow or S&P 500) is considered an entry into a bear market.
Recession: A significant decline in activity spread across the economy, lasting longer than a few months. It is visible in industrial production, employment, real income and wholesale-retail trade. The technical indicator of a recession is two consecutive quarters of negative economic growth as measured by a country's gross domestic product (GDP).

These two terms are usually taken in investing to have negative connotations. Anyone who is long the market probably does not want either one of these scenarios to occur. However, is this reaction really justified? If a bear market or recession or both occur will the net long term results on my investments be negative? Is this something I should be afraid of?

Well, I've never invested through either of these scenarios, so I can not be sure. Let's assume that we went into a bear market in equities while the North American economy dropped into recession. How would this affect my non-registered portfolio? These might be some of the likely advantages and disadvantages of such a situation:

Disadvantages

• Portfolio paper value might shrink for the duration of the bear market due to negative investor sentiment and shrinking earnings growth.
• Company earnings from North American activities might grow slower or even decline for the duration of the recession.
• Company dividend increases might grow slower, stay flat, or even decline for the duration of the recession.
• Commodities could fall substantially, due to falling demand, causing stocks like Petro Canada (PCA) to plummet.
• Watching the daily happenings in the market would be depressing.
• Total market returns for this period should be negative, and could be below -10% annually.
• This period will be a bad time to sell investments.

Advantages

• Quality dividend growing stocks may fall to very low levels causing buying opportunities. These stocks may be able to be bought for low prices, and high yields.
• Some stocks like Procter & Gamble (PG), Johnson & Johnson (JNJ), and Walgreen (WAG) may outperform due to their defensive nature and non cyclical earnings streams.
• Non-North American business should still grow, albeit slower.
• Dividend payments will still come, and dividends will still grow, perhaps at a slower pace.
• Energy prices might fall causing a significant reduction in input costs for most companies.
• A bear market and recession are usually followed by a period of growth and prosperity.
• Long term this period should actually boost my returns if I continue buying. In other words, this period should be a good time to buy investments.

Looking at things this way, strictly from an investment perspective, I hope this occurs. To me, the advantages outweigh the disadvantages if and only if I behave in this way:

• Do not sell any investments
• Keep buying companies that grow their dividend every year, that I deem to be cheap
• Don't let bad market sentiment get me down

The earnings of the stocks that I currently own should be fairly resilient to a recession. I would imagine my paper losses would be the greatest on economically sensitive stocks like Petro Canada (PCA), Reitmans (RET.A), General Electric (GE), and Scotts Miracle Gro (SMG). Several of the remaining stocks might actually be viewed as safe havens in times of trouble.

What we should probably fear more as investors is a bubble situation as occurred in the late 1990's. Although a different set of adaptive behaviour might be required in a bubble. Judging by stock valuations currently, I am pretty sure we are no where near a bubble.

U.S. recession is here already?

my greatest investing fear

I've recently been thinking about what my greatest fear is with respect to: investing, my investing strategy thus far, as well as going forward. At 28 years of age could it be a coming major market downturn, faulty stock selection, or inappropriate allocation of assets? No, none of these scare me at all.

My greatest fear is looking back and realizing I didn't take enough risk!

I really like my current strategy. I am comfortable with it, I understand it, and I believe it will allow me to prosper long term if I exhibit discipline, patience, and common sense. However, given my age, tolerance for risk, and low level of need for capital, should I be making some bets that could potentially yield higher returns. Will I regret going with a 100% boring, conservative, dividend growth, large cap, fundamentally solid, smooth earner strategy? Will I have these regrets when I look back at my investing activity, when I turn 50 years old.

This is my greatest investing fear. What's yours?