Monday, July 31, 2006

Canadian Real Estate Still Charging Ahead

The latest statistics show that Canadian residential real estate prices are still charging ahead.

Since last December, the average home across the country has increased by 11.8%, (a 23% rate if annualized) which is phenomenal since our prime rate too has been increasing over that period. Sales volumes too are up, by 3.6% on a year-over-year basis.

The average house price across the country is now $304,328 (about $272,000 USD), which compares to about $231,000 (USD) for America.

Price increases are being led in oil-rich Alberta, which is facing rises of 40% annually. Although prices have seen a dramatic increase, most market commentators say that the Canadian market, overall, isn't as vulnerable to a downturn as the US market, for two reasons:
  1. If Alberta is stripped out of the price picture, the average price increase is much more sensible, and
  2. Interest rate increases have been subdued here, and our prime rate about 2% below the US prime rate.


The Confused Capitalist

Saturday, July 29, 2006

Ignoring the rear view mirror when investing

Just like you shouldn't invest in home-builders shares right now, I'd also suggest that you stay away from anything which depends mostly on new home construction for a bulk of its' revenues. Such is the life of an OSB maker right now. Two Canadian forest products companies holding two of the top five spots, globally, for return on capital in the industry, Ainsworth and Norbord, have seen their share prices continue to slide in the face of weakening US home sales.

However, just like the home-builders, you shouldn't invest in them when their PE ratios are absurdly low (like the 2.2 and 5.1 they are currently). Better to invest in them after several years of poor home sales, when the likelihood of an upswing in home construction would boost earnings significantly. Buying today, at today's prices (even though they've fallen significantly), is like driving using only a rear-view mirror.

Something to think about, and perhaps even put in your investment scrapbook to pull out in a few years from now.


The Confused Capitalist

Tuesday, July 25, 2006

Real Estate Buyers Continue to Bail ...

The most recent data show that the real estate market continues to soften, with sales volumes down between 8-15% (depending on the category) over a year ago. As always, prices remain the lagging indicator and have posted very minor increases (1.1%) over a year ago. However, with inventories continuing to rise, overall national price declines on year-over-year comparisons are now not far off.

Around the net, I've seen a few financial bloggers postulating that home-builder's stocks - having fallen to levels of half of that one year ago - might now be buys. This is bull thinking, in what is very likely to be a long bear market for real estate. You can't have the kind of appreciation stemming from practically free money boil off in just a year. These down turns are almost invariably longer and deeper than most imagine at the outset, as discussed over here by Don Tomnitz, CEO of the No. 1 home builder, D.R. Horton.

In my other life, I too have seen these types of real estate downturns, and they can be absolutely brutal. Think it's safe to buy shares in home-builders or land developers (they're often intermingled, given that large builders like to hold substantial land banks) on a 50% decline (as has already occurred)? How about if it goes down another 50%? This is a very real possibility and one that I've personally witnessed in the underlying land stock.

Home builder's confidence is lower than any point since late 1991 and, realistically, isn't likely to get any better in the near future, as inventories continue to build, and year-over-year prices finally start their much discussed decline, on the back of the "end of free money" Fed policies.

No, the time to buy shares in home builders isn't when their prices are at PE's of 4 or 5. It's when their PE's are in nose-bleed territory of 50, 80, 130 - or don't exist, because the "E" in "PE" is missing.

It won't be pretty out there in 2-4 years. So patience is in order. Patience my friends. The wound is only being opened just now.


The Confused Capitalist

Friday, July 21, 2006

Morningstar's Value Chart Seems Odd

Perhaps I'm reading this wrong, or am lacking some understanding, but a Morningstar Chart purports to show that the universe of stocks they cover is now about 3% undervalued. This compares to about 6% over-valued in February through May, suggesting a 9% improvement in valuations since then.

Since valuations are governed primarily by two components, overall interest rates, and growth (earnings) prospects, it begs the question: Since neither has improved (i.e. earnings growth is reportedly stable at best, and interest rates have moved up), how do these factor into their model?

Obviously, overall values have dropped over this period, but looking at the S&P 500, this can only account for about 6 or 7% of the change, without considering the (negative) change in interest rates, and any diminution of growth prospects.

Maybe it's just me, I might be missing something.

The Confused Capitalist

Read: Missed the best "x" days in the market, once too often!

Although I think that market timing is tough for most investors, I've suggested that many successful value investors regularly parlay this skill of being slow to redeploy resources when it's tough to find value into a superior market return. These "market timers" seem unusually successful to me, even at the expense of being "underdeployed" in the market at certain times.

But I've just read - once too often - another rendition of the same old chestnut purporting to show how if you'd missed the best 5, 10, 20 etc. days in the market over the past 1, 5, 10 years, etc. your return would fall from 12% annually to 1, 3, 5% etc. over the same period. And this is purported to be rationale to stay fully invested in the market at all times.

What this old tale seems to me to miss, is that those days with a dramatic boing have lots of times followed days where a drop has been almost as dramatic, has been preceded by a day or two where there's been a notable fall. So, by missing the best X days, you often would have missed some of the worst days right around that time too.

So I think that your overall return rate may not have been diminished that much, if you include a couple of days on either side of the boing day: more like real life, yes?

Big ups and downs are often correlated: rather like a trampoline, don't you think?


The Confused Capitalist

Thursday, July 20, 2006

I must catch up to the herd, for I am their leader ... "wait, wait, wait for meeeeeee ..."

Wow; those institutional money managers. From an almost universally optimistic bunch in May, to a bunch of global grumpy grouches in July, their turn around has been remarkable.

A recent Merill Lynch survey reported this:
"There has also been a hike in the numbers of money managers expecting the global economy to worsen. Of those questioned, 72% expected a deterioration in the economic backdrop over the next 12 months, compared with just 11% who thought it would improve. The net difference of around 60% compares with just 5% three months ago."

At least my crabiness preceded the May dive.

The Confused Capitalist

Wednesday, July 19, 2006

The China file

A couple of items in the news medium recently caught my attention, both relating to a favorite topic of mine: emerging markets. I have long argued (1,2)that most long-term investors are poorly served by the traditionalist advisors on the emerging market side, suggesting that portfolio weightings of 5%, or perhaps 10% are appropriate.

China recently announced blow-out numbers, with second quarter GDP expoloding by 11.3%, compared to 10.3% in the first quarter, and an official government target of 8%. Here are some figures for the first half of 2006 for China, together with the goverment target (target is bracketed):

Real GDP growth: 10.3% (8% target)
Investment in fixed assets: 31.3% (18%)
Money supply growth: 17.4% (16%)
Trade: 23.0% (15%)
Inflation: 1.3% (less than 3%)

India too, grew at 9.3% for the first quarter, nearly tracking the dragon nation.

China is forecast to continue growing in the medium term in the 7-10% range, while India is forecast also for growth in the 6-9% range.

Finally, a recent report by Scotia Bank economists Warren Justin and Mary Webb indicated that, based on purchasing power parity, newly industrialized Asian nations now account for 30% of global GDP. Even accounting for trade in U.S. dollars, newly industrialized Asian nations account for 12% of global GDP.

And your advisor is telling you to put only 5% or 10% of your portfolio into emerging nations? And you say you're a long-term investor? Really? Then why are you underweighting your portfolio so badly??


The Confused Capitalist

Friday, July 14, 2006

It feels pretty cool ...

I've been selected (The Confused Capitalist) to respond in a weekly poll of "popular and respected" investment bloggers over at / Birinyi Associates Inc. on market sentiment; bearish, bullish, or neutral. That feels pretty cool ....

What's also cool is a lot of the bloggers I read daily and respect, have also been selected too ... see Barry Ritzholt's story on the same, over at the Big Picture ...

Anyone care to guess which way I voted???


The Confused Capitalist

Wednesday, July 12, 2006

Those crazy inventors (with a not half-bad idea)

There was a very interesting story in Business Week recently. The article related to Nathan Myhrvold and Intellectual Ventures which is an invention company. More precisely, they buy existing patents, and file new ones, with the hope of commercializing these inventions through licensing agreements.

A former top scientist for Microsoft, Myhrvold views inventions as an under-invested asset class of its own. He argues, rather convincingly I believe, that this particular asset class suffers from a lack of interest, or even generally a proper process to commercialize results.

His company has both been buying up existing patents in what it currently sees as core areas (primarily around technology), and has also filed 500 patent applications over the past three years. The purchase of existing patents in particular has led some to be suspicious of Myhrvold and his intentions - whether "greenmail" techniques will be used to extract monies from companies wanting to avoid the uncertainty of lawsuits, a la, Research in Motion/Blackberry. He likens himself to the first generation of venture capitalists and private equity investors, who were initially widely vilified.
We think that if we specialize in invention, we can do it a lot better better than people who do it as a sideline."
- Myhrvold

However, Myhrvold says that from his experience at Microsoft, it's difficult to see which inventions will be commercially successful, and the only way to mitigate that risk is to invent on an enormous scale. Intellectual Ventures is doing just that, with its patent applications ranking them in the top 50 of companies who file patents worldwide.

I admit I have to think that this venture (or similar tack) is poised for enormous success as the rise of another recognized asset class. For those of the ...
Everything that can be invented has been invented.
(Charles H. Duell)

... thought process, need only consider the innovations just beginning to change the shape of the humble surgical scapel, an instrument that remained essentially unchanged for nearly 100 years, despite its obvious flaws and shortcomings (a story I related here).

Now, if I can only get Myhrvold to sit down for a meeting on my design for a water and energy saving bathtub ... initial target market ... nursing homes ...


The Confused Capitalist

Monday, July 10, 2006

My new blog (matters of the spirit)

I've started a new blog on matters of the spirit, which might have some interest for a few readers here.

You can go here, to Faiths Faces, to see my spirit quest.


Faiths Faces

Sunday, July 09, 2006

Kelly Criterion Limitations

I've recently written about a way to base asset allocation decisions - the Kelly Criterion. This suggest a way to maximize your returns while still positioning your portfolio for relative safety.

Another link also shows a way to apply the same criterion in more complex situations, that also offers some utility in business situations, or asymmetrical investing situations. However, it can be a time-consuming effort to apply this to every investing situation. Probably a better way to do it is to calculate the Kelly Criterion for your own portfolio and then use that as a baseline guide for your own investing behaviour.

However, using it in this simpler way requires some thinking about it's limitations. For example, calculating my own Kelly, suggests that based on my historical purchases, and assuming equal weightings, I should purchase about 11% of my portfolio into each position. Approximating my actual historical purchase amounts, suggests my Kelly in that instance is about 14.5%, indicating I was successful in properly overweighting more promising positions.

However, these Kelly calculations presume - to some extent - that our investment opportunities are symmetrical (as shown in the Mauboussin example), whereas most investors begin to recognize that investment opportunities are asymmetrical. In other words, sometimes you'll spot opportunities that you clearly feel are much better than some others.

For instance, in analyzing most of the trades I made to calculate my own Kelly, I had bit of a mixed bag in terms of wins and loses. Excluding my five largest purchases (of an initial 37 or so), I had 18 wins out of 32 purchases (37-5), which is a 56% win/loss ratio.

However, adding those five large purchases I made into the mix significantly changed both the absolute and relative results on the entire portfolio, and so are worth considering on their own.

On four of the five, I made significantly outsized gains, something I believed was possible ex ante. This expectation was clearly achieved. I also believed, ex ante, that my inherent risk in those five investments was much lower than my portfolio average. Even the one investment that wasn't quite as good as I thought, still turned out to be a break-even proposition.

So, while the Kelly Criterion would have maximized my gains if all the opportunities were highly similar, it couldn't quite close the gap here. Using your common sense in this instance would have helped you take advantage of this situation, just as I did, and just as I intend to do so in the future.

A couple of quick other limitations I can think of with the Kelly, when you analyze your portfolio trades the way I did:
  1. A rising tide lifts all boats; it's only when the tide goes out that you get to see who has been swimming naked - in other words - be careful to think about whether your Kelly covers a bear portion of the market as well as a bull portion - otherwise it may cause you to under or over state your Kelly.
  2. Analyzing the Kelly considers your history over the time considered - if you are getting to be a better investor (as shown by your more recent investments), then you might want consider upping your Kelly to properly reflect that. Of course, the opposite applies too ...
  3. Finally, you could consider segregating your portfolio analysis, so that - for instance - if you allow yourself 1/3 of your portfolio to be invested in small caps, 1/3 in mega caps, and 1/3 in ETFs, you could consider your Kelly on each of those segments. This might help you with portfolio risk and returns into the future.
The Kelly Criterion - not the be all and end all - but a useful tool ...


The Confused Capitalist

Saturday, July 08, 2006

Global Energy Demand and China

An interesting story in the New York Times magazine last weekend, regarding the growth in China of the car culture. It points to a growth like that in the early car years of America:
  • Total miles of highway, now some 23,000, more than doubling what existed just six years ago;
  • Year over year growth of car sales of 54%;
  • Passenger cars on the road, now 20 million, compared to about 6 million in 2000;
  • Government announced target of 56,000 miles of freeway by 2035 (the US has 46,000 miles of interstate highways);
  • and by 2030 carbon dioxide emissions are projected to exceed those of the US.

Anyone who thinks that the demand for global fossil fuels will abate anytime soon, should also consider that the average American uses about 25 barrels of oil annually, versus 1.8 barrels in China and 0.8 in India. Those latter two figures are obviously going to move upwards at a rapid rate, considering those countries recent growth rates in the 7-10% range annually and the apparent embedding of the car culture in China particularly.

Which of course provides a long tailwind to investing in the fossil fuel industry.


The Confused Capitalist