Tall Trees can't grow to the sky ...

It is often said that "Tall trees can't grow to the sky", meaning that things cannot continue past their natural boundaries.

Although current stock market bull commentators often act as if this doesn't apply to today's stock market, the fact is, is that natural "rules" apply. And the two key rules remain impenetrable as always and they relate to PE ratios and interest rates: when PEs are above historical norms, and interest rates are on the way up - then stocks will inevitably fall (exact timing is, as always, the only question).

Nevertheless, as small investors today, we don't simply have to hope for a bull market to make money - we can use quasi-shorting techniques, even in tax-protected accounts. Given that this is one of the longest bull markets in the past fifty years, the direction of interest rates is up, and PEs are above averages, it doesn't take a rocket scientist to prepare for the worst.

That doesn't mean pulling everything from the market - the market often proves people foolish, by adding a few more points than expected. But it does mean doing a balancing act, that might produce a more stable portfolio over the mid-term. For some investors who agree with the thesis that we are in the prelude to a bear plunge, this means retaining solid core positions, and raising some cash, and perhaps using inverse leveraged positions to gain alpha on the downside.

Given that the last major bear market lasted 16 years, and produced numerous plunges (and subsequent near recoveries), a correction (at the minimum) seems in order - fairly soon. So, by investing 5%, 15% or 25% into a levered bear position, such as that available from ProFunds.com, this can allow you to profit while the market is in decline, and then allows you to throw it into the market, when it's hit what you consider to be the bottom.

The risk is that you dampen your return should the bull continue on longer than you thought, but the reward side is the potential to significantly mitigate the downside damage, and be ready to put more funds into the market when it's "on sale".

Just be sure that you aren't risking an excessive amount on the "downside" bet. Remember, it's having a well-reasoned approach - often contrary to popular thinking - that produces the best investment returns. Something to ponder (but not for too long), while this aging bull looks for a face-lift.


JW

The Confused Capitalist

Time is on my side ...

Time is on my side, yes it is ... (apologies to the Rolling Stones) ... or at least it's on my kid's side.

I was thinking about this today with my two teenagers, and thought how little money it would take, with decades of compounding ahead of them, to fashion a comfortable retirement, some 50 years hence. Of course, compounding within the confines of a tax-deferred account will make it all the better.

So with that thought in mind, I considered what $5,000 could be worth with a little leverage working for them for a long period of time. Recently, Horizons BetaPro Funds announced two leveraged index mutual funds. Both are levered to produced twice the change as their underlying indices; which are the Canadian S&P/TSX 60 (the largest companies in Canada); or the NASDAQ index. Both funds are designed to mimic their index, except with twice the upward and downward movements. The MER on the S&P/TSX 60 index is 1.5%.

To consider what could become of $5,000 in a tax-sheltered account (IRA or RRSP), compounded for 50 years, I used considered a long-term rate for large companies of 10.5% annual return as reasonable (about 10.5% is a widely quoted number). However, this might be slightly optimistic going forward, so I scaled this back to 8-9%, say 8.5% as a long-term rate. With a fund leveraged like this, it would mean an 17% return over the long haul, less the 1.5% MER charged by the fund. This would leave a net return of about 15.5% per annum.

I then went over here to use the financial calculator, and this indicated that the $5,000, compounded at 15.5% over 50 years (in other words, when my children turn 65), would be worth $6,703,839 at the end.

However, inflation has averaged 3.15% per annum over the past 90 years. Accounting for that 3.15% inflation factor suggests that the $6.7 million will be worth the equivalent of $1.42 million in today's dollars. More than enough to provide a very comfortable supplement to whatever else they have accumulated for their retirement.

Excuse me, I'd like to continue talking to you, but I have to go speak to my wife about an idea I have ...


JW

The Confused Capitalist

Augment your returns with levered stocks and investments

There's more than one way to enhance your long-term investment results than borrowing money from the bank to buy stocks as I've written favorably about recently. There's also some opportunity - at least here in Canada - to buy stocks or investments which THEMSELVES are levered on an underlying company or index.

They therefore magnify the potential gains (but also losses too) that can be had compared to the underlying stock or index. For instance, Scotia Managed Companies offer a number of "split share" companies that use another index or company to magnify the returns. Some of the ones they offer include one which uses the S&P500 Health Index as its basis, but it offers leverage at a 3.22 factor against the underlying index. Which wouldn't have been good for your portfolio over the past several years, as that index slid, and the sliding has been magnified by this leverage factor.

On the other hand, they also offered split shares on the TSX 60 benchmark - which would have been fabulous for your portfolio recently, given the 1.79 factor leverage on an index that's been on fire the past few years. They also offer narrow (company specific) or more broadly based split shares, such as ones that highlight the Canadian banks or banking sector, life insurance companies, utility companies, as well as other sectors. There's also the shares that lever on the trophy property and asset manager, Brookfield Asset Management company through BNN Investments at about 3x leverage.

One thing I like about many of the levered investments discussed here, is that they are on staid, conservative companies. In this way, I can get some of the returns offered by smaller companies, but without so many of the risks inherent in them.

Finally, there's even mutual funds offered by Horizon Beta Pro Funds that offer 2x upward OR downward leverage.

For more on the whole split share structure, go and read this article by the Money Sense people. For an investor with a long enough time horizon to ignore the inherent volatility in this type of investment, I say definitely take a look at these types of investments.

JW

PS If anyone knows of any levered US market investments please drop a comment here, or send me an email. I'll pass it on.

The Confused Capitalist