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.

JW

The Confused Capitalist

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.


JW

The Confused Capitalist

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.

JW

The Confused Capitalist

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?


JW

The Confused Capitalist

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.

JW
The Confused Capitalist

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??


JW

The Confused Capitalist

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 Tickersense.com / 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???

JW

The Confused Capitalist

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 ...


JW

The Confused Capitalist

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.

JW

Faiths Faces

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 ...

JW

The Confused Capitalist

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.



JW

The Confused Capitalist

Sweet Vacation ... Back Monday July 10th...

Hi readers. Thanks to everyone for dropping by since I started my blog in February.

I'm taking a brief holiday, and don't expect that I'll be doing any posting until as late as July 10th (although I may post late the prior week).

In the interim, I'm going to be thinking about how to tie together two recent postings. And I'm going to think about how to apply the Kelly Criterion in a forward-looking manner. I can't promise it'll happen, but I'll be thinking about it.

In any case, see you by July 10th at the latest.


JW

The Confused Capitalist

Asset allocation: how much is enough/too much?

Successfully outperforming the index requires identifying sufficient favorable trends to give you a distinct advantage, and then pressing that advantage to the maximum within a reasonable context of overall portfolio safety.

Said another way, for consistent outperformance, it's not good enough just to identify favorable investment opportunities, but you must also identify how much of your assets to allocate to the take full advantage of the opportunity. In other words, how much to weight your portfolio with that particular holding.

Generally, amateur investors like myself who hold focused portfolios, have some instinctual understanding that positions must be overweighted to outperform the index. We may reference general comments and schools of thought, like knowing that superinvestor Warren Buffett once held over 50% of his net worth in a single stock (GEICO), and also once invested more than 25% of his public stock holdings in American Express to help us with our portfolio weightings.

But the question remains of how much, scientifically, to allocate to a particularly favorable opportunity in our own portfolios. The Kelly Criterion (link also provides an example of how to use it, based on your own historical trading success and patterns) provides one such answer. I'm going to borrow a different and simpler example (using the Kelly Criterion) to illustrate the point.

Suppose, on a coin toss, you were to receive $2 for every time the coin turned up heads, but had to pay $1 for every time it turned up tails. How much should you allocate to maximize winnings, while ensuring that a few coin tosses don't send you to ruin? The Kelly Criterion says you can effectively maximize winnings by using this formula:

• Edge/Odds = Allocation percentage (the answer we're seeking)
  

The edge is calculated by comparing how much of an advantage, over an infinite period of time, this particular coin toss strategy has. It's calculated by comparing the odds of winning, against the odds of losing. In this case, you can expect that 50% of the time, you'll win $2. This is part [a]: (50% x $2 = $1). However, in 50% of cases, you'll lose $1. This is part [b]: (50% x $1 = $0.50). You now subtract [b] from [a] to determine your edge, thusly: $1.00 - $0.50 = $0.50. This is your edge ($0.50), the top part of the equation.

The odds are calculated by knowing how often this the event will turn out favorably. Since we know the coin has only two sides, and one sides value is double the other, then we know that the odds are 2:1 (ie. $2/$1). So the odds figure is $2.

We then divide one figure (edge, $0.50), by the other (odds, $2), to arrive at the suggested allocation for the portfolio, or "the bet". In this instance, $0.50/$2.00 = 25%. This suggests we should allocate 25% of our portfolio in each particular round, to this particular "bet" (assuming all odds and edge factors remain the same).

This system has several noteworthy features:

1. It's theoretically impossible to go bankrupt, given that money is theoretically infinitely divisible (down to the 1 cent level anyway);
2. The system produces the maximum return in the shortest period of time, on average;
3. The returns are very noticeable and lumpy - for example, if your first three coin tosses were negative, and you started with a $10 bankroll, you'd be down to $4.22.
   

If you want to use this system, I suggest you study the materials in both links I've provided until you have a good understanding of the benefits and drawbacks of it.

Hat tip to Abnormal Returns for sending us out there ...


JW

The Confused Capitalist

Thinking like John Maynard Keynes

Picture: Famed British Economist and Asset Manager John Maynard Keynes.

Not only was Keynes far ahead of his time on certain economic issues - including the establishment of a world bank with a world currency - but he was also a first rate investment manager. Managing the investment portfolio for for Kings College, Cambridge between 1928 and 1945, his investing acumen resulted in a return rate of 13.2% annually, a period that also covered the Crash of '29.

This compared to the general market in the U.K. (a local benchmark) declining by 0.5% annually over that same period.

Keynes had a couple of thoughts on investing that I intend to expand on over the next few days, so I thought I'd leave you with both to cogitate on:

"It is a mistake to think one limits one's risks by spreading too much between enterprises about which one knows little and has no reason for special confidence ... One's knowledge and experience are definitely limited and there are seldom more than two or three enterprises at any given time in which I personally feel myself to put full confidence."

and ...

"To suppose that safety-first consists in having a small gamble in a large number of different [companies] where I have no information to reach a good judgment, as compared with a substantial stake in a company where one's information is adequate, strikes me as a travesty of investment policy."

This is something I've talked about generally before, that is, having a "focused portfolio" to enhance your probability of outperformance. I'll explore one particular aspect of this in the near future.

Some other postings dealing with outperfomance are here and here.


JW

The Confused Capitalist

Real estate values still to be knocked down ...

There's an interesting report on the value of housing in America, updated this month. The Global Insights/National City report suggested, based on 21 years of data, that of 317 metropolitan areas around the US, covering 84% of the housing stock, only 88 markets are currently undervalued (by any amount).

Against that, there are some 71 metro markets - covering 39% of the housing stock - that are "extremely over-valued", meaning that the valuations are at least 34% above what their model projects as correct values. The report further notes that as recently as the first quarter of 2004, only three metro markets were "extremely" overvalued.

And for those that think the housing market is due for a rebound (and prices aren't yet statistically showing up as falling much), the report states that the median correction in overvalued markets in the past 21 years is 17% and that it lasts 14 quarters. That's three and a half years folks. To those that like the seemingly cheap valuation metrics of home-builders and development companies, may I suggest .... patience.

In Canada, however, things are different as the good times appear to roll on for as far as the eye can see. Although there's no apparent signs of a real estate bubble here, perhaps some leading edge indicators suggest that a bubble may be in the early stages of forming.

ReMax just reported that sales of high-end luxury houses are booming across the country, with sales volumes up year over year by 31% in Toronto, by 90% in Vancouver, and by 124% in oil-rich Calgary.

Another five or ten years of this, and we might end up in the same boat as the US market is!

JW

The Confused Capitalist

Emerging Market Commentary from the front lines

This is the first (or last, depending on how you look at it), of a trifecta of late day bloggerings today, on the longest day of the year.

I've been reading a blog recently that concentrates on India. In India, apparently by an Indian person. Seems they - financially - have many similar concerns to us here - inflated house and asset prices, etc. In a recent posting, the writer states ...

"While it is not the end of the real estate rally, in general, like any commodities, property prices also go through the boom and bust cycle (in fact, the rise in property prices is not just unique to India!). The reason why we thought it is relevant to highlight the property market to our readers is that even after the fall in the stock markets in the last one and half months, we still hear brokers selling 'real estate' stories to retail investors. While some companies have a long-term strategy to tide volatility in prices, it is pertinent that we, as investors, exercise caution in our judgment. Ultimately, it is our hard earned money!"

In any case, the blog is well worth a visit, if you're considering investing in more than just Indian cuisine.



JW

The Confused Capitalist

Weighing the odds of emerging market outperformance

Well, as sports fans here know, I'm a big fan of many emerging markets, mainly because I consider them to be cheap. For that, you get a good growth profile, better than ever ROEs and current account surpluses - all good stuff. Having said that, all emerging markets are not alike.

A recent UBS report makes many of these same points, suggesting that they offer a good investment profile. As to whether the market continues its' emotional response in the face of further inflationary pressures, or some sort of crisis, is yet to be determined. I suspect that will be the case: in other words, EM market volatility will continue for awhile. I personally hope to profit on this volatility: that in the next plunge, these values will discount at a higher beta than the S&P500.

Yet, the UBS report makes the case that many offer good value, particularly my personal favorite, South Korea.

I suspect that one day off in the not too too distant future (timing, as always Stella, remains the question), the US market and EM market will finally disconnect, with the EM market finally being accorded more respect and lower volatility.

May I suggest you peruse the report?


JW

The Confused Capitalist

Climbing back into the market

Although many investment types warn against market timing, I'm going to suggest that it is a small but important part of any fairly successful investor's repertoire. Basically - at the most correct level - it involves selling assets when they are above a realistic value, and being slow to redeploy proceeds when few or no bargains can be spotted.

Once cash is in hand, however, you should prepare a plan on how to redeploy those proceeds, when "the market" you like (through an ETF), or a particular stock you like, is marked down to the right level.

And just like someone picking his or her way up or down a rock, this involves some careful consideration. For example, since I believe that the market is poised for a fall, I've constituted a plan whereby I step back into the market at pre-determined levels. In some cases, this might be when a specific stock or ETF has hit a certain level, while in others, it's just based on a broader market decline.

The point is, is that I haven't selected a single entry point as the time to redeploy my idle cash back into equities. I have a phased plan. For me, my re-entry points are (generally speaking), a three-tiered structure, using a point around a 15-20% decline in the S&P500 for re-deploying about 50% of my idle cash, and two further points at 25% and 30% declines for the balance.

While some of these points might not be reached, at least I've made a plan on how to maximize the inevitable upswing. And of course that's not to say I'm out of the market entirely - one way bets using all of one's assets aren't a particularly prudent way to invest, in my opinion.


JW

The Confused Capitalist

Do it yourself stock investing is extraordinarily difficult because ...

... because the knowledge base required is fairly extensive, complicated and mostly because the feedback loop takes a long time to complete.

As peoples barely removed from the hunter-gather stage of development, as investors we are still barely above our fight or flight method of handling things. Fight or flight is a fabulous mechanism when being chased down by a lion, but not all that great for quelling an emotional response to a stock market beating.

So, while we think we've done a good job analyzing an investment and weighting the odds of success in our favor (both by the investment itself, and by the relative weighting of that investment in our portfolio), we don't have a whole lot more to go on for some period of time. As superinvestor Warren Buffett has frequently noted, over the short term the stock market is an emotion measuring machine, but over the long term it is a weighing machine.

However, we're always looking for the constant feedback that tells us if we're doing something right or wrong. In sports, like soccer, we get very good immediate feedback. If we keep getting beat to the inside by a striker, we learn to back up more, or take better body positioning. After a couple of games and practices, we find it's not happening so frequently.

In investing however, we look for immediate feedback and validation that we've made a correction (or incorrect) choice from the market. Unfortunately, proper market feedback (i.e. the weighing machine, not the emotion machine) often takes several years to materialize. In the interim, we have turned to the measure of observing the daily (hourly?) price change of our securities to provide the feedback loop we desire.

But we really know that this isn't going to work too well. My suggestion would be to turn off your computer and re-visit your holdings every quarter or so. Benchmark it against a comparable investment set. Then give yourself some feedback.

I fully intend to do just this ... but I just need to check my holdings just once more ... or so ...


JW

The Confused Capitalist

Raising the Median - Gas Mileage - Global Warming

In light of this morning's posting, I'll offer up a very small suggestion. Reduce your global warming load with a cheap bike conversion.

200 mpg, 20 mph+. All for a $400 conversion. Paid for once you've saved the cost of five fill-ups for your SUV.

Great for those small trips under six or seven miles or so. Fifty dollars gets first crack at it! As seen in Popular Science.

Better and cheaper than a Segway.

More here on the revolution.

And since this IS an investment blog, the extra savings you can put into the market. (OK, it's weak, I know, but hey ... you've got to try ... can't give up ...)

"I am only one, but still I am one. I cannot do everything, but still I can do something; and because I cannot do everything, I will not refuse to do something that I can do."

- Helen Keller


JW

The Confused Capitalist

Investing in a Hothouse World

I often lament to some friends that I don't understand why a few souls don't seem to get the whole "global warming" thing. For those of us in the great white north (Canada), we are well aware of how dramatically our winters have changed over the past twenty years.

Because of this dramatic change, most folks here don't subscribe to any of the junk science school of thought claiming that global warming is either:

1. Not occurring, or
2. Due to naturally occurring phenomena

To most of us Canadians, it's pretty clear what's going on. Recently, asset manager Eric Sprott of Sprott Asset Management, a firm with $3.4 billion under management, weighed in with a 56 page missive, entitled Investment Implications of an Abrupt Climate Change. In that document, Mr. Sprott says it's "shockingly clear" we've caused a spike in greenhouse gases, and further says that ...

"We are now in uncharted territory and may well be on the cusp of a warming of the planet at a rate well beyond what can be predicted using our limited knowledge of history."

Mr. Sprott considers further trends such as the massive industrialization of much of the world's remaining rural populations, and other trends in place as not projecting a bright future for the planet. Water shortages, food shortages, droughts, too much rainfall in places, rising sea levels, ever accelerating weather change, etc. Pretty much the usual bane of stuff that we manage to ignore every day, without too much thought or effort.

In any case, a goodly portion of the paper is directed to current statistics, events, and trends relating to global warming. (But I must tell you I learned something new: the paper suggests that the melting of the permafrost and its' sequestered methane gases as being an absolute tipping point - page 25 is a must read page).

By page 28, Mr. Sprott arrives at the investment risks and opportunities. He suggests the following sectors are at risk, if there is a 20% emissions constraint regulated:

• Automobile
  
• Chemicals
• Electric utilities
• Metals and mining
• Oil and Gas
• Banks (some banks have high rates of commercial loans, whose clients may be subject to various types of business risk from global warming)

Unfortunately, Mr. Sprott doesn't offer too many investment opportunities. He points to obvious ones, such as nuclear, wind and solar power as being some. He suggests however, that the ethanol craze is just adding to the global warming load (production of ethanol fuels requires more energy inputs than they produce), and that hydrogen as a fuel isn't quite ready for prime time. He suggests that micro power projects may offer some potential as well.

Finally, he suggests a hyper-inflationary environment could ensue at some point, thereby accelerating demand and prices for commodities in general, and gold in particular.

As one sentence in the document points out, a Swiss Re (insurance) executive stated that ...

"Global warming has accelerated from a problem that might affect our grandchildren, to one that could significantly disturb the social and economic conditions of our lifetime."

In light of this, may I suggest one further solution we can provide as investors? Perhaps directly investing a very small portion of our investable assets, towards some source of lowering the warming load. Whether this is in a company that is in nuclear, solar, wind power, or any other investment that lowers or reduces the warming load, it doesn't really matter. By helping to provide more abundant equity available, we'll help spur the advance of technologies to save the life of this planet. Sometimes we have obligations beyond that just of short-term investors - we have obligations as human beings.

May I suggest 1/10 of 1% of your investable assets this year, or a minimum $100, increasing by a similar amount every year for nine more years? Consider it a donation - a donation in an area we have special knowledge and awareness in - the investment field. If we wait too long, the cost may be far, far too high.


The Confused Capitalist

Inside the Private Equity World

I've been reading a blog recently that's both educational and interesting, and highly amusing. If you want to look into the world of leveraged buy-outs, go and visit
Going Private, The Sardonic Memoirs of a Private Equity Professional.

Start with the "Start Here" link, and dig into the links. Enjoyable.

JW

The Confused Capitalist

Dividend Divas

Ain't dividends grand?

Boy I remember back in the bad old days of the late 1990's, when dividend-paying stock-owners were looked down upon, by their Nasdaq-investing friends. Their stocks seemingly soared, while boring old dividend-paying stocks just kind of coasted along. Time has shown of course, that many Nasdaq-type stocks were destined to crash and burn, while the dividenders did nothing more than produce reliable consistent wealth growth.

A recent study by RBC Dominion Securities show how dramatic that difference has been. They isolated stocks into three silos, one which was stocks that paid no dividends over the past ten years, another consisting of stocks with stable dividends, and the last consisting of stocks that consistently increased their dividend over the period.

In the US market, to May 30, the average annual rate of return was as follows:

1. No dividends: 6.5% annually
2. Stable dividends: 8.8% annually
3. Increasing dividends: 9.6% annually.

In Canada, the difference was even starker, and more remarkable:

1. No dividends: 1.3% annually
2. Stable dividends: 15.5% annually
3. Increasing dividends: 17.2% annually

Just to remind you of exactly what kind of return 17.2% is - that'll double your wealth in just over four years. Please bore me some more!



JW

The Confused Capitalist

Conundrum solved

The other day, I was challenging some conventional wisdom, and it seems that a more elaborate answer was recently discussed by a Legg Mason manager, Michael Mauboussin, who the Legg Mason site advises is the ... "Chief Investment Strategist of Legg Mason Capital Management (LMCM), Legg Mason's cornerstone equity fund management subsidiary."

Here are his comments, directly:

"Jack Bogle provides what may be the most sobering statistic in the investment industry: from 1983-2003, index funds tracking the S&P 500 returned 12.8 percent and the average mutualfund gainedd 10.0 percent annually. Meanwhile, the average investor only earned 6.3 percent annual returns. This seemingly impossible result is attributable to one crucial variable: market timing.

The Bogle data refer to average percentage changes, not dollar-weighted changes. When you consider the extraordinary proclivity for investors to invest in the wrong place at the wrong time, the data start to make sense.

For example, at the height of the technology and telecom bubble in the first quarter of 2000, investors poured a record $140 billion into growth funds while pulling $40 billion out of value funds. In the subsequent five years, value funds substantially outperformed growth funds. Using over twenty years of market data, Evergreen Capital Management paired mutual fund flows with a valuation measure to generate buy and sell signals.

High inflows and high valuation triggers a sell signal, while large outflows and cheap valuations mean buy. Following a sell signal across various investment styles, the return of the investment strategy underperformed the S&P 500 by an average of 490 basis points over the subsequent two-year period. Buy signals generated an even more impressive 870 basis points of excess returns in two years. As noteworthy, the sell signal was reliable nearly 80 percent of the time, while the buy
signal was accurate over 90 percent of the time.

Why do investors make this mistake? The most likely explanation is the recency bias, which says individuals tend to extrapolate recent outcomes without giving full weight to the full time series or prevailing circumstances. This bias defines one of the most reliable sources of inefficiency in the market.

Recent academic research, spanning twenty years of data, shows the buying and selling patterns of individual investors provide a hard-to-beat contrary indicator. More specifically, researchers found heavy buying leads to above-average short-term results and below-market returns in the subsequent year. The mirror image holds true for stocks individuals sell. "

Thinking about buying or selling one of your investments? Sobers one, doesn't it?


JW

The Confused Capitalist

Santa Claus is coming to town ... make your list too!

You better watch out, you better not cry, ... yada, yada, yada ... he's making a list, and checking it twice, yada, yada ...

Time to make your list too! As regular readers of this blog are well aware, I think that some sort of correction is in the offing, if not now, probably within the next six months. I remain skeptical of whether current market levels can be maintained in what I see as signs of rising inflation, which must ultimately be met by rising interest rates. Against a backdrop of PE ratios at or above historical norms, I believe that this sets the stage for a market decline.

So while I've raised some cash in my portfolio, I happily await the correction. This should give me the opportunity to purchase some of my desired stocks and ETFs at nice discounts. I'm hoping for some of the following top-quality names to drop far enough for me to purchase nice big chunks that'll fuel my portfolio for awhile to come. Some of the blue-chip names I'll be following include:

• Coke (KO)
• Pfizer (PFE)
• Brookfield Asset Management (BAM)
• Wells Fargo (WFC)
• Goldman Sachs (GS)
• Procter & Gamble (PG)
• Manulife Financial (MFC)
  
  

and a few Canadian blue-chip stocks I'll be keeping my eye on ...

• Bank of Nova Scotia (BNS)
• Power Financial (PWF)
  
• TSX Group (X)
  

and I'll also be looking for deep, deep discounts in some emerging markets, including Brazil, South Korea, Taiwan, and Russia.

So, during this phoney war, don't waste your time either. Make your list and check it twice too.



JW

The Confused Capitalist

Challenging conventional wisdom

As investors, it's important - if we want to outperform the indices - to think differently. And that means challenging accepted conventional wisdoms, by continually asking questions that reveal underlying assumptions. Also, looking at the quality and quantity of the data before us, can also help us become better investors too.

I enjoy reading articles that consider common investing mistakes, so that I can hopefully minimize these mistakes myself. One recent one I read (by way of Abnormal Returns) was a list of 15 common biases reported at The Kirk Report, from the investor magazine, Trader Monthly. The list is full of good stuff.

But I finally (i.e. years late) suffered some cognitive dissonance when reading item #12 on the list ...

12) Asymmetry of risk tolerance: Investors are risk-averse with regard to gains (preferring to sell "winners" and ensure the gain) but risk-takers when it comes to losses (preferring to hang on to "losers").

Now this isn't the first time or place that I've read this statement, but I finally realized that this is in complete contrast to two other accepted wisdoms I've read multiple times over the years:

a) That investors in mutual funds - in the aggregate - underperform the performance of the mutual fund itself, primarily because they pile into the latest hot fund (whose performance decays thereafter), and

b) That reversion to the mean exists, meaning that stocks and mutual funds that have underperformed for a relative period, generally outperform in the following period.

Something has got to give - all of the above statements cannot be true. While I'm not certain which of the three has to give, I personally think it's the first one. Having seen more than a few investors, I tend to believe that a) is true, and by reasonable extrapolation, also applies to most other investors (i.e. not just those who invest in mutual funds).

I've also seen a fair number of studies showing that underperforming stocks rebound typically have a rebound (because they got priced too cheaply) and outperforming stocks often falter (because they became too expensive ... "priced for perfection). So I tend to think that b) is also true.

So, I'm going to say that I think bias #12 is probably false - and I think in fact it might be the opposite - investors holding "winners" for too long, and dumping "losers" too early.

But what do you think?


JW

The Confused Capitalist

Upside Downside complete review

I've now finished a decent book relating to risk management, Upside Downside: Simple Rules of Risk Management for the Smart Investor. The three main ideas of the book are profiled here (a call for scenario thinking, instead of most-likely case forecasting) here, (know what you own) and here (anticipate "regret" in your investing).

While these three ideas are certainly worthy of consideration for any investor, it's a small book (nothing wrong with that), but it feels "stretched out" with some narrative stories in attempting to hit 200 pages (not quite done, if you exclude the index). So it seems relatively expensive at $29.95.

The book was co-authored by Dr. Ron S. Dembo whom the dustcover describes thusly ...

"... is the founder and former president of Algorithmics Incorporated, and grew it ... to the largest enterprise risk management software company in the world, with ... over half of the world's top banks as clients. He was a professor at Yale ... and holds a number of patents in computational finance. ... In 2003, he was among the first fifty people indducted into the Risk Hall of Fame."

One of the pieces of advice given several times in the book relates to portfolio insurance (and in fact is the concluding sidebar piece), suggesting a good way to achieve this is to invest in a zero (stripped) coupon bond for the face amount of your investable capital, and the balance in some type of stock market investment. In one of the later examples, of a 55 year old looking to the next ten years (i.e. retirement at age 65), takes the investable capital of $200,000, places $130,000 in the strip bond (which has a $200,000 face value at maturity in 10 years), and then uses the other $70,000 to invest in a broad market EFT, which the book suggests could double over the ten years, resulting in a total of $340,000 at retirement. It suggests that this is a well-protected investment.

While that may be the case, this doesn't seem like a particularly good way to invest, given the overall return rate is only 5.3% which isn't a lot better than could be achieved simply by investing the entire amount in a bond which hasn't been stripped. It also suggests that buying futures (puts/calls etc.) is another way to protect a portfolio. Again, while this is true it will generally reduce the rate of return for most portfolios. Insurance always costs money.

All in all, I'd give the book 3.5 stars out of five. Good ideas, but a feeling of having stretched out the book and some examples that don't show particularly strong risk-risk/reward management techniques, in my own opinion.


JW

The Confused Capitalist