Reacting to headlines is perilous!

You can avoid plenty of grief by reading headlines and as George Costanza (from the popular sitcom Seinfeld) says: “Do the opposite.”

You might notice that the average ‘Joe’ was far more concerned about his job (justifiably) until we began seeing headlines such as ‘Dow Hits Highest Close Ever.’ All of a sudden the stock market is once again a worthy topic for discussion and it’s okay to actually speak to one’s investment advisor. Judging by money flows it’s a good bet that clients are instructing their advisors to buy stocks, EFT’s, equity mutual funds or whatever it takes to get them invested and fast. There’s nothing but good news. As I type this, ‘Stocks resume winning ways’ appears on the TV screen (CNBC).

Before succumbing to the urge to herd let me take you back to June of 2010.

In the first chapter of A Maverick Investor’s Guidebook (Insomniac Press, 2011) I wrote the following:

In one newspaper, under the title “Economic crisis,” I found the headline: “World recovery under threat as growth slows, stimulus wanes.” On the same day in another newspaper, under the title “Recovery angst” was the similarly ominous caption: “Economic trouble is all investors see.”

If you are spooked by such nonsense and inclined to adopt a ‘wait-and-see’ approach before investing any of your money at all in financial markets, then give your head a shake. These headlines are gold!

I went on to pose the question: “If the press is even partially representative of what economists and strategists are recommending, and if investors all share the same sentiments, then what happens when there’s some good news?”

There was plenty of good news even in 2010, but it was generally delegated to those pages in the back of the newspapers which people seldom read. One example, and a very important one for stocks, was rapidly improving corporate profitability.

While the general mood was (and continued to be) let’s say ‘despondent,’ institutional and retail investors kept taking money out of stocks and channeling it into money market funds and bonds – to take advantage of what tiny returns were available in those securities (yes, I am being sarcastic).

Meanwhile in answer to my rhetorical – because it should have been obvious what the answer would be – question in 2010 we certainly know now what happened when there was good news. Stocks skyrocketed and recently surpassed their previous highs.

My concern today is that investors will make the same mistake they always seem to make. Rather than ‘interpreting’ headlines, they will simply take them at face value and chase the stock market at an inopportune time.

I am paraphrasing, but I’ve heard and read nothing but good news of late such as:

  • “It’s definitely a ‘risk on’ market.”
  • “Don’t fight the FED!”
  • “Looks like we might avoid the usual summer slowdown this year.”

Most worrisome: Kramer (wait long enough and you’ll eventually be right) is more wound up than a four-year old high on chocolate. I do believe that stocks are a better investment than bonds over the next several years, but the trend in corporate profitability (and consumer sentiment, GDP and job growth) will be interrupted – count on it – affording convenient opportunities to get invested. With nothing but good news and euphoria, what happens if we get some bad news? A chance to invest at lower price levels. Right now, ‘risk-on’ is exactly what you should expect if you respond to headlines.

Click on this link for a chuckle: George Costanza Does the Opposite

Mal Spooner

 

 

 

 

 

You want back into stocks…but should it be growth or value?

Decades ago, the academic community and financial services industry, in an effort to better understand what causes good versus bad rates of return in stock markets, began studying differing styles of investment management. There isn’t a hope of my staying awake long enough to cover even a sampling of the variety of styles that are out there, so I’ll keep it simple. Two styles in particular get plenty of attention: growth and value.

With the growth style, portfolio managers use their ingenuity to identify companies that are growing most rapidly. Since I carried around a BlackBerry (aka CrackBerry) for many years, I’ll use its creator Research in Motion (RIM) as an example. When the company was first getting its legs, it offered me and other research analysts a free trial of a little device with a monochrome screen that allowed you to send and receive text messages. We became addicted to them overnight and believed that this kind of service would catch on. Early movers can grow businesses very quickly with sufficient research depth, management expertise, and capital. We professional money managers provided the capital to RIM and the rest is history.

Early on, RIM was a growth company because even though they weren’t profitable and wouldn’t be making money for many years, the company kept selling more and more units. Revenues grew like crazy and, with some occasional disruptions (a market crisis, the technology bubble bursting), so did the stock price.

Portfolio managers who specialize in companies such as RIM are commonly called growth managers. The funds they manage are “growth funds.” The portfolio will usually have many stocks in various industries. They can be fast growing companies in slow growth industries or companies benefitting from an industry that is suddenly growing. Growth stocks can be very expensive. Investors expect the company to grow fast and so are willing to pay a higher price. However, you’ll have to buy a book explaining price/earnings (P/E) ratios, P/E to growth rate ratios, price/sales (P/S) ratios if you really want to get into security analysis yourself.

A value manager is more interested in buying and owning cheap stocks. Some companies grow slowly but pay their shareowners high dividends as compensation. A stock can be in an industry that is out of favour with the investment herd, or an industry can be out of favour entirely, making all the stocks in the sector cheaper. There are measures such as price/book ratios (P/B) and price to net asset value ratios that analysts use to gauge whether a stock is cheap or not.

Growth funds are considered riskier or more volatile than value funds. For instance, if the market is going higher because of a particularly strong economy, then the growth fund should go even higher still. A value manager might not perform as well as a growth manager in a bull market but won’t do as poorly in a bear market. A value manager is therefore considered more conservative.

A strategist friend of mine of TD Newcrest Research allows me to use his charts on occasion.  One of the most telling charts compares growth stocks in the S&P 500 Index to Value stocks.  The adjacent chart is an older one.  When the line is rising, growth stocks are significantly outperforming value stocks.  You can see vividly the technology bubble – growth stocks skyrocketing relative to value stocks – prior to the bubble bursting in the year 2000.

The shaded areas are periods of economic stimulation (US Federal Bank monetary easing).  During these periods it’s not unusual for growth funds to perform much more strongly than value-oriented funds.

Conventional wisdom says that conservative investors who can’t stomach as much volatility should use value funds and that investors who don’t mind a wild ride should use growth funds. Alternatively, you can invest most of your money into a value fund while also putting some into a growth fund so that you might occasionally get more returns in a buoyant market with at least a portion of your savings.

Why not growth when growth is performing and value at other times?

There are portfolio managers like me who hate being pigeonholed into either one of these styles. However, it is inevitable that one label or the other will be associated with a money manager because of the way consulting services are compensated and the way mutual funds are marketed (when growth is sexy, it only makes sense to promote the growth manager).

A maverick investor who understands the ebbs and flows of market sentiment will want to be invested in their favourite growth fund at the right time and to switch into a value fund at other times.

Whenever I’ve recommended a more active approach to selecting mutual funds in print or on television, such as using a growth fund and switching into a value fund when appropriate, I always get the same question: “How do you know when to switch?”

There is an easy answer, but nobody likes hearing it. The answer is: “You will know!” You should switch when your intuition or emotions tell you not too. It is that simple. If the fund you own has been doing extremely well and drifted up towards the top quartile or is now in the “best performing funds” category (rankings are available from a wide variety of publicly available services) and so you’ve begun to love it dearly, it’s time to switch into a different style of fund.

Here is a more current chart.  In this case the shaded areas are periods of recession, and we are all aware that for the past few years monetary stimulus has been the norm.  Not surprisingly then, growth stocks – avoided by most investors like the plague – have been outperforming value stocks.

As investors divest their income biased stocks (and bonds) they will naturally be tempted to move the money into the better performing growth style.  However if history (and experience) is any guide, they’d be well advised to focus their attention on stocks and funds that have not yet participated in the recent market rally.  In the event that government policy, encouraged by the rebound in the housing market, strong corporate earnings and slowly improving employment outlook, becomes less stimulative then value will in all likelihood become the place to be.

Mal Spooner

 

 

 

 

 

Market Week

Market Week: February 4, 2013

The Markets

A stream of strong earnings reports helped the Dow industrials end their fifth straight week of gains by closing above 14,000 for the first time since 2007. The Nasdaq’s best week since the first of the year helped it close the gap with the other domestic indices, while the small-cap Russell 2000 continued to lead the pack.

Last Week’s Headlines
•Hampered in part by fiscal cliff fears and Superstorm Sandy, the U.S. economy slowed substantially in 2012’s final quarter. According to the Commerce Department’s initial estimate, gross domestic product contracted during the quarter at an annual rate of 0.1%. That’s dramatically lower than Q3’s 3.1% growth, and is the first quarter of contraction since Q2 2009. A 22% decline in defense spending, lower state/local government spending, and reduced inventories and exports were major contributors to the contraction. The initial GDP estimate is subject to two revisions over the next two months.
•Businesses added 157,000 new jobs in January, according to the Bureau of Labor Statistics, and the figures for November and December were revised upward. Unemployment edged upward slightly to 7.9%; it has stayed within one-tenth of a percentage point of that level since last September.
•Congress passed legislation that would temporarily suspend the debt ceiling until May without requiring spending cuts. However, lawmakers’ paychecks would be withheld if their chamber of Congress doesn’t pass a budget resolution by April 15.
•Durable goods orders leaped 4.6% in December, in part because orders for transportation equipment, which had declined for two months, soared 11.9%. The Commerce Department said new nondefense orders–an indicator of capital spending by businesses–also were up 3.8%. Durable goods orders have now risen in seven of the last eight months.
•U.S. manufacturing saw solid growth in January as the Institute for Supply Management’s index rose almost 3 points to 53.1 (any figure over 50 represents expansion). The ISM said that was the index’s highest level since April 2012.
•Going into the holiday season, home prices in the 20 cities measured by the S&P/Case-Shiller index fell 0.1% during November. They were 5.5% higher than a year earlier, though the average price nationally was still 30% below its 2007 peak.
•Personal income jumped 2.6% in December. However, according to the Commerce Department, much of the increase resulted from lump-sum Social Security benefits, the rebound from Superstorm Sandy, and companies accelerating payment of dividends and bonuses because of uncertainty about 2013 tax rates; otherwise, the increase would have been 0.4%. The personal savings rate was also up dramatically, rising from 4.1% of disposable income in November to 6.5% in December; that’s the highest savings rate since 2009.
•Steady as she goes: The Federal Reserve Open Market Committee reaffirmed its plan to continue its bond purchases and keep interest rates at current levels until unemployment falls to 6.5%.

Eye on the Week Ahead

Data on factory orders will be watched to see if they confirm last week’s encouraging manufacturing data. Also, the European Central Bank will meet on interest rates.

Key dates and data releases: factory orders (2/4); U.S. services sector (2/5); labor productivity/costs (2/7); international trade (2/8).

Data sources: Includes data provided by Brounes & Associates. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results.

The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indexes listed are unmanaged and are not available for direct investment.

Is AAPL bruised or beginning to rot?

There’s a huge difference between Apple the company and AAPL the stock.  Back in July when the stock seemed to headed to the stratosphere I began to get concerned.  At the risk of seeming ridiculous (which has never stopped me before fyi) I will quote myself at the time:

 “The market value of Apple Inc. has ballooned.  It really hasn’t mattered that Android devices are kicking butt; rapidly gaining market share and being adopted by the more technology-savvy consumers (the nerdy trailblazers).  Until now?” July 29th, 2012

Apple’s 2nd quarter results had just been released and were considered disappointing by most analysts.  However my misgivings were based more on experience than the company fundamentals.  Over decades I’ve watched stock market darlings follow a pattern time and again.  At the outset it’s product itself that folks fall in love with, but eventually it’s the company’s stock they become infatuated with.

Admittedly the rewards to the company are plentiful if the product catches fire, especially in the middle stages of the lifecycle (pricing power and growing demand), but gradually management is obliged to focus on producing more and more of the product; which can mean skyrocketing revenues and economies of scale (reduced costs of manufacturing) – good for the company and its investors.  Eventually competition rears its ugly head, and the company is forced to innovate rapidly (rising expenses) to keep market share.  Competition (Android devices offered by the likes of Samsung, Research in Motion) will inevitably cause prices and profit margins to fall.

Finding a new hit ‘premium-priced’ product is difficult to do unless the company is managed by a tyrannical genius like Henry Ford or Steve Jobs (who can be oblivious to the rantings of those myopic stakeholders who’d rather have dividends than invest in research and development).

One might think that the stockprice should mirror the fortunes of the company.  But there are periods when this just isn’t the case.  This is the chart I was looking at (back in the summer months) when I began to get the heebeejeebies.  The financial results weren’t that impressive, but the share price had gathered its own momentum.

A GOOD  THING: Lineups to buy iPhones and iPads.  DANGEROUS: Lineups to buy shares.

I like to think the stock market  is like a party.  When my daughter was a teenager, she asked if my wife and I could disappear for a few hours one evening so she could invite some friends over for a party (I’m sure this has happened to many of you).  Things went fine until a contingent of uninvited guests began showing up.  No doubt a few more youngsters added to the fun, but once the house was too crowded bad things began to happen – items got broken, drinks were spilled on hardwood floors and carpets, there were empty bottles scattered all over the property and suddently her little party turned into into a nightmare.

When uninvited people (not really investors) scramble to own a stock it usually ends up like my daughter’s party.  At first a few more (uninvited) investors drives up the price which is great for existing shareholders and the company.  Indeed, AAPL shares continued to ramp up into the final quarter of 2012.  But just like my daughters party, things began to get ugly for the stock once it got too crowded.

 There is much speculation concerning the causes of the rapid decline in the price of AAPL shares:  Weak demand for the iPhone V, the threat of Android market penetration and so forth.  Some of this might be true, but pure speculation doesn’t ordinarily impact the price of a company’s shares this radically.  Hard evidence will hurt the stock to be sure but my own experience is that as soon as people realize they’re at a party that just isn’t as much fun as they’d hoped for then they all try to leave at the same time.  There is a great deal of risk associated with buying into stock market darlings.

I mentioned above that there can be a huge difference between the fortunes of the company and the behavior of the stock.  It could very well turn out that Apple (the company) will continue to thrive despite the decline in the share price.  After all there are a great number of people that still plan to buy iPhones.  No doubt there are also many planning to buy other Apple devices.

A recent survey suggested that 50% of those asked what smartphone they intend to buy over the next ninety days said they wanted an iPhone.  This is the same result Apple has enjoyed for that past couple of years.  There will come a time when the company will have to come up with another big hit product or re-invent itself.  After all the company was nearly banktrupt once (1987) and survived.  The introduction of the iPhone in 2007 certainly gave Apple another shot of adrenalin.

There’s no evidence to suggest Apple the company is beginning to rot just yet, but AAPL the stock was due to take a bruising.  Can Apple continue to take advantage of its solid franchise indefinitely without Steve Jobs?  Well that’s the billion dollar question isn’t it?

Mal Spooner

 

 

Is it all over for stock market investors? Don’t bet on it!

I’ve been reading lots of articles suggesting that the stock market is ‘overbought’ (an expression meaning that we’re in some sort of a bubble, stocks are overvalued and risk is high that they’ll plummet) but then I’ve been reading the same thing over and over for a few years.  In fact I’ve been hearing the same thing ever since I suggested buying stocks while writing my book (A Maverick Investor’s Guidebook, Insomniac Press) back in 2010.  I’ve been a portfolio manager for a very long time, and find it fascinating that investors – even professional money managers – let their judgement be unduly influenced by their opinions which are biased by experience.  Experience is a funny thing.  For instance, the wife of a good friend of mine went to the trouble of working towards getting her motorcycle license.  Although she passed the test with little difficulty, she hopped on her husband’s bike to go for a ride, lost control and dropped the bike.  She never tried riding a bike ever again because of one bad experience.

Consider this quote from a smart friend of mine:

‘How much has your equity portfolio given on a yearly basis from January 1 , 2007 to today ( 6 years in 3 weeks. By bet is around 2%. You are doing some wishful thinking Mal.  The growth game is over.”

Why did she pick that particular date?  It’s probably not an accident.  Timing is everything when it comes to volatile assets and the stock market is nothing if not volatile.  Randomly chat with folks (like I do) and you’ll find some just can’t believe the stock market has made anyone any money…..EVER!  Talk to someone else and they might tell you they’ve been very happy with their experience.  Have a look at this graph:

If you’d invested your money (starting point) five or six years ago, you’d understandably be disappointed – see the red line.  If you’d decided to include stocks in your financial plan ten years ago (green line), it’s likely you’re satisfied and have no difficulty weathering a temporary storm.  An investor who read my book and put money to work coming out of the financial crisis (orange) will not only be ecstatic, he/she will no doubt have an exaggerated sense of their own investment ‘skills.’

In my estimation (which could be dead wrong) economic growth has only just begun to accelerate and I am not the only soul that believes it.  John Aitkens is an old friend and an excellent investment strategist at TD Securities.  These are his words (and his chart):

We continue to believe that global policy stimulus is driving a re-acceleration of US and global growth that will become increasing evident over the next few months. We therefore continue to recommend an overweight in stocks and an underweight in bonds. We recommend overweighting non-price sensitive cyclical areas (technology, industrials, consumer discretionary), while underweighting defensive sectors (utilities, telecom, consumer staples). We have financials, resources and health care at market weight.

Over many years John and I have been in agreement about the direction of markets…..i.e. he’s usually right.

 

Mal Spooner

Is it the 1950’s again? The financial war is over!

There is a plethora of articles and blogs out there desperately trying to find a period comparable to now, in order to get some understanding of what markets might have in store for us over the next several years.  After three decades in the investment business, the only thing I can say with certainty is that such comparisons just don’t work.

George Santayana (December 16, 1863 – September 26, 1952) the philosopher and man of letters, is often quoted: “Those who cannot learn from history are doomed to repeat it.

It’s true people will make the same mistakes over and again, but history never actually repeats itself.  Trying to forecast the future is absurd, and so it must be even more ridiculous to expect that the future will be similar to some time period long ago.  Nevertheless, it’s winter and all my friends are on vacation so I’ve nothing else to do.

Post-War Reconstruction: In my simple mind, we’ve just fought a global war against financial corruption.  The weapon of mass destruction?  The ‘derivative!’ These things managed to infiltrate the entire global banking system and almost brought it crumbling down.  Like most wars, it’s difficult to put a pin into when things flipped from a crisis to all out war, but let’s say the seeds were planted when the U.S. Senate tried to introduce a bill in 2005 to forbid Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) from holding mortgage-backed securities (pretend capital) in their portfolios. That first cannonball missed the mark when the bill failed to pass.  By 2007 the two government sponsored entities were responsible for 90% of all U.S. mortgages, and the fly in the ointment was the use of ‘derviatives’ instead of real capital to hedge their interest-rate risk.   Banks did the same thing but much more aggressively. What followed is a long story we’ve been living for years.

Paul Volcker once said, “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence.”  Well, we’ve plenty of evidence now that financial innovation led only to the mass destruction of wealth.

When the foundation fell out from under us (value of the derviatives dropped) we went to war in earnest.  The list of casualties like Lehman Brothers Holdings Inc. (announced September 15, 2008 it was bankrupt) just kept getting longer.

I believe the war ended six years after that failed 2005 Senate bill – in the summer of 2011. You can disagree, but your opinion is as meaningless as this whole exercize. (Laughing out loud.)

Way back when World War II (1939 – 1945) ended, governments around the globe began to print money and spend to rebuild the wealth that had been destroyed.  Isn’t this precisely what we’ve been doing since our financial crisis decimated wealth on a global scale?

So maybe some of what happened in the 1950’s post-war period will happen again?

In 1949 there was a brief struggle with the threat of deflation (and again in 1954) but for most of the decade inflation remained steady between 0% to 3%. We too saw the threat of deflation briefly in 2009.  However since then inflation has been fairly steady:  1.5% (December to December) in 2010 and 3.2% in 2011 in the U.S.  Although T-bills are currently paying a negative real rate of return (yields are below the inflation rate) there will come a time soon when investors insist on earning something or they just won’t hold them.  Short term rates will climb as they did throughout the 1950’s.

Prediction #1:  T-Bills will begin to rise until their returns cover the rate of inflation (see chart).

What happened in the stock market back then?  Government spending to rebuild infrastructure and create jobs had a significant impact, because arguably the 1950’s was one of the best if not the best decade for making money in the stock market.  Unfortunately, we only have reliable data for the Dow Jones Industrial Average dating back that far (okay, there might be more data out there but I’m surely not going to go looking for it). 

At the end of 1949 the Dow was at 200.13 and by the end of 1959 it had climbed to 679.36.  Excluding dividends that equates to a (IRR) return of about 13% per year for a decade.  As always lots of volatility had to be endured in stocks, but in the long run the reward was not shabby!  On the other hand, in Treasury bonds you might have averaged a 2% return, but suffered an actual loss in 5 out of the 10 years.

Prediction #2: Global growth fueled by government initiatives will translate into healthy returns on average in stock markets for several years to come.

Are we doomed to repeat history?  Although the 1950’s turned out okay, a wild ride was to come during the following couple of decades.  Easy money and inflation would eventually get the better of us and although there were some very good years for investors in the stock market (and those invested in shorter term T-bills for sure), inflation mayhem was on its way.

All we can hope for is that today’s policy makers have studied their history.  If we allow inflation to get out of control, interest rates will skyrocket like they did through the 60’s and 70’s. Younger folks today will have to suffer rising interest rates (mortgages, car loans) of the sort that created havoc for decision-makers and choked economic growth to a standstill for us older generations back in the day.

It’s true that if we don’t learn from history, we can and will make the same mistakes over again.  But I also said history does not repeat itself.  Although we somehow managed to eventually wrestle the inflation bogieman under control before, this does not mean we will be so lucky next time around.  And it’s a wealthier more technologically advanced world we live in now….which means we’ve so much more to lose if we really screw things up.

Prediction #3:  If governments don’t slow down their spending, bond investors will really get burned.

My instincts tell me that 2013 will be a happy New Year.  And bear in mind that if none, any or all of these predictions come true it will be an unadulterated fluke.

 

 

 

 

Malvin Spooner.

 

 

Sex and the January Effect!

A perplexing phenomenon for money managers and academics alike is the so-called “January effect.”  Also known as the small-cap effect it generally refers to the fact that January tends to be a pretty good month for the stocks of smaller companies.  Despite efforts to come up with an explanation – window dressing by institutional investors, tax-loss selling and so forth – there seems to be no rational reason for the superior performance of these smaller company stocks early in every new year.  Before devling into my own radical theory, is this a real or mythical phenomenon?

Personally, I’ve bet on this phenomenon over many years – loading up the mutual funds I’ve managed with smaller companies during December that I considered inexpensive (their share prices were beaten up for any number of reasons).  The strong January investment performance would often put my portfolio in the top rankings for several months into the new year.  Always good for business.  I’d also encourage clients to buy our specialty fund that concentrated on smaller growth companies in early January, and hold it for a few months to capture the excess return.  It simply worked.

Experiencing or just believing in the effect is one thing, but does the data support the myth?  There are many studies confirming the anomaly.  I found the adjacent chart illustrating that in in January the smallest publicly traded companies indeed do better than the bigger companies.

“From 1926 through 2002, the smallest 10% of all stocks (or “10th decile”) beat the 1st decile stocks by an average of 9.35 percentage points in the month of January.”

Despite repeated efforts to explain why there is a January Effect, everyone agrees that it still remains pretty much a mystery.  Academics refer to such patterns as ‘anomalies.’  My own belief is that there are many instances when statistical observations are better explained by human behavior rather than analytics.

Ever notice that most babies are born in August and September?  Biologically speaking, this would suggest that our species do tend to act somewhat differently nine months prior to these births every year.  During the festive season there’s a whole lot of warm and fuzzy feelings that seem to influence our behavior.  In some cultures there’s a surge in indulgences – food and wine for instance – and for a brief couple of months stress and fear are reduced signficantly.  How do we respond?

Clearly we are inclined to be more intimate.  Couples (if you’ve been married for awhile you’ll understand this) successfully avoid romantic activity for most of the year; bored with their partners or simply turned off by their annoying habits and personality flaws.  Suddenly during the holidays we set aside our grievances and become more tolerant. Those quirks might even seem endearing for a brief period.  Perhaps in the northern hemisphere humans are genetically engineered to seek warmth and comfort during the colder winter months?

 Consider these cold hard facts:

  • We are more than willing to be intimate (hence the birthrate 9 months later) despite the risks – being asked to do more chores and the inevitable burden of an increased level of conversation.
  • During these months we spend recklessly on family and friends who don’t need the consumer items and in some cases don’t deserve them.
  • People drink more alcohol than they should and eat food that is bad for them.

Why wouldn’t the perennial change in our emotional makeup also have an impact on our investment decisions?  My theory is that once a year risk aversion takes a brief backseat in our psyche – and while our hearts and wallets are open why not take some free-spirited risk in the stock market?  Collectively hoping for a big score in those smaller company stocks that occasionally pay big, we all dive in together and cause their prices to rise.

The evidence of humanity’s willingness to take on more risk in the bedroom during the holidays becomes evident nine months later.  And it should come as no surprise that the financial consequences of investment decisions made in a fit of euphoria during the holiday season also show up by September of most every year also.  September is pretty much always the worst month for those stocks bought earlier in the year – small and large companies alike.

I certainly hope you had a good laugh reading my theory explaining the mysterious January effect.  In my opinion it is certainly as good as the explanations you’ll read in the media.  Truth is there is much we’ll never understand about so-called ‘anomalies’ whether they occur in financial markets or in human behavior.  Simply knowing they do occur however can be a powerful tool when making one’s own investment decisions.  Come to think about it, just knowing about some behavioral anomalies might also help when it comes to family planning.

Best wishes to you for a Happy Holiday!

Malvin Spooner.

 

 

Banks own the investment industry! A good thing?

Let’s face it!  In the battle for investment dollars the Canadian banks are clearly the winners!  Is this a good thing?

Once upon a time, the investment business was more of a cottage industry.  Portfolio manager and investment broker were ‘professions’ rather than jobs.  Smaller independent firms specialized in looking after their clients’ savings.  There were no investment ‘products.’  The landscape began to change dramatically – in 1988 RBC bought Dominion Securities, CIBC bought Wood Gundy and so on – when the banks decided to diversify away from lending and began their move into investment banking, wealth management and mutual funds.

Take mutual funds for example.  Over the past few decades Canadian banks have continued to grow their share of total mutual fund sales* – this should not surprising since by acquisition and organic growth in their wealth management divisions they now own the lion’s share of the distribution networks (bank branches, brokerage firms, online trading).

An added strategic advantage most recently has been the capability of the banks to successfully market fixed income funds since the financial crisis. Risk averse investors want to preserve their capital and have embraced bond and money market funds as well as balanced funds while eschewing equity funds altogether. With waning fund flows into stock markets, how can equity valuations rise?  It’s a self-fulfilling prophecy.

Many of the independent fund companies, born decades ago during times when bonds performed badly (inflation, rising interest rates) and stocks were the flavor of the day, continue to focus on their superior equity management expertise.  Unfortunately for the past few years they are marketing that capability to a disinterested investing public.

The loss in market share* of the independent fund companies to the banks continues unabated. Regulatory trends also make it increasingly difficult for the independent fund companies to compete.  Distribution networks nowadays (brokers, financial planners) require a huge and costly infrastructure to meet compliance rules.  Perhaps I’m oversimplifying, but once a financial institution has invested huge money in such a platform does it make sense to then encourage its investment advisers and planners to use third party funds?  Not really! Why not insist either explicitly (approved lists) or implicitly (higher commissions or other incentives) that the bank’s own funds be used?

Stricter compliance has made it extremely difficult for investment advisers to do what they used to do, i.e. pick individual stocks and bonds.  In Canada, regulators have made putting clients into mutual funds more of a burden in recent years.

To a significant degree, mutual fund regulations have contributed to the rapid growth of ETF’s (Exchange-Traded Funds).    An adviser will be confronted by a mountain of paperwork if he recommends a stock – suitability, risk, know-your-client rules) or even a mutual fund.  An ETF is less risky than a stock, and can be purchased and sold more readily in client accounts by trading them in the stock markets.  Independent fund companies that introduced the first ETF’s did well enough for a time but not surprisingly the banks are quickly responding by introducing their own exchange-traded funds.  For example:

TORONTO, ONTARIO–(Marketwire – Nov. 20, 2012) – BMO Asset Management Inc. (BMO AM) today introduced four new funds to its Exchange Traded Fund (ETF)* product suite.

In fact, the new ETF’s launched by Bank of Montreal grew 48.3% in 2011.  When it comes to the investment fund industry, go big or go home!  You’d think that Claymore Investment’s ETF’s would have it made with over $6 Billion in assets under management (AUM) but alas the company was recently bought by Blackrock, the largest money manager in the world with $29 Billion under management.  It will be interesting to see if the likes of Blackrock will have staying power in Canada against the banks.  After all RBC has total bank assets twenty-five times that figure.  Survival in the business of investment funds, and perhaps wealth management in general depends on the beneficence of the Big Five.

Admittedly, the foray of insurance companies  into the investment industry has been aggressive and successful for the most part.  With distribution capability and scale they certainly can compete, but the banks have a huge head start.  Most insurance companies are only beginning to build out their wealth management divisions.  I can see a logical fit between insurance and investments from a financial planning perspective, but then the banks know this and have already begun to encroach on the insurance side of the equation.  Nevertheless I would not discount the ability of the insurance companies to capture signficant market share.

So, is it a good thing that larger financial institutions own the investment industry?  Consider the world of medicine.  No doubt a seasoned general practitioner will feel nostalgic for days gone by when patients viewed them as experts and trusted their every judgement.  The owner of the corner hardware store no doubt holds fond memories of those days before the coming of Home Depot.  Part of me wants to believe that investors were better served before the banks stampeded into the industry but I’d just be fooling myself.  Although consolidation has resulted in fewer but more powerful industry leaders, the truth is that never before have investors had so wide an array of choices.  Hospitals today are filled with medical specialists, while banks and insurance companies too are bursting at the seams with financial specialists.

It is not fun becoming a dinosaur, but this general practitioner has to admit progress is unstoppable.

Malvin Spooner

 

 

 

 

 

 

 

 

*The industry charts are courtesy of the third quarter Scotiabank research report Mutual Fund Review.  The annotations are my own.