If the first few trading days of 2008 are any indication of the year to come in the markets, then volatility may well be one of the main focuses for many investors. As a long-term investor volatility holds the potential to create opportunities that are difficult to pass up. If you’re an investor who understands market cycles and the pressures currently being expressed on your portfolio in the short-term economic climate, you may still want to protect a portion of your capital against erosion regardless of what pain you can endure.
Although my outlook is long-term (25-30yrs), I don’t necessarily jump into the water feet first without scanning the surface for what might be lurking beneath. I spent a good portion of December reflecting on the market and my portfolios in an attempt to gauge what strategies or focus I wanted to take heading into 2008. Although my main objectives will continue to remain the same, this year will likely provide challenges just as the previous years have in different capacities. Self-reflection, just as in my nursing practice, becomes a very important tool in performing a SWOT on yourself.
One focus I’ve adopted in the past few weeks (due to so much M&A activity in the portfolio this year) is to concentrate on minimizing portfolio turnover. Although one of my Value Rules focuses on stocks as potential takeover targets; at key points this year I was turning over ~15% of the portfolio in only a few short weeks due to opportunities I perceived while sitting at approximately 20% cash. Regardless of any short-term success, I found that I wanted more stable, long-term appreciating investments rather than so many short-term moderate positions. This not only will help minimize trading costs, but provide more stable appreciation of the portfolio than swings in one direction or the next depending on what I’m taking positions in.
With so much volatility of late it’s often hard for investors to resist the temptation of jumping into opportunities on cheap stocks. But simply because a stock is X% off its 52-week high doesn’t necessarily create value in a company. Whether you evaluate a company on dividend yield, price to earnings ratio or anything other metric; the fundamentals of the company should be your focus for evaluating what value the business is truly worth. If banks in your analysis are trading cheap relative to the market or historical trends then buying them shouldn’t cause you any cognitive dissonance later down the road. Investors in the market today should be very keen on not becoming victims of the dreaded Value Trap. I define these as when investors select a stock due to its current cheap value when compared to its value historically, but when unforeseen fundamental risks are imbedded in the company. Someone might ask how an investor can know they’re walking into a value trap IF the risks are unforeseen or hidden, but there are tactics you can use to determine what might be lurking beneath the surface.
Lessons learnt from my own experiences:
As with my prediction on BMO earlier in the year – Brand protection can often help an investor to predict future events based largely on when a company initiates damage control. The difference between brand protection & advertising can be difficult to differentiate, but often you’ll see key business leaders in the public eye or behind closed doors walking the walk after they talk the talk. Other activities can include inside ownership activity regarding share purchases (buying or selling), selling core assets at below-market prices (fire-sale), high payout ratios on dividends (at risk) or a company share buyback programs being cancelled when the stock price is obviously discounted heavily..
Ever considered a switch to actively managed funds? An investor might ask why go to all the work and effort of a Do-It-Yourself investor only to seek active management anyways, but that’s not exactly what I was alluding to. When markets go sideways or down for a period of time people have to put their money somewhere. We’re not likely to hide it all under the mattress and the truth is that many investors don’t want to worry about asset allocation, diversification or where to put their money – that’s why they pay for active management; let someone else do it for you. At this time of year mutual fund companies blitz potential customers with advertisements everywhere for RRSP season in the hopes of attracting more business. A DIY investor most likely knows that these companies often charge high MER’s, front/back end fees or other trailers as sources of commission but the majority of uninformed investors don’t. They take the advice that computer software generates for them with their advisors or invest in over-diversified funds and invest accordingly. In both the ups and downs in the markets these fund companies always collect their fees regardless of overall performance. Redemptions may fluctuate over periods of time, but revenue from fees will continue to remain strong. Why else would so many people try to attract naïve investors so feverishly? Instead of ignoring active management all together: own it. Companies such as MFC, IGM, GWO, SLF, AGF and the large Canadian banks all have exposure in some part to this segment of investors and pay attractive dividends that are often grown on an annual basis.
Over the past few weeks I’ve had conversations on investing with all sorts of individuals in my travels during the holidays to see family and friends. I’ve heard claims ranging from extremes of a twelve year commodity bull market to plummeting nickel prices and gold at $1200/ounce due to exploding inflation. For some time now I’ve completely ignored specific commodity prices in a broader attempt to look at the whole picture. In a past post I provided links to comments on my decision to play the commodity cycle through transportation stocks. My reasoning has been that massive amounts of these raw materials are needed for infrastructure in developing countries and unlike in Star Trek we can’t simply use transporters to dematerialize & rematerialize objects across vast distances. Unless you can carry 2 tonnes of metal ore on your back 3500km; air, road, rail & sea are the only means to move things from point A to B economically. To my knowledge the new Airbus A380 is not nearly big enough for this feat. Trucks can only pull so much weight safely on our roads and trains don’t run too well underwater. That leaves ships to haul materials over long distances at cost efficient prices. The problem is that for the amount of material to be moved into India, China & elsewhere there aren’t nearly enough ships and they can’t be built on an assembly line like cars or trucks. It comes down to supply vs. demand. For 2008, possibly forget specific commodity prices because the easiest money has likely already been made and focus on an alternate strategy.