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moneysense.ca, 6/05/08
Are you comfortable with your portfolio?
Stocks have staged a significant recovery after falling sharply in the first quarter of 2008. The TSX Composite is up about 19% from its low in January and the S&P 500 is up about 11% from its mid-March swoon. If the lows reached in the first quarter was indeed the market bottom, we can classify the plunge as a severe correction – the TSX was down 18% from its 52-week high and the S&P 500 tiptoed into bear market territory when it was down 20.25% briefly. During the market storm, diversification within stocks wouldn’t have helped; cash and government bonds provided the only refuge.
While the reasonable course of action when markets are correcting is not panicking and staying the course, now may be the time to revisit your asset allocation in light of your reaction to falling stock prices. At times of market turmoil three options are available: (a) sell enough to reach your comfort level (b) stay the course or (c) scrounge every nickel you can find and invest it in stocks. If your inclination was to sell some stocks, your risk tolerance may be less than you originally believed and you may want to increase your allocation to bonds and cash (Now may not be the ideal time to buy bonds either as Government of Canada 5-year bonds are barely yielding 3%).
moneysense.ca, 6/05/08
Unfortunately, I cannot recall the name of the investment professional I watched on BNN who said that earning 3% on a GIC can beat the heck out of losing 20% on a poor performing stock. If I were to take a guess, I think it might have been Peter Brieger who said that on television.
I personally still think there is a lot of pain and misery to come, but obviously the market disagrees with me as the index has bounced back on strong commodity prices. But that’s what makes a market – differing opinions on where everything is headed. I haven’t sold off any of my existing equities just in case I’m totally wrong. But all of my new money is going into temporary holding tanks known as investment savings accounts and GICs, waiting for “the big one”. I am expecting all of the TV personalities to be wrong and the US recession to be much worse than they all think it is going to be and Canada’s economy will be dragged through the mud as the USA is still our biggest trading partner, consuming over 75% of our exports since I last saw the statistic, which was over a year ago.
And things may go from bad to worse for Canada if any of the rhetoric from the politicians down there prove accurate and they want to re-negotiate NAFTA. Either way, the USA seems to be going protectionist.
I think we’re getting a mixed picture. On the one hand, the financial markets seems to be relatively immune from shocking new write downs by banks. Barring a massive increase in foreclosures, I think the risks associated with the housing crisis have been mostly priced into the market. American housing prices will stay stagnant until the supply of foreclosed properties and inventory clears up. As for the liquidity crisis, I think the pain will be prolonged. Many banks have weak capital positions caused in part by sub-prime-related writeoffs. For the near future, I expect the banks to continue to be cautious, which doesn’t bode well for credit growth or economic growth.
I could well be wrong (my view may be too optimistic), but I think the US is in for a year or two of sluggish but not necessarily negative real economic growth. Without increases in real wages or asset prices to drive consumer spending growth, and business profits damped by high input prices, the only bright spot I can envisage will be the US export sector, which benefits from a weak US dollar. America’s current account deficit has narrowed with the decline in the dollar’s fortunes, but it is still massive.
CC, I think you missed a option in the list of coping mechanisms. Investors could have “bought insurance” or hedged a certain amount of exposure in their portfolio by going long on short ETFs like DOG or SDS, although that is almost like option (a).
The problem with option (a) in practice is that many people have a fluctuating comfort level. They are comfortable with a high stock allocation after a long period of price increases, and they are comfortable with a low stock allocation after a big drop in stock prices. This is a formula for poor long term performance.
I’m in the (c) camp. But, because I had so little available cash that I wouldn’t be needing within the next few years, my actions were mostly consistent with a (b) philosophy.
Michael: I agree that it is not advisable to pick (a) in the face of falling prices. But if the inclination was to pick (a), perhaps risk tolerance isn’t as high as originally estimated in a cool, logical state of mind and it might make sense to revisit the asset allocation policy now that stocks have recovered nicely.
I fell in the (c) camp. I kept buying VTI, VEA, a couple of Canadian stocks and REITs through the correction.
Robillard: You’re right that the option to “insure” the portfolio is available and should have been listed. But investors on average are notoriously bad at timing markets, so (a) and the “portfolio insurance” option should preferably be avoided when markets are tanking.
I decided to stay the course throughout, though I wish I could have scrounged up some more cash for option C. What little I did I reinvested into my US and international index funds / ETF’s and a REIT ETF. I’m still not sure if it is all over yet, but on the other hand I wasn’t able to tell where the top was last year! Hindsight is truly 20/20 when it comes to the markets. This proves overall it is good to index and go long. My portfolio is almost back to where it was before all this happened.
I stayed the course and I am happy I did. Within my mutual fund package I can exchange funds without cost so I rebalance my portfolio every month. That meant that I was selling bonds to buy stocks for a few months (option c, to a small degree) but happily sold some of those stocks to buy bonds again at the beginning of this month when my analysis showed me it was time.
I have a spread sheet set up for analysis that is linked to my spreadsheet on my holdings, so it is simple for me to see what is needed to do the balancing. It works nicely and doesn’t take long, even on a monthly basis.
Oh, was there a correction?
My investments are in it for the long haul (retirement) so I don’t pay attention to what the market is doing, although I do read the news so it’s kind of hard to stay oblivious. My RRSP portfolio is 100% stocks (two index funds); I do have a more diversified retirement portfolio with Vanguard in the US from the years I lived there, but even that is currently 70 percent stocks. And I never touch it.
But I’m 49. Ask me again in 10 years and the story will be quite different.
“I personally still think there is a lot of pain and misery to come, but obviously the market disagrees with me as the index has bounced back on strong commodity prices. But that’s what makes a market – differing opinions on where everything is headed. I haven’t sold off any of my existing equities just in case I’m totally wrong. But all of my new money is going into temporary holding tanks known as investment savings accounts and GICs, waiting for “the big one”. I am expecting all of the TV personalities to be wrong and the US recession to be much worse than they all think it is going to be and Canada’s economy will be dragged through the mud as the USA is still our biggest trading partner, consuming over 75% of our exports since I last saw the statistic, which was over a year ago.”
I’m doing the same thing. I try to follow Warren Buffett’s advice to be fearful when others are greedy, and greedy when others are fearful. Even though the market dipped a little, I never saw much fear. Everyone seems to have the attitude of “I’m glad the bear market is over, now we can get back to constant growth.” I don’t think a lot of investors even know what a real bear market is.
I thought a lot of stocks were overvalued even during the dip, and I certainly think that now. The fallout in the bond market is far from played out. There’s a lot of bad debt out there that has yet to be marked to market, propping up balance sheets with made up numbers. When it gets written down banks and hedge funds will implode. I won’t be at all surprised if one of the major bond insurers in the US goes belly up. Then I expect investors to be fearful.
Aleks, Phil: I guess you’re in good company because Buffett reckons the pain ain’t over yet either. For me, I’m never any good at figuring out these things, so I look at valuation and if it looks reasonable, I keep investing. If I get a 10% sale, I buy a little bit more. I thought there was plenty of nervousness in the first quarter – if the front page of the newspaper says stocks are plunging, I figure it is time to go shopping. Of course, stocks might keep falling but it’s hard to get the timing exactly right.
I think there’s a huge wallop still to come. The whole world is in a stand-still until the U.S. election is decided. Afterwards, some of these measures to try to prop up the economy will not be used as often. The Feds are really doing the government’s job right now to prop up the economy and not defend the currency.
Hmmm, even assuming the worst of the credit/liquidity mess has yet to be felt, where is a safe place to put money? Cash might be but what about inflation? Remember the 1970s when a spike in oil prices caused rampant inflation? After a few years of 10% inflation, your cash is worth much less. And the signs of inflation are starting to show in parts of the world e.g. food price riots. Same inflation problem with bonds. Real return bonds do keep pace with inflation but yield almost nothing before taxes even. Gold? Maybe. Stocks, short-term hit, perhaps drastic, but then companies can recover eventually by raising prices. Oh well, back to the diversified portfolio.
Overall, I’m just staying the course. I have my bi-weekly deposits going in exactly the same percentages as ever. The only thing I’ve done based on my feeling that the worst is yet to come is to put off rebalancing, allowing my portfolio to get bond-heavy, and to put the extra $1000 deposit RRSP I made in January entirely into bonds. I haven’t sold any equities.
All my investments are in PHN funds. If I were buying individual stocks, then earlier in the year might have been the time to buy CIBC or BMO. However, PHN did that for me.
To Canadian Investor. Although I am currently putting all of my new cash into high interest savings accounts and GICs, it’s not going to sit there until retirement. It will only sit there collecting 3% until I find a good time to deploy the money back into stocks or REITs or long bonds or whatever. I just find most of everything to be overvalued when looking at forward earnings, if we assume an impending deep US recession.
If you use trailing earnings, then I agree with CC, that the valuations look OK right now. But if you think earnings are heading south in the future (forward earnings), then I would suggest that may not be the case. If however, the stock price falls below what I think would be the forward earnings, then the valuations would look much better.
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Like many I’ve accumulated substantial core holdings that I don’t like to market-time, but have a more speculative “trading” account. This year for the first time I’ve bought some of the new “double-short” index instruments, by Canadian Horizonbs BetaPro and U$ SKF (financial), SDS (S&P500), and FXP (China) which are offsetting the dips in core indexes. These new double-long and double-short investments are the most interesting thing I’ve seen in years, but I’d give an Academy Award for a really thoughtful and useful discussion of what a retail investor could or should do with them. Unlike options, there’s a fixed downside risk (the number of shares at the price you buy) and the 2X leverage makes them work at a discount to the cost of the index. I don’t think, with due respect to CC, that it’s enough to say “trim the sails” on your long positions when there’s good reason to worry about the markets and these things are available. Best for Mother’s Day in the meantime.
I’ve just begun blogging and I started by reviewing each chapter of Benjamin Graham’s The Intelligent Investor. I found a lot of the same themes in this post as in The Intelligent Investor and used it to illustrate Graham’s lessons. Anyways, great article!
My post: http://frankvoisin.blogspot.com/2008/05/are-you-comfortable-with-your-portfolio.html
Comments appreciated
– Frank
I’ve got a question about asset allocation…For the foreign content part of your portfolio, say 25% exposure to the US. What is the driving force there: should it be 25% in stocks of companies that are listed on US exchanges? 25% in stocks of companies that do the majority of their business in the US (which could include canadian and int’l companies now)? I’m sure we can all find US-listed stocks that do over 90% of their business outside the country. And vice versa for stocks that are listed in Canada, but essentially do all their business abroad. What about companies that are listed on US exchanges but HQ’d somewhere else (like Bermuda for tax reasons)? Shouldn’t an exposure of 25% US also be an exposure to the complete tax system?
What about currency, seems to me if you’re supposed to have 25% exposure to the US that should include their currency as well. Of course the last year or two you would have suffered on the f/x rate, but I suspect over a long enough timeline (the timeline you should be focussing on for investments), it’s all a wash.
Or is this getting too much in to semantics?
noblelea: I keep the foreign equity portion quite simple: I just allocate it based on the rough weightings in world stock market capitalization ex-Canada in just three ETFs: VTI, VEA and VWO. I don’t have any exposure to VWO at present but it will get cheap at some point and I’ll load up to my 5% weighting at that time.
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