Monday, August 25th, 2008
A concept that I’ve explored lately in this recent volatile market is reversion to the mean, which suggests that prices have a tendency of eventually moving back towards their long-term historic averages.
A good example of this could be the price of oil. After rising 47% in the first half 2008 and hitting a record high of $147 per barrel on July 11, the price of oil has dropped more than 20% in less than eight weeks as supply-demand dynamics adjusted (Not including the speculative bounce last week). Albeit $120 oil can still be considered high by historical standards, the point is that dramatic increases over short periods of time represent imbalances that are likely to self-correct.
Using The Reversion Theory In Your Portfolio
Within the context of recent history, many people might associate reversion with a downward movement so the first thing that comes to mind is something that’s overpriced. However, if we turn this concept over in order to highlight value as well. For example, while oil has soared to new heights, at the other end of the spectrum global equities have been punished and U.S. stocks in particular have struggled amid the credit crunch and a deteriorating economic backdrop.
Over the last 12 months, the return on the S&P 500 Index has been about -11%. Consider however that the average annual return on U.S equities over the past 25 years is 11.4%. On this basis, investors (especially those sitting on the sidelines in cash) might want to ask themselves whether they think stock prices in the world’s largest and most diverse economy will stay at current levels indefinitely, or whether it’s more reasonable to think that at some point, they’ll revert to more historically normal levels.
Analysts spend many hours and a boat-load of money determining what they perceive as fair value for equity markets. Their valuation models incorporate long run averages for inflation, interest rates and growth and based on current levels for these factors, U.S. equities appear to be trading below fair value. Another way to interpret the reversion theory essentially is a version of the “stocks on sale” message.
Reverting To Positive Returns
If U.S. equities are trading below where they should be based on historic averages for similar environments, then it follows that at some point, they should move back towards fair value, meaning stock prices should eventually rise.
Now, I am NOT forecasting what the price of oil will be or where U.S. stocks will be trading six months from now or when reversion will happen – I’ll leave that to the “experts” . The message to take from this is that amid 200 point swings in the stock market or $10 spikes in oil prices, it’s prudent to think about where prices are in relation to historic long run averages.
In a volatile market it becomes very difficult to predict which individual stocks are going to be most successful. However, buying a broad index such as the S&P 500 will offer significant exposure to a US equity market that has become oversold and is valued at well below historical averages. Not to mention that the S&P 500 has a dividend growth rate of about 11%. So, buying this index offers you an average of 11% raise each year while we wait for valuations to return to the mean.
Posted in Investor Education | 5 Comments »
Thursday, August 21st, 2008
There’s really nothing like a poor economy and a tumbling stock market to send people’s financial plans into a tizzy! So, where can we look for guidance and assistance in these troubled financial times?
Some “experts” are now saying that this is the time to buckle down on spending with rising energy and food prices. Wow, I guess that “late breaking news” really caught us off guard – good thing there are financial experts out there to save us from this financial apocalypse.
Let’s see what the experts have to say:
The Canadian Government
Statistics Canada says gas and food prices are eating up a larger portion of our spending money, while CIBC reports household debt in Canada is rising faster than personal disposable income.
You don’t say? I guess nobody saw that one coming!
A “Smart” Canadian – The Usual Suspects
“It takes a rough patch in the economy like this for people to take a look and see where they can save money,” says Pat Foran, author of the Smart Canadian’s Guide to Building Wealth.
I’m pretty sure that this is what everyone should constantly be doing to build wealth. Always look for ways to cut spending and use that extra cash to increase your asset base.
- Foran recommends reviewing everything from your cable and cell phone bills to seeing where you can trim costs, going to the library instead of buying books, and renting movies instead of going to the theatre.
- Bringing your lunch to work a few times a week also saves money, as does cutting back on daily trips to the coffee shop for a java jolt.
- An economic slowdown is also a good excuse to cut expensive bad habits, such as smoking or overdrinking, Foran says.
- On big ticket items, he says consumers should consider used cars instead of new and putting off that vacation to Mexico when a trip closer to home might suffice.
For many families, Foran says budgets don’t work and instead recommends “forced savings,” which means setting aside a certain amount of money from each paycheque for investment.
Could Foran be any more vague? I guess we have to buy the book – good marketing strategy!
Go On A Money Diet
Patricia Lovett-Reid, author and senior vice-president at TD Waterhouse, recommends cutting back spending as if you were cutting back on calories for a diet.
Because we all know how easy it is to stick to a diet!
“There is some mindless spending going on,” she says.
“Look for ways to cut back so you don’t feel like you are on a budget.”
Hmmm…any ideas?
Another tip she has is to avoid shopping in bulk because the mass quantities that are purchased are sometimes not used and are discarded or wasted.
“If you look at what you throw out, you aren’t really further ahead … it might be better to purchase in smaller quantities.”
She also says that being an early adopter of technology is very expensive. I can concur with this as many folks purchase more computer than they need (you don’t need a $3000.00 computer to surf th enet and write e-mails) and don’t even know about half of the features of the new iPhone, for instance.
Review Your Debt
Many experts recommend refinancing your mortgage and consolidating high-interest debt through a line of credit where possible.
This makes sense if you have credit card or other high interest consumer debt.
“If you refinance and get a new mortgage you pay principle and interest on the entire amount from day one … . However, if the purpose of your refinance is to consolidate but not use all of the money at once, then set up a line of credit. You only pay interest on the amount you borrow at the time you use it,” says mortgage expert Peter Kinch.
However, he says be wary of how you used that line of credit.
“We want to make sure people don’t get into the habit of using their house as an ATM machine,” Kinch says.
Very thoughtful for a guy who just “sold” you a line of credit. Too bad this advice comes a little too late for some. For the sake of disclosure, I have a home equity line of credit that I use for investment opportunities.
What I Don’t Get
There are two major things that stick out to me in all of these expert articles and financial media mumbo jumbo.
Nobody suggests paying down debt. Everyone talks about consolidating debt and lowering interest rates, but nobody actually says (or writes) that you should pay that debt down. This is absolute craziness. In an economy like we are facing today, it should make absolute sense that people should be reducing their total debt. I recently outlined how reducing debt provides a guaranteed return on investment that is virtually unmatched.
What about the stock market? When the stock market is high all of the experts are telling us to buy stocks and that stocks are a great investment, but when the stock prices of those “great companies” are 20% lower, all of a sudden investing in the stock market is “risky” and not at all a good idea. This is absolutely counterintuitive to the basic investing tenet of buy low – sell high! In fact, one could argue that investing in the stock market now is less risky because prices are lower.
I am not claiming to be a financial expert, but the more I read the news media, the more disappointed I become. Basic financial advice changes from day to day and even the simple tenets of investing and finance are twisted or even discarded for the sake of selling a few magazines or newspapers.
At the risk of making it too simple, here are some ideas for building wealth:
- Live within your means
- Reduce personal debt
- Buy assets (Stocks, Bonds, Real Estate, Precious Metals)
Of course each of these points can be fleshed out and much more detail can be added to each point. However, I find that when the articles from the “experts” start getting in my head and causing doubt, I look back to these guiding principles for direction.
Do you ever get distracted by the media? If so, what are your strategies for dealing with the constant barrage of information?
Posted in Investment News | 4 Comments »
Thursday, July 17th, 2008
While I am convinced that some (read: very few) people in the world have the ability to time the market, you and I are not them. That is not meant to be an insult to you, but if you could successfully time the market then you certainly wouldn’t be reading this article.
The Market Moves Mysteriously
Yesterday the American stock market had one of the best days in recent memory. The returns of the major indexes were as follows:
- Nasdaq – 3.12%
- Dow – 2.52%
- S&P 500 – 2.51%
Why do I tell you this today?
You see, yesterday was a great day to be invested in the stock market. However, you would not have known it if you had been listening to the so called “experts”.
Here are some of the morning headlines from major investment news sources:
(Heresy is a dislocation of some complete and self-supporting system of belief)
Fed Worried About Rising Inflation at June Meeting – CNBC
Unemployment rise at 16-year high – Financial Times
Dollar Declines Against Yen as US Banks May Report Losses – Bloomberg
Fed Chief Gives Gloomier Outlook On US Economy – CNBC
Inflation Data Tame Stock Futures – Investors Business Daily
Recession Under Way? – Morningstar
Seeing Bad Loans, Investors Flee From Bank Shares – New York Times
Is Your Cash Safe at the Bank? – TheStreet.com
What Does This Mean?
No, I am not saying that just because I said to stay the course and keep investing in equities yesterday that I am any better at predicting the future than the authors mentioned above. Heck, for all I know the market could lose yesterday’s gains and then some in today’s session!
What I do know, however, is that being a long-term investor is a better option for me than being a short-term trader.
What I am also suggesting is that we have to develop our own investment plans that work for us and stick with the plan. We can’t be bothered by the hype in raging bull markets, nor the doom and gloom sentiment in bear markets. I know as well as you that what I propose is easier said than done, but it is for our own financial well being that we develop an investment plan that makes sense to us and stick to it. Once we start straying from what we know, we are more likely to get burned.
Remember, the above authors get paid to sell papers not to invest your money! Those headlines make them money, but you don’t have to let them lose your money.
Just think about it.
Posted in Investment News | No Comments »
Monday, June 9th, 2008
A recent article in The Globe and Mail has me slightly concerned about the financial well-being of our baby boomer generation. It appears that there has been a trend of late (from 2001-2006) according to census data that shows baby boomers assuming more debt.
Why This Concerns Me
At a time when many folks should be enjoying life and harvesting the fruits of their labor, they have assumed more debt. Why are taking on more debt?
It appears that many are completing renovations to their homes, and that is not all bad. If the repairs are needed to sustain the home for the rest of their days, like new windows, shingles, furnace etc. then so be it. However, taking out a second mortgage to add a sunroom or additional living space does not make sense for the majority of empty-nesters.
Even worse, some are taking out a second mortgage to buy depreciating assets like vehicles and may find themselves on the car loan treadmill for the rest of their lives if they are not careful.
Why This Is Smart
Taking out a second mortgage is smart if you are not planning on retiring until the mortgage is paid off because mortgages are the cheapest source of capital (next to student loans). There is no sense paying more interest that you have to, which is why I have a large line of credit on my home. The line of credit on my home is currently at 4.75% and is interest only. This works great for acting fast on “no-brainer” investing opportunities.
Another reason that this data might not represent a clear picture of a trend is that it is not indexed to life expectancy rates. You see, people of a certain age, even 10 years ago, had a much lower life expectancy that baby boomers do today. Not only that, their health and quality of life is much better than previous generations. What this means is that they may be working later in life and they expect to live a healthier and longer life being more active. All in all, today’s baby boomers may not be in as much trouble as this data may lead us to believe.
My Take
While I certainly don’t plan on having to use the equity in my home when I am in my 60′s (at least for anything other than investing), I suppose we never know what circumstances might present themselves in the future.
I am a relatively conservative individual by nature and I don’t really like to own “stuff” just for the sake of having something, so I can’t see myself wanting to increase my standard of living if I don’t have the additional income stream to provide it.
Have the baby boomers finally fallen victim to the consumer driven marketing ploys that have been so effective at convincing those of us in our twenties and thirties that we must keep up with the Jonses?
What do you think?
Posted in Investment News | 1 Comment »
