Why I'm not worried

OK. Calm down. Breathe. You're going to get through this.

I'm not going to lie to you, it's not pretty. The TSX has been a ski-slope downwards all year, and all of 2007's gains have been wiped out in the first three weeks of 2008.  And today's 600-point loss is just the cherry on top -- although I suspect there's more to come.

If you're new to this game, you're probably cursing your rotten luck for jumping in at the worst possible time, or worse, blaming yourself and thinking you're the only dummy managing to lose money on the stock market. You're not -- we're all in this together.  And I promise you, there's a way out.  

The old me would have been right there with you. Whining, and wincing, and screaming about the injustice of being cheated out of money for doing the right thing and investing even while everyone else my age is blowing their cash on vacations, cars, and consumer debt.

But that's not me anymore. There's a new sheriff in town, and his hand is calm and steady when he's staring down the bad guys. I'm not worried. For a few simple reasons.

Thanks to the pruning I've done in recent weeks and months, when I look at my battered portfolio today, there isn't a single name that I don't think has the ability to weather this storm and be a thriving, growing business several years down the line. Not next week, or next month. But down the line. And I'm likewise sure that those beleaguered stock prices are one day going to be worth much more than they are today -- not to mention much more than what I paid for them -- at some point in the mid to distant future. Gone are the penny stocks, the poor-quality income trusts, and of course, the Biovails (down another 5% since I sold, not that I'm keeping track or anything  :)  ) that ordinarily made me worry because they were speculative flyers I bought out of greed. I'm down to the bedrock I'm building my future on.

I'm looking at the banks, large-cap ETFs, asset managers, REITs and of course, failed textile manufacturers that populate my portfolio and I like what I see. I don't necessarily like the numbers next to them at the moment, but I'm sure these are the companies I want to own for the long-term. That's how I'll sleep tonight.

Will you?

Going against the flow

Considering their impressive track record as profit-making, dividend-paying machines, it's rare to hear people bearish on Canadian bank stocks (especially during the multi-year run they've been on of late) but there's an interesting contrarian view in the Toronto Star this week.

Consider that shares in all five major Canadian banks are worth less today than they were at the start of the year -- some by double-digits. When was the last time we were able to say that?

An eye-opening excerpt from the selected article:

David Tiley, who works with a team of value seekers at Mackenzie Cundill Investment Management in Vancouver, said this week “we don’t own Canadian banks, and have not for a couple of years.” “It’s related first and foremost to valuation,” said Tiley. “Earnings are closer to a peak than a trough, so you are taking a risk.

I always like analysis that throws "conventional wisdom" out the window. Food for thought.

(DISCLOSURE: I own shares of BMO)

The bear [market] necessities

Need a little context for the stock market carnage we've been living through for the last little while?

The money I set aside every month from every paycheque hasn't even come close to offsetting the losses I've undergone in my portfolio. It's gotten so bad that my net worth actually dropped this month for the first time since I started keeping track of it. My non-registered account has taken such a beating that it's on the cusp of going below the threshold value where I don't have to pay any administrative fees. I might have to put some cash into it just to keep it over...

When Finance Minister Jim Flaherty dropped his nuclear bomb on trusts back in October, conventional wisdom had it that income-hungry investors would flock to dividend equities, but would have a hard time getting the yields they were used to. That appears to be changing as there are now plenty of TSX companies yielding more than 5% after the recent sell-off (RUS and ROC to name but two off the top of my head.) Most astonishingly of all? Biovail is now yielding more than 8%. (Full disclosure -- I own Biovail)

So what does it all mean? From where I sit it's looking like bad companies are getting knocked back to where they belong, and good companies are on sale. The one sector I currently don't have any exposure to and am champing at the bit to get into is emerging markets, but I'm still not prepared to jump in at these prices. Definitely on the watch list, though. Two stocks I am contemplating getting into are increasing my stake in BMO, and taking a position in Brookfield. I really like what they're doing in infrastructure and the company's management overall.

What about you? What's in your shopping cart at the moment? You're not being a bad little investor and heading for the hills, are you? Are you afraid of a little old bear?

Hooray! It's a bear market!

Well, OK. Maybe not.

After an impressive four-year run, the TSX appears to be in some sort of sideways holding pattern of late, where every three-digit gain in a trading session is often followed by a three-digit loss. I realize it's a fairly small sample size (and doesn't the stock market always swoon in the summer?) but I really can't shake the feeling I have that we've had it too good for too long, and the times are about to get a little bit tougher. If it happens (and please understand I'm not necessarily saying it will -- I'm just some putz with an investing blog) it will a watershed moment for me in my investing life. Thanks to my young age (27) I've only really gotten serious about investing for the past 3-4 years, since I've been out of school and have finally had a bit of money to play with. The only investing reality I've known is this one, where gold, financials, trusts, REITs, energy and now, commodities have taken turns driving the TSX to record highs.

To be frank, all I've ever known is this bull. And don't get me wrong -- I love the bull. I hope the bull lives a long and happy life before keeling over in about 90 years, surrounded by his loved ones. I'm just naturally cautious enough to know that the bull won't last forever. Mr. Bear is going to show up at some point. It may as well be now.

As investors, we're generally supposed to love bull markets and loathe bears, but for the last few days, I've been kicking around a few reasons I can think of for why I wouldn't mind a bear market.

1 - It's a learning opportunity. It's all well and good to say you have a "plan" and boast about your 48-page excel spreadsheet with your ideal asset allocation strategy. But it's amazing what a 25% drop in the markets will do to make you change course and question your plan. Maybe you're not diversified enough. Maybe you've crafted the ideal portfolio for weathering out the storm. Maybe you’ve' guessed right. Hell, maybe you really are better off putting it all into gold. I don't know. But a downward market seems like an excellent litmus test to me. I'm still something of a naïve investor, so a new environment to work in -- where money isn't free and gains are only found by doing your homework -- would a good thing going forward. I think it's the kind of thing I'll appreciate in 40 years. After all, I'd rather lose it all to my own stupidity in my 20s then do it when I'm 50 and have a mortgage to pay and kids to feed. Anything that makes me a better, more disciplined, savvy investor down the line is a good thing. Even if it costs me a bit on paper now.

2 - More ammo in the active vs. passive debate. Regular readers know my distaste for high-fee mutual funds, and a financial industry that I think preys on ignorance and laziness. Generally, active-management advocates like their strategy because not only does it allegedly maximize gains in a bull market, but a shrewd managers can supposedly steer around the icebergs when the market as a whole heads south. I'm skeptical that's the case, and that all but a select few people can ever hope to outsmart Mr. Market. Maybe it's true, but I doubt it. I've known too many turkey mutual funds to buy in. In short, if people haven't been convinced that it's a waste of time to pay somebody to "beat the market" (remember the oft-quoted "80% of all mutual funds" statistic) then maybe paying somebody to lose money for them will convince them to see the light for once and for all. Hey, if I'm wrong, so be it. Maybe the Canadian mutual fund industry is worth what it gets paid. I think changing the rules and eliminating the easy money is an excellent way to find out just who's right.

3 - It's hard to be a downer in an up market. A personal story. My girlfriend's company has an incredibly generous employee-stock purchase plan which encouraged her to sign up for. I think she was skeptical at first, but as soon as she saw the discount she gets, and the direction the stock has headed since (straight up) she's now a believer. The problem? Her company's stock has done so well that I think she should sell off some and use the gains for something else. No matter the news -- good, bad, whatever, the stock chugs higher and higher. It's uncanny. But she won't listen. To her, "More company stock = more good". I try to preach the mantra of diversification, but when the only investment she's ever known has done nothing by go up for her, it's hard to convince her of the virtues of a low-cost, diversified ETF. I hate to say it, but maybe a 20% portfolio haircut will show her the light. Unless, of course, it turns her off investing altogether. That's not what I'm trying to accomplish.

4 - Slow the train down, and let me get on. This one's a bit of a stretch, but generally, when the stock market does poorly, the Bank of Canada likes to slash interest rates to make borrowing easier to stimulate the economy back up again. After a prolonged period of crazy-low rates, the Bank appears to be leaning toward rate hikes to slow the economy down. That's bad news for mortgage-owners, or people like me looking to jump into real estate. A bear market would mean I would feel better about keeping my money in secure GIC's and high-interest savings, and also mean I'd have a larger downpayment to jump into a cooler real estate market in a few years' time.

Anything I've missed? I realize it's hard to celebrate the bad times, but can you think of any advantages of a stock market that's headed into a prolonged downward direction?

ETFs 2.0

I was a little later than usual in getting my hands on the latest issue of MoneySense magazine this month, and I'm not sure what to think about an article on ETFs I read in it. (I can't find it available online yet, but it's on page 10 of the May 2007 issue, written by Duncan Hood.)

BetaPro Management -- a division of Jovian Capital Corp. -- has come out with two ETFs that essentially allow investors to bet on what direction the TSX is headed in. The Horizons BetaPro S&P/TSX 60 Bear Plus fund (HXD) is designed to provide bear market returns by betting that the market is headed down. The company also has a similar product designed to supercharge returns in a general bull market.

Essentially, this makes it easier for retail investors to short-sell the stock market.

Think the blue-chip-laden TSX 60 is headed down? Buy the HXD ETF. Every 1% loss in the index translates into a 2% gain in this ETF's value. But beware -- if you guess wrong and the index goes up, the value of the ETF will decrease, again, by twice as much. Theoretically, you could see your investment go all the way down to zero. And don't forget, the MER is above 1% -- a number that strikes me as being suspiciously high for an ETF.

My initial reaction was shock. I mean, this seems like a fairly speculative vehicle. But the more I think about it, I can perhaps acknowledge a limited role for this product in a conservative portfolio -- albeit a very small role.

Say you set aside a small percentage of your portfolio -- something under 10%, and put it into a product like this. With the TSX having been on such a good run for so long, we all know a pullback is coming at some point. So perhaps some exposure to this potential for gains in a down market could provide some sort of protection.

But sensible investors would limit this product to a small percentage of their overall portfolio. Anything more than that is just asking for trouble.

I'm not particularly inclined to jump in myself at this point, but I do think it's interesting for what it says about the evolution of the ETF: A vehicle that was originally designed to provide market-indexing at rock-bottom prices now includes variations of itself that actually do neither.