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January 3, 2000, The Last 20 Years, A Personal History
October 2007, A Conversation with Dave Heinze
January 2009, Another Conversation with Dave Heinze
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How is that for a definite maybe? Should we be running out and adjusting our strategy? Actually, we plan to continue to manage our own portfolio just as we have in the past, regardless what happens in the short run. We believe that our approach continues to be the best long term strategy. We establish our balance according to our circumstances, not the market. For nearly everyone that includes some equities. Then we continue to save as rapidly as we can, especially when the market adjusts itself. As we save we invest, regularly and gradually, buying the high quality companies that we like, as they provide buying opportunities. Strangely enough, even in bull markets something we like always seems to be out of favor and providing a buying opportunity. While we watch our overall mix to ensure that we do not become overexposed in any one sector, diversity is not usually a big issue. Over time different types of companies provide different opportunities and the portfolio becomes well diversified. Did someone ask, “What about selling?”
Why would we sell? We are investors who like accumulating wealth by holding a diverse portfolio of high quality stocks. That means buying more, not selling. We hate to sell, but we love to buy more. Yes sometimes we do sell, but not that often. If we change our mind about a stock then we immediately sell. We do not wait around for it to recover, after all if we no longer believe in that company, we have no reason to keep it. So we sell, then buy something we like. This does not happen often because we put a lot of emphasis on quality. If we feel that we are becoming overweighted in a stock or sector that is doing well, then we may reduce our holdings. Also, if we are concerned about our short term cash requirements (in this context short term may be 5 to 10 years) we may divest some stocks that we think are overpriced in order to create cash. Also, if we believe that something we hold is way overpriced, then we may sell some or all our holdings in it. Regardless of the reason, we rarely sell and are always reluctant to.
Why is this the best long run strategy? First, lets remember Dave’s Rule from February, “The market is irrelevant.” What matters is the value of the companies we own. Since we hold quality, if the market drops, we know that we hold value and that sooner or later the market will figure that out. Also, because it is a diverse portfolio of quality companies, we may temporarily lose some ground during a correction, but overall, we rarely lose much. Sometimes we actually go up during a correction, as there is often a flight to quality, and guess what, when that happens, we have what everyone suddenly wants. Of course when the market goes up, we usually make money too. So the market goes down, we do okay, the market goes up and we do great.
You might say that for bullish investors like us, the glass is half full and starting to fill up. Our biggest fear is not having more to invest.
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This added vigor is likely a result of a number of things; how far we are into the bull, emotions attached with new highs, how long this bull market has lasted already and since the Dow is at record highs, an equal adjustment is a lot more points. At five thousand a five percent adjustment is 250 points, however at ten thousand it is 500 points. We suspect that we will see two or three adjustments of about five percent before 1999. If we are right that means two or three 500 point drops. If we see a ten percent adjustment, not something we are predicting for 1998, but it could easily happen, the market will drop one thousand points.
None of these things are really a big deal, but consider the emotions attached to a 500 to 1000 point drop in the DOW. Or a (20%) 2000 point drop for that matter. If you follow your emotions you are likely to buy high, sell low, buy high and sell low again. Then you might just swear of buying stocks. All of these choices are bad for your financial health.
Where are we going? Up in the long run. We are sure that the DOW will break ten thousand, then twenty, and even one hundred thousand eventually. It is just a mater of time. Over all we expect that both the TSE and the DOW will see more record highs this year and likely finish the year above where they are now. We doubt that the DOW will break ten thousand this year. Then again, we have been wrong before.
As for strategy. We are holding on to all our favorite stocks and adding new ones as we see buying opportunities and have more money to invest.
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| Period / Index | DOW | S & P | TSE 300 |
|---|---|---|---|
| 1 Month Return: | 3.1 | 5.1 | 6.6 |
| 3 Month Return: | 11.7 | 14.0 | 12.8 |
| 6 Month Return: | 11.7 | 17.2 | 7.4 |
| 1 Year Return: | 36.0 | 48.0 | 29.2 |
| 5 Year Avg. Annual Return | 27.9 | 22.3 | 16.0 |
| 10 Year Avg. Annual Return | 19.5 | 18.9 | 8.6 |
| 15 Year Avg. Annual Return | 18.5 | 17.7 | 8.7 |
| 20 Year Avg. Annual Return | 17.6 | 17.7 | 10.3 |
As you can see from the above table, the short term shows that Year to date (3 Months Jan. 1 to Mar. 31) the market is up just over 10%, about the historic annual return for one year. If we look at the longer periods, 10 year, 15 year and 20 year we see that the average annual returns of the U. S. markets are significantly over their historic average return of about 10 % per year while the Canadian market is very close to the historic returns. This would suggest that the U.S. markets have been over performing in recent years and that the Canadian markets are about right on a historic basis. Of course there are other factors to consider.
If you look at the demographics, you will note that the Baby Boomers (probably the most powerful economic force of all time) are leaving the borrowing stage of their life cycle and entering the savings stage. Add to that the fact that the U.S. and Canadian Government’s are starting to get their borrowing under control and you have a case for low interest rates and low inflation. Add the emerging markets (Asia’s temporary crises aside) and over the long term you have the potential for unprecedented demand for North American products and expertise. Plus a growing word wide work force that when coupled with technology is bound to keep inflation in check. Over the long run, all this is a receipt for a great bull market and a thriving economy. Then again, even the best bull markets have corrections.
We have heard it said that even in a bull market there are an average of three corrections a year of up to 5%. We cannot support or refute this number, but we can say that there will be regular corrections of this sort and occasional ones of 10 to 20 percent. We could even be experiencing one now, although we think that until the fall we will just be running through some choppy water, then we expect to see some more gains.
As for strategy. Nothing changes! Stay invested, hold quality and as opportunities arise continue to invest. We do not know about the short run, but in the long run (ten or more years) we are very confident that this approach will pay off.
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June was an interesting month. We had a fairly significant downward adjustment, then when we were just accepting that we would end the month with some losses, the market rebounded in the last few days. This seems to have been a common theme lately. In the end the Dow finished the month up just over one half a percent and the TSE was down about 2.5 percent.
This leads us to another point. Do not pay too much attention to the market. What is important is your personal investments, not the market. We noted that while the TSE dropped 2.5% in June, our personal Canadian Stocks rose just over 4%. So was June a bad month or a good one for Canadian stocks. Apparently it was not that good for Canadian Stocks, but it was good for us. Of course, July and August could do the opposite, and it would not be the first time for that either. So watch the market, but pay more attention to your own investments as in the end they are what really count.
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Where will things go from here? We expect sideways for a while, and the next 500 to 1000 points (in both Canada and the U.S.) could be in either direction, but we are confident that the next 5000 point move will be up. We expect the year will finish up from here, maybe only a little, but then again it could be closer to April’s high. Which leads us to the usual question, what to do now?
If you are invested in reasonably priced high quality companies, then you are well positioned to ride out the storm and profit from the next major market rise, which could start any time, or be delayed for a few years, while the different crises and panics sort themselves out. In either case, if the companies you hold are sound, in the long term you have little to worry about, as the underlying value is there. If you are holding hot or trendy junk then you have a lot to worry about.
So the approach is what we have been recommending in this letter since we first published it in 1994. Balance your investments according to your personal circumstances (regardless of the market). Stay diversified so that if you misjudge the quality of a company it will not impact you significantly. Invest in quality, then you will be able to ride out any storm knowing that in the end your companies will prosper. Finally, invest regularly and gradually. This last point deserves further comment. It is human to want to stop investing or sell your investments during times like this when the market is low. However, you should think of it as a sale and continue to invest. Remember the old adage, “Buy low and sell high.” Following your emotions could cause you to do the opposite.
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We are still confident that the market will recover and that we will eventually be seeing new highs. It is just a matter of time, maybe a few months or possibly a few years. We believe that at year end the market will be above where it is now and that in 1999 we will be seeing new highs again. It would not even surprise us if our past prediction that the DOW will break 10,000 in 1999 comes true. Then again, if it takes longer than we thought, it would not be the first time for that either.
It is our strong recommendation that you hold the line. Continue to hold a diverse portfolio of high quality stocks and continue to add to your portfolio on a regular basis. This approach is difficult to stick to at times like this, but at times like this it is more important than ever. Based on the recent markets, it appears that many investors are not sticking to this approach (hopefully none are our readers). Those investors have been divesting themselves of their stocks; selling during the weak market. They will continue to stay out because the market feels bad. BUT, may we remind you that the DOW went up from 7539 to 7843, (about 4 percent) in September, not a bad return for one month in anyone’s book. What if October, November and December all do the same? Bounce all around leaving you with that sinking feeling, yet slowly inching themselves back. At the end of the year, the market might have snuck back to 9,000, up about 20 percent in four months. By the time the market timers and the bears realize that the correction is over, they will have missed the boat again. Selling low during a correction and buying back during the highs.
Now it may not happen that fast, however, it easily could and we know that eventually the market will bounce back. So as we said, hold the line, as difficult as it may seem, in the long run you will be glad you did.
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Our recommendations have not changed. Stick to our four IFC principles holding a balanced and diversified portfolio of high quality securities. If you have some lower quality investments, this may be a good opportunity to unload them. If you have more money to invest, continue to add to your holdings on a regular and continous basis and as the opportunities show themselves.
If you are fully invested and holding quality, sit back and enjoy the ride. We are sure it will be a bumpy one.
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On the other hand, the TSE is very heavily weighted towards the resource sector, so if the world economy gets going and commodity prices improve significantly, then a TSE of 10,000 in the year 2000 might not be that unreasonable. We will just have to wait and see. Regardless, our advice holds.
There are still plenty of well-priced high quality Companies out there. If you own a properly balanced portfolio with the equity portion made up of a diversified group of high quality reasonably (or even acceptably) priced companies, in the long run you should ride out the bumps and do fine. You are unlikely to have a top performing portfolio, but you will probably do better than most, and in the long run, that is all you can reasonably ask for.
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If you have been invested in a diverse portfolio of high quality stocks you probably made a small loss or gain on your Canadian equities and did very nicely on your U.S. equities. If you were also applying a dollar cost averaging approach (of investing a regular amount every month) and you stuck to it, you probably faired quite nicely in 1998. Maybe you did not get double digit returns, but a return of ten percent is the historic average, and considering the level of inflation and interest rates in both Canada and the U.S. even a small return is nothing to scoff at.
We cannot be certain about any given year, except the ones in the past, but historically, equities have returned an average of about 10 percent a year. It is probably fair to expect that average in the future. We believe that 1999 will start out strong, and that the Dow will break 10,000 in the first half of the year. Then, at some point we expect investors will start to get nervous about the effects of the Y2K bug and we will see some weakness. Depending on the overall market sentiments and emotions, this correction could be mild or very severe. By the end of the year the markets will likely be up about ten percent, unless there is an over reaction to the Y2K problem. We also expect that in early 2000, once people have seen that the world did not come to an end, the bull will continue. Also, at some point in the future, resource prices will start to recover, and when they do, we expect the Canadian market to outperform the U.S. market. Until then, they will probably more or less shadow each other.
So our advice continues. Stay balanced according to your personal circumstances, not your market expectations. For your equities, hold a diverse portfolio of high quality stocks or mutual funds. Continue to add to your holdings, especially during times of market weakness. However, in the next year or two, we cannot over emphasize the importance of being well diversified and holding quality. While we expect that in the long run, the Y2K bug will only be a blip, companies that do not prepare properly will be seriously hurt and some will go out of business. Holding quality reduces your risk significantly, and being diversified helps ensure that no one company can impact you too greatly.
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In the 1940’s, the second world war ended. This started something that would have an enormous impact on the decades to come. The North American baby boom. There was new hope in the air, and the world was to be run by a group of people who knew how to survive hard times, were prepared to work hard to better their lives and who would save whatever they could.
In the sixties, a new generation was growing up, the baby boomers. A generation that had not known hardships like the depression or the war. This generation saw prosperous times ahead, although it did live in the shadow of the cold war. They could see where the success of the generation before them had some dangerous implications and in their youth they embraced a concept of peace, love and self fulfillment. Then they became adults, the working class, and started to have families. Not knowing the hardships that their parents knew, this generation did not save the way their parents did, instead they borrowed for homes, cars, vacations and many other things. They also demanded excessive services and safety nets from their governments. The governments provided these things by borrowing. All this put a large demand on the money supply. This in turn drove interest rates and inflation to unprecedented levels. In recent years the baby boomers have moved on to a new stage. As they reached middle age, they started to realize that retirement was not to far away, so they should save. Second, they were beginning to hit an age where their earning ability was maximizing, plus their children were starting to leave the nest, so they had more ability to save. Also, while governments are taking credit for reducing their debts, what really happened is that due to the age of the baby boom, they were collecting more taxes, spending less on interest and facing less demand for services. All this is resulting in more money to be loaned or invested with less demand from borrowers. This in itself should reduce inflation and interest rates, but there is more.
We mentioned above the savings of the baby boomer's parents. That generation is now just starting to die off, and they will be leaving their children enormous wealth. Of course there are some who will not inherit much while others inherit a fortune, but most baby boomers may be surprised at what they receive. Consider what is probably a fairly average family with three children. The parents die leaving about $250,000 of investments, pension and insurance, plus about $50,000 of other assets and a $200,000 home. Each child inherits about $160,000. Chances are the children (baby boomers) now have their house nearly paid off, and have some savings of their own. So their savings and investment power is boosted even further. Then there are some other implications.
The opening up of the world economy, the fall of communism, the future prospects for many third world countries and the advent of the euro should create, and is creating an environment where significant global growth and low inflation are likely. Add to that the impact of computers and automation, which are really just starting to significantly impact efficiency, and the opportunities for business are mind boggling. Actually, deflation could result and be a good thing, as it would be the result of improved productivity and competition rather than a shrinking economy.
In the past, deflation has been feared because it was associated with the declining economy of the depression. However, in the future, we might see a growing economy fueled by deflation. This could happen if improved technology and efficiencies reduce the resources required to produce goods and services. Then, if an entrepreneurial spirit is embraced, the entrepreneurs might put the freed up resources to work, creating new goods and services, which would further grow the economy. This would create even more opportunities and improve everyone’s standard of living. Then again, if the governments try to control things, protect their weak industries, build walls around their countries and squash this spirit, the future will not be so rosy. While that is likely to happen in some countries, we believe that with the current world globalization, few governments will be able to maintain that approach.
So what does this mean about future investing? Well, as you have probably guessed, we are still bullish about the long term. However, the road will be a rocky one. There will probably be plenty of opportunities and plenty of capital to keep the markets and business growing. However, there will also be many losers. Further, we cannot stress enough the you must keep your expectations reasonable. While there will be years of double digit returns, over the long run you should expect single digit returns. Historically, stocks have averaged about 10%, so that is all you can reasonably expect from them. If inflation and interest rates stay low, then there is all the more reason to expect single digit returns. Then again, if inflation is around 2 percent, and fixed income investments such as bonds are yielding about 4 percent, why should you expect double digit returns on your stocks. Actually, in this scenario a return of 10 percent is more than double the return of bonds and five times the rate of inflation. Pretty good when you think about it.
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First, referencing James D. Wolfensohn, “Remarks at the Council of Foundations Luncheon,” Washington, DC, April 28, 1998, p. 3. the report said: “Ten to 15 years ago, one country in four had a democratic government. Today it is two in three. Ten years ago, a billion people lived in a market economy. Today, 5 billion people live in a market economy.”
With the exception of the last row, we prepared the following table with information from “Statistics Canada National Balance Sheet Accounts, Bank of Canada." which we found in the Task Force report.
| Asset Category | 1977 % | 1987 % | 1997 % |
| Mutual Funds | 1.0 | 3.0 | 14.2 |
| Pension Claims | 9.6 | 15.4 | 21.6 |
| Shares | 19.6 | 20.8 | 14.2 |
| Bonds & Money Mkt. Instruments | 11.1 | 10.9 | 5.3 |
| Deposits | 31.0 | 30.0 | 25.1 |
| Life Insurance | 10.5 | 10.6 | 10.7 |
| Other | 17.2 | 9.3 | 8.9 |
| Total Financial Assets ($ Billions) | 307.2 | 916.3 | 1791.0 | Ten Year Avg. Annual Growth Rate | N.A. | 11.5 | 6.9 | Ten Year Avg. Annual Inflation Rate | N.A. | 7.6 | 2.8 |
If the above analysis is correct, it means that those bears who keep waiting for the bubble to burst, not only missed the great opportunities of the last few years, but if they continue to wait, they will miss even greater opportunities. Actually, it is conceivable that this big burst that they are waiting for will not happen, or at least, will not happen in their lifetime.
The above is obviously a very long term outlook. We are not talking in years, we are talking in decades, and we may all have died before it can be determined if the above analysis is really correct. In the mean time, expect both the expected and the unexpected. There will be years of exceptional returns. There will be some massive sell off’s, probably starting when confidence is at its highest. There will also be some normal years, but in the long run, ten, twenty, thirty, forty years; we believe if you stay invested in equities, as long as you follow our basic IFC Investment Principles, you will be glad that you did.
What about the short run? Well, we think that there is likely to be a Y2K panic sale later this year. That sale will probably drop the market between ten and forty percent. Then at some point, likely early next year, when it is evident that the world did not come to an end, well, hang on to your socks. Then again, in the short term, markets can be very fickle, so you had best follow our principles and concentrate on the long term.
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The next little while should prove very interesting. There are bound to be two or three minor adjustments of 5 to 10% during 1999. The question is whether the bull will continue, flatten, or will there be a significant correction later this year. Our guess is all three. This recent run up does not seem to be slowing down, but by the time you are reading this, the DOW might be below 10,000 again. Or it could have broken 12,000. Here is what we expect.
This run up will continue to somewhere between 11,500 and 12,500. There will be some minor adjustments, but sometime later this year we will see a more significant correction of between 10 and 20 percent, possibly fueled by a last minute Y2K panic. Where the DOW ends up on December 31, is anyone’s guess. We suspect in the 10,000 to 11,000 vicinity. Then we expect that the bull will continue next year, and then into the next century. We are also optimistic about the Canadian market. Actually, for the next year or two, we are even more optimistic about the Canadian Market than we are about the U.S. market. The recovery in the world economies will mean a recovery in most commodities, which ultimately will be good for Canada. Also, we are finding it relatively easy to find great Canadian companies that can be bought for less than we believe they are worth. While it is easy to find great U.S. companies, buying them at a bargain is increasingly difficult.
As usual, our advice stays the same. If you stick to our four IFC Investment Principles, (listed below), in the long run you should do well, regardless if our predictions are right or wrong, but especially if we are right.
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So what is the strategy? Well, when there are dips, you can use them to add to your holdings, and during the upticks you can thin some holdings, but on the whole, it is wise to stay invested. Most importantly, continue to stick to our four IFC investment principles.
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The rest of this year should prove very interesting. Will this bull just continue onward, will it go to sleep for the summer, or is a significant correction around the corner. The last few summers have had some fairly good corrections, then by the New Year; it seems that all had been forgotten. We cannot help but think that sooner or later the market will pause for a summer rest, then be followed by a fairly healthy correction, which could easily be fueled by a last minute Y2K panic. What we find most interesting is the current lack of discussion on Y2K. We thought for sure that the Doom and Gloomers would be out in full force by now. Regardless what happens over the next few months, it is still just a matter of time until today's high markets are just a distant memory of a time when the DOW was only in the 10,000 zone. It might be a couple of years, or it might be a decade, but rest assured that one day 10,000 will sound low.
So what is the strategy? Well, when there are dips, you can use them to add to your holdings, and during the upticks you can thin some holdings, but on the whole, it is wise to stay invested. Most importantly, continue to stick to our four IFC investment principles.
Maybe we are being a little lazy, but this month we feel exactly the same, so "dido".
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So in a nutshell, continue to follow our four IFC principals, and if you are wondering where to put new money, do not overlook Canada, it may not be the in vogue place these days, but that may turn out to be a good thing.
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So what will happen next? At this point, we cannot say for the rest of the year. The bull could easily continue right through year-end and then on into the New Year. We expect that the year 2000 will be a good one, especially the first half. From all accounts, it appears that there is a lot of money waiting on the sidelines until after the year-end, just in case there is a Y2K disaster. Also, the economy seems strong, earnings are growing and in the United States, the year 2000 is a Presidential election year. All of these are usually positive for stocks. Things look especially good for Canada, as commodity prices are rising, and a depressed market is making for many great bargains. Something that is starting to be noticed both at home and abroad.
Our advice stands. Hold a balanced portfolio of high quality stocks. There could easily be a year end correction driven by Y2K fears, but that seems less likely every day. We suspect that any money that was to be taken out of the market because of Y2K, already has. Either way, if we are right about next year, by this time next year, what ever happens in December, will have become a distant memory. We believe that the only ones with regrets will be the ones who strayed from our IFC Investment Principles. Of course, it is possible that we are wrong about next year, however, in total, over the longer term, markets have always gone up more than down, so it should be safe to say that avoiding stocks will be wrong more often than not.
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This was a special issue, that described different events of the previous 20 years indicating similarities of previous train wrecks (so to speak) and how they were similar to what was then the technology/dot com boom. Then the issue went on to give a very long term forcast and our recommended course of action. The bubble finally showed weakness a few days after the original publication and burst a few months later.
Here is a link to a reprint of that issue. We believe that it is worth reading again and that its message and advice are always timely. But that is just our opinion!
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For the fun of it let us look at January's results. In Canada, the TSE, whether measured using the TSE/S&P60 or the TSE 300, rose a little less than one percent. However, in the United States, the Dow Jones Industrial Index dropped 4.8%, the S & P 500 dropped 5.1% and the Nasdaq Composite, which looked all month like it would be up for the month, dropped 3.2%. This would indicate that Canadian Markets will rise and U.S. markets will drop. Funny thing, we would say that there is about a 70% or better chance that the Canadian Markets will rise and about a 30% chance of the U.S. markets dropping for the year 2000. What we think is more interesting is the high level of volatility that January showed. In fact, the markets were all over the place, and every time you thought it was starting to show some direction, either up or down, it fooled you and took a leap in the opposite direction. This high volatility is something that we expect to continue for some time.
We expect that the year 2000 will show a lot of volatility and that for the year, all the major Canadian and U.S. markets discussed above will be up, however, not near the amount that they were last year. You should be looking for the more historic returns of about 10% per year. Some years will do better, which will make up for the worse years, but 10% is a realistic long-term average expectation. We continue to urge you to hold on to your Canadian stocks, as we think that there is a very good chance that Canada will outperform the U.S. for the next year or so. This will be a result of the Canadian Markets being better valued, which is a result of investment money shunning Canada in favor of other markets like the U.S., and the recovery of commodity prices that should be good for Canada's economy as a whole. We also note that there seems to be a lot of American interest in Canadian stocks lately and that it appears that a lot of Canadian mutual fund money has been finding its way out of Canadian funds. We would consider both of these to be positive indicators for Canadian Stocks. The U.S. interest is positive because even if only a small amount of U.S. Capital flows into Canadian stocks, it could have a significant impact on those stocks. We consider the Canadian mutual fund money flowing out of Canada to be a positive indicator because as a group, we think that this group of investors is likely to be wrong more often than not.
One final point, as with all markets, there will be individual winners and losers, so diversification and quality continue to be important. This leads us back to our standing advise. Continue to stick to our four IFC Principles; in the long run you will be glad you did.
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First there were technology stocks, then dot-com, then Internet, then bio tech and now it is new economy stocks. There is definitely a trend toward new economy and out of old economy stocks. Even in Canada, the TSE 300 is up 14% but this is mainly because of three companies that due to their incredible growth now make up a very large percentage of the index. Even with the current high prices for oil, no one seems interested in buying petroleum companies. And why should they, when they can count on the almost sure thing of great returns in the new economy. Or is that also part of the trap.
The new economy, which mainly refers to things like the Internet, communications and the like are definitely going to change the way we live and do business. People, money, information and resources will be better connected, more mobile and freer to go anywhere. Competition will reduce cost and improve the way people live. We believe that this is the greatest change since the industrial revolution and it may even rival that. However, this does not mean the end of the old economy or traditional businesses, in fact, we think it is quite the opposite.
Sure, for some time there will be a lot of companies going great guns in these new economy industries. In time, many will pass away or get swallowed up by the enormous competition as everyone rushes to invest in these new businesses. This is not unlike other times in history. Around the beginning of the twentieth century, there were hundreds of car manufactures, only a few survived, but look at how the automobile changed the world. During the gold rush, masses of people rushed to stake out their claim, but only a few got rich. We expect to see a lot of similarities over time.
The greatest benefactors will be the old economy companies that embrace and use new technology most efficiently and effectively. While the new economy is producing a lot of new products that people want to use, in the final analysis, its greatest impact will be in how it changes and improves the way we do things and business. People are still going to want to eat, drink, have nice shelters, live longer healthier lives, be mobile, travel, socialize, relax, partake in sports activities and learn. The new economy will not change this, however, it will improve how we do these things. First by making us (society as a whole) more efficient and effective and second by improving the way we do them. This leads us to the question of who is making the best profits.
Many old economy companies are making record profits and growing their earnings at rates that they have not imagined for years. This is largely a result of the new economy. It is mostly because of new technologies that companies are able to move into new markets, bring their goods and services to people that in the past could not obtain them, hire people that at one time were doomed to lives of poverty and despair and to deliver goods at lower costs. This is also why we are seeing unprecedented growth without inflation.
So the old economy companies are the biggest benefactors of the boom in these new economy companies; the ones that in many cases are not making money, but that investors cannot wait to invest in. How long this situation will last is anybodies guess, but sooner or later the tides will shift, and to be honest, while we cannot put our finger on any specifics, we feel that we are already seeing some early signs. So what is an investor to do?
It is our belief that diversity is more important than ever. Usually, quality is our highest emphasis, and while it is still extremely important, we think that now more than ever diversifying among high quality companies is critical. There will still be a lot of success stories in the high tech sector, but there will also be some serious casualties. We think that the best way to take part in this is to hold a few of the very highest quality companies in this sector as part of a reasonably balanced portfolio. We also, recommend that you do not get overweighed in this or any sector. Then if you hold the rest of your money in high quality companies, in the so called old economy, some selected for their growth potential, some due to their value and some (maybe most) for a mix, you will be well positioned to benefit from any shifts that happen. In a way, while it will take some patience, you will get to have your cake and to eat it to, without exposing yourself to undo amounts of risk.
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"There will be great opportunities in the future, well-run companies that develop or use technology skillfully will thrive, and those that do not will die. Our four IFC principles are more important than ever. We expect this bull to continue for a long time, however, all bull markets suffer setbacks. Most years we suffer three or four, often one or two are intense. Given the rate of recent growth, a correction of twenty percent is very likely, and a forty percent correction for technology stocks should almost be expected."
On Friday, April 14, 2000, the TSE 300 closed at 8474, off 16.7 percent from its record high of 10,177. The Dow Jones Industrial Average closed at 10,306, off 12.3 percent from its record high of 11,750. The Nasdaq closed at 3321, off 35.3 percent from its record high of 5133. While we do not know what will happen next (although by the time you read this you may have an inkling), this appears to be one of those expected corrections that we referred to at the beginning of the year. Actually, we have been constantly warning of this kind of a correction and stressing our four IFC investment principles. We have done that because while this approach might not result in the best returns during the hottest markets, it will allow you to profit handsomely from whatever sectors are gaining and to maintain your wealth during the tougher times, which is what it has done for us, for a long time now. While updating our portfolios on April 15, we noted the following.
For the first two weeks of April, the TSE 300 was off by 10.4 percent, the Dow Jones Industrials were off 5.6 percent and the Nasdaq was off by 27.4 percent. However, we were pleased to see that during that period, 40 percent of out portfolios were actually up, (albeit less than 3%) and of the rest, the worst performance was a loss of less than 3 percent. So, while during the hottest of times, we lagged the market, so far our portfolios have stood up through the worst of times. We like to say, "That is the difference that quality makes."
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If you are a regular reader, you can guess the rest of this paragraph. Stick to our four IFC investment principles. They will help you to take advantage of the good markets and to weather the bad ones. In some cases they will even help you profit from poor markets, as when the going gets tough, there is usually a rotation into the higher quality companies. This explains why our portfolios have been doing very well lately, despite the overall market's lack of performance.
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In 1999, the DOW broke 10,000 and went on to break 11,000 where it closed out the year. At the time, the TSE was still below 9000 and all the smart money was leaving Canada, despite our continued advise. However, half way through this year the DOW has settled back into the mid ten thousands and seems to be having trouble breaking 11,000. Meantime, the TSE has broken 10,000 and as we are writing this, it is making new records daily. By the time you read this, the TSE 300 index may have actually passed the DOW Jones Industrial index, something it has not done for some time. So if you do not mind, we would like to take a moment to pat ourselves on the back, and to pat you on the back if you stuck to our advise, after all, it was not always easy. So where do we go from here.
We believe that while there are less opportunities in Canada than there were six months ago, there are still plenty of good stocks that have not met their potential. We also believe that many of those that have moved up significantly, still have a long way to go. Finally, it is just a matter of time until the DOW breaks 11,000 again and then starts moving on to new heights. So it is fair to say that overall we are still very bullish, both long and short term.
However, there will always be spurts, setbacks, and droughts; and regardless what happens in the overall market, some companies will thrive while others disappoint. So as usual we must stress our four IFC investment principles. If you stick to them, we believe that in the long run, you will do very well.
Authors note: Well the heat is on, between the time that we wrote this (July 13) and when we posted it (July 14); the TSE 300 passed the DOW Jones Industrial Average. We heard that the TSE 300 had been below the Dow Jones Industrial Index for 5 years.
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So while we are optimistic about the market in the long run, we continue to stress the importance of sticking to our four IFC investment principles. Following them will continue to enable you to build an overall investment portfolio that will help you hang in during the bad times while profiting from the good ones.
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Now the new captain takes some time to get a handle on what is happening, but at 7 miles to the iceberg he realizes that a course correction is required and at 6 miles he has determined a new course and started the correction. Just in time as it will take 5 miles to make enough correction to completely clear the iceberg. Things go along pretty good to the 3 mile point, when the owners get upset that the ship is not going where they want it to go, so they reinstate you, the original captain. Now you take some bearings and realize that the ship is starting to change course but still aimed at the iceberg. All hell breaks out and at 2 miles you start even greater corrective action that will not even start to take effect until 1 mile after the iceberg. The whistles blow and everyone scrambles as the ship has a near miss with the iceberg. A tragedy was adverted. One that you caused by ignoring the warnings 10 miles back and that the relief captain avoided by taking action 6 miles back. Things are good though, after all the tragedy was adverted and it looks like clear sailing ahead.
You can now claim to be a hero, after all, the relief captain was sailing toward an iceberg that surely would have sunk the ship. Luckily you got back in command in time and avoided it. Now you can reset your compass and sail straight for your goal. Oh yes, remember the radar guy, well he is just a pesky nuisance anyway, so you fired him, after all, it is clear sailing from here on. Isn't it?
The following table was compiled with information obtained from the Canadian Department of Finance web site. It indicates the Canadian Federal Governments program spending, Budget Surplus/Deficit at the end of each fiscal year (March 31) since 1970 and the Net federal Debt as of those dates. It also indicates who was the Minister of Finance on those dates.
| Fiscal Year End March 31 |
Program Spending in Millions |
Budgetary Surplus (Deficit) in Millions |
Net Public Debt in Millions |
Finance Minister on March 31 |
Party in power on March 31 |
| 1970 | 12,566 | 139 | 19,277 | Benson | Liberal |
| 1971 | 14,111 | (1,016) | 20,293 | Benson | Liberal |
| 1972 | 16,295 | (1,786) | 22,079 | Turner | Liberal |
| 1973 | 18,807 | (1,901) | 23,980 | Turner | Liberal |
| 1974 | 22,076 | (2,211) | 26,191 | Turner | Liberal |
| 1975 | 28,238 | (2,225) | 28,416 | Turner | Liberal |
| 1976 | 33,892 | (6,205) | 34,621 | MacDonald | Liberal |
| 1977 | 36,598 | (6,896) | 41,517 | Chretian | Liberal |
| 1978 | 39,974 | (10,879) | 52,396 | Chretian | Liberal |
| 1979 | 42,974 | (13,029) | 65,425 | Chretian | Liberal |
| 1980 | 45,502 | (11,967) | 77,392 | MacEachen | Liberal |
| 1981 | 52,762 | (14,556) | 91,948 | MacEachen | Liberal |
| 1982 | 60,867 | (15,674) | 107,622 | MacEachen | Liberal |
| 1983 | 72,808 | (29,049) | 136,671 | Lalonde | Liberal |
| 1984 | 78,968 | (32,877) | 169,549 | Lalonde | Liberal |
| 1985 | 87,100 | (38,437) | 207,986 | Wilson | Progressive Conservative |
| 1986 | 86,106 | (34,595) | 242,581 | Wilson | Progressive Conservative |
| 1987 | 90,005 | (30,742) | 273,323 | Wilson | Progressive Conservative |
| 1988 | 96,453 | (27,794) | 301,117 | Wilson | Progressive Conservative |
| 1989 | 99,688 | (28,773) | 329,890 | Wilson | Progressive Conservative |
| 1990 | 103,848 | (28,930) | 358,820 | Wilson | Progressive Conservative |
| 1991 | 108,765 | (32,000) | 390,820 | Wilson | Progressive Conservative |
| 1992 | 115,215 | (34,357) | 425,177 | Mazankowski | Progressive Conservative |
| 1993 | 122,576 | (41,021) | 466,198 | Mazankowski | Progressive Conservative |
| 1994 | 120,014 | (42,012) | 508,210 | Martin | Liberal |
| 1995 | 118,739 | (37,462) | 545,672 | Martin | Liberal |
| 1996 | 112,013 | (28,617) | 574,289 | Martin | Liberal |
| 1997 | 104,820 | (8,897) | 583,186 | Martin | Liberal |
| 1998 | 108,753 | 3,478 | 579,708 | Martin | Liberal |
| 1999 | 111,393 | 2,884 | 576,824 | Martin | Liberal |
| 2000 | 111,763 | 12,298 | 564,526 | Martin | Liberal |
Now for the economy things have clearly improved and you can draw your own conclusions as to responsibility. While different governments have had some influence, the fact that many governments had enormous deficits in the 1980's and are only now turning things around would indicate that there are a lot of factors at work, some that governments can influence and some that they have no control over, although they love to take credit for the good things. Regardless of your interpretation of the past, that is now water under the bridge. The question is, where will we go from here, what lessons have we learned from the past, and do we understand how some things really are different? The second and third parts of this question are what worry us.
Sometimes it seems that governments are trying to steer the ship by standing on the bridge with a pair of binoculars that only show a mile ahead. In the United States, the Fed has been constantly raising interest rates for fear of inflation. They are concerned that a runaway economy will create inflation that is pushed by wages. The basic theory is that as the economy improves, unemployment decreases, which is good, however, if left unchecked, it means more prosperity, increasing consumer demand that increases demand for employees and further reduces unemployment. Eventually, there is a shortage of workers and through supply and demand this pushes up salaries, which pushes up prices and creates an inflation cycle that eventually ends in recession. The approach used to control this is to raise interest rates. The idea is to tighten the money supply. As interest rates rise, cost will increase and hopefully slow industrial growth to a more sustainable level and advert a recession. No one can question the motives here, but our concern is that by overdoing it, the medicine might become the cause of the recession, rather than the cure. We must admit, we do not envy the Fed in this tightrope walk.
Our first concern is that the economy is a very large ship and course corrections take a long time to show their impact. It has been said that it will take 6 months for an interest rate adjustment to filter its way through the economy. We would say at least six months. So by adjusting regularly, there is a very good chance that the last few increases were not needed and a concern that they may turn out to be overkill, doing more harm than good.
The Fed's concern about inflation has also been heightened by concerns about high oil prices. While it is true that there is bound to be inflation caused by high oil prices, this is not part of the wage inflation spiral. We believe that it is more likely to have the same dampening effect on the economy that higher interest rates would have, thus slowing economic growth and doing the feds job for them. If we are right, further interest rate hikes would result in overkill at a time when they should have been lowering the rates to stimulate the economy and counter the effects of higher oil prices.
Finally, there are several new factors that are driving this economy, and they are pretty much beyond any government's control. These factors include: Great increases in productivity being realized by mass computerization and the popularity of the personal computer. The baby boom generation finally reaching there peak production and earning years. The fact that the baby boomers are at the stage in life where they are eliminating their debt, and are starting to inherit vast amounts of wealth from their parents, a group of people who were likely the best savers in history. Further, there is vast globalization going on. For some time this will ensure a competitive work force and help stave off inflation. This globalization will increase the wealth of the wealthy countries (by reducing living costs) and help bring prosperity to many poor countries that are finally getting a shot at prosperity. This prosperity will further drive growth as these people who once lived in poverty will become consumers and eventually increase everyone's wealth even more. Yes, there are many moral and ethical bridges to cross, but there always have been, crossing them has always been and always will be a work in progress. However, great strides have been made and we are confident that while the path may not always be a straight one; it will continue in the right direction.
We are not sure if this is a state of the globe, or a state of Canada address, but it does highlight many factors that have influenced where we are, how we got here and where we are going. The above analysis shows how there is a very good chance of a slow down in the next year or two, but that our overall long-term outlook is still very strong. This leads us to be even more convinced that our overall approach of sticking to our four IFC principles is still the right one. By being diversified and holding quality, we will be ready for any temporary down turn, and by being balanced correctly we insure that we will also profit from the long-term prosperity that we believe is ahead. The above brings up one other thought. When there is a down turn, utility stocks usually do well. This has been a neglected area lately, so it might be wise to review your portfolio to ensure that you are properly balanced in this area. We would not recommend being overweight in this or any other area, but if you are under weighted here, maybe it would be a good idea to correct the balance, something that is usually wise to do anyway.
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In our October 1999 issue, in an article discussing if stocks were overvalued, we commented on the "This Time it is Different" phenomenon. We said:
"There are also some that claim that the world has changed and that the old methods of evaluating stocks no longer apply. They are what you might call the flip side of the doom and gloomers. They believe that the tremendous rates of growth are sustainable, and that it is a mistake to apply the old measures to the new economy and especially the new technology. They believe that this time it is different. Well we have heard that before, and it is not. We are not even leaving room for discussion on this. The basic rules still apply, and those who choose to ignore them will get burnt. This is not to say that PE's cannot be higher, but we have already discussed that. Nevertheless, there are certain rules that always apply, and we have seen nothing to change them. These are rules like; Companies cannot carry unlimited amounts of debt, or a stock's price will eventually reflect earnings."
In our January 2000 issue, (a copy of which is linked from the index above), we discussed a number of events that had occurred over the previous twenty years, and noted that there were some striking resemblances to the current time. Some of the events we noted were:
We went on to point out, that technology stocks were all the rage and that many people were claiming that traditional valuations no longer applied. We stressed that technology has always changed the world and would continue to and that this was nothing new. We indicated that, as in the past, there would be setbacks and that a 20 percent correction was very likely. We pointed out that sooner or later many people will get burnt by those hot technology companies, that we expected that there would be some sector rotation in the future, and that our four IFC Investment Principles were as important as ever.
In our March 2000 issue, in the Your Questions section, we explained how a breakdown in the technology sector could happen. We said:
"So what will change demand? Well it could be a gradual shift, or happen all of a sudden. The sudden shift could be a result of a change in the fortunes of a couple of major players. For example, there are several companies that are very hot, have never turned a profit and have no idea when they will. They are in effect concept stocks and not profitable companies. In the most important cases, they have sales, and sales are growing, (and so are loses), and unfortunately, thanks to investor enthusiasm, they have very large market capitalization's, so they significantly influence some market indexes. As long as investors are enthusiastic things will continue nicely. When they need more money they just issue more stocks. Who needs profits, or debt for that matter? However, sooner or later they will disappoint investors, as all companies do from time to time. This could be because losses are greater than expected, sales do not rise as expected, or strangely enough, because they turn a profit, and the notion of reasonable profits suddenly kicks in. When this happens, the shares of the company in question will fall significantly, perhaps collapse. This will put the company between a rock and a hard place. They will need cash flow, but it will not come from operations that are losing money, they cannot issue more shares without further hurting the share price and no one will loan them money. The result could easily be bankruptcy.
All it would take is for the above to happen to a few, or maybe to one or two of the right players, and investor sentiment could change overnight, which would greatly effect the demand for these stocks. Or we might be witnessing a gradual shift already. "
The above description shares remarkable similarities with what has happened since then. Actually, all of the above concerns did happen to some extent this year. This is not surprising, as history tends to repeat itself and as long as greed and fear drive the markets, one should expect more of the same. So what has happened over the last year (January 1 to Dec. 8, 2000)?
The Canadian markets have done very well. The TSE 300 finally broke 10,000 and went on to peak at 11,402 around the end of the summer. It has dropped 16 percent since then to 9549, but it is still up 13 percent so far this year.
The Dow Jones Industrial average peaked at 11,713 in January. Since then it has declined 9 percent to 10,713. For the year it is down 7%.
The Nasdaq peaked in March at 5133. Since then it has declined 43 percent to 2917and is down 28 percent for the year. This is very bad for those who got in near the top, but not so bad for longer-term investors. The Nasdaq composite index has risen a total of 33 percent since January 1, 1999 (23 months) and a total of 85 percent since January 1, 1998 (35 months).
So the question as always is; where do we go from here? Well we expect that the year 2001 will be a good one and probably yield more normal returns in the 10 to 15 percent area. There will be ups, downs and some rotation, but at the end of the day (a year, maybe two but possibly 5), order will be restored, and the market will be fueled by growth in the economy and in earnings. And of course, just when you think you have it pegged, the market will humble you. The conclusion: Do not get too concerned with the market's day-by-day gyrations. If you stick to our 4 IFC Principles and focus on the long term, in the end you should do very nicely, and that, our friends, is as good as it gets.
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First, at the beginning of the year 2000, all the news was about how great the market was and how everyone was making a killing in Technology. The attitude was that all the rules had changed, and that people like us who stuck to their guns and applied the old rules were just being foolish and ignoring the new realities. We must admit it was not easy sticking to those guns, let alone publishing our position. Essentially our position was that the old rules did apply, that many of those who ignored them would get burnt and that it was as important as ever to stick to our four IFC Investment Principles. So we must confess that we feel vindicated. To see what we actually said and read our recommendations from our January 2000 issue, you can take the link from the index above to our repost of last January's issue.
Second, there is the satisfaction of success. In 2000, the TSE went up about 6%, the DOW dropped about 6%, the S&P 500 dropped about 10% and the Nasdaq dropped almost 40%. These numbers explain the headlines we have been hearing. However, we are happy to note that while we will not reveal the details, all our portfolio's made money in the year 2000 and our personal portfolio had a return of about 26%, with a three year average annual compounded return of over 15%. Compared to Canadian Equity mutual funds, that put us in the top 5% for the year and 10% for our three year average annual compounded return. Needless to say, we are pleased that we were foolish enough to stick to our principles and bucked the trend.
Enough about us, let us take a look at where we have been and where we are going. Historically, on average, stocks return about 10 percent per year. So over the long term, this is the sort of return you should expect from your stock portfolio, less a couple of percent for mutual funds to cover the management expenses. This may sound low, but in times of normal inflation of about 3 percent, it is about three times the rate of inflation, and triple the rate of inflation is nothing to scoff at. Actually, we would prefer to make 10 percent with 3 percent inflation than 18 percent with 10 percent inflation. We should also expect a lot of volatility. You cannot expect to get 10 percent every year. Many years, maybe even most, you get over ten percent which makes up for the years when you lose money. In the end, an average of 10 percent per year is a reasonable expectation for a stock portfolio.
In that light, 2000 was not a good year, but certainly something to be expected. The following link is to a chart showing the TSE 300, Dow Jones Industrial average, Standard & Poors 500 and Nasdaq composite index year-end closes for the last 7 years.
The average compounded annual returns for the period (excluding dividends) are as follows:
TSE 300 = 10.9%
DOW = 16.3%
S&P = 16.0%
Nasdaq = 18.0%
We choose 7 years because at a 10% return an investment should double in about 7.2 years. As you can see, the last seven years have been phenomenal. Historically speaking, this has truly been an exceptional period, even after the Tech Wreck 2000. Add one to two percent to the TSE, DOW and S & P for dividends and the returns are even more impressive. Most of the shares in the Nasdaq do not pay dividends so the above return pretty closely matches its total return.
We expect that technology will continue to drive the future, as it has for generations. However, it is not always technology companies that benefit from technology. The biggest benefactors are usually the companies that use the technology, not the creators of the technology. After all, the technology only has value if someone can use it to their advantage. Also, the rate of technological advance suggests that a new breakthrough can easily become obsolete before its creators can reap the rewards of creating it.
In the future, we expect that there will be an ongoing rotation where different sectors and companies will move in and out of favor. This means that if you can pick the right sector at the right time, you will make a killing. However, as we have said before, there are more ways to be wrong than right, and if you get it wrong, you will likely eliminate any gains you made and probably lose money in the process. However, picking good companies with good prospects is a realistic objective. If you do that, most of your picks will probably make you happy in the long run, as long as you hold on to them. They may not always move the way you expect them to, but overall the direction should be the right one. Who can ask for anything more?
So we are long term bullish and if you have not guessed, our standing advice continues to apply. Stick to our four IFC Investment Principles, in the end we believe you will be glad you did.
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We warned last year that this might happen. We said that all the fed tightening would be slow to take effect and was likely to be the wrong action, as high-energy prices would probably have a slowing effect, not a long-term inflationary effect. We think that the effects of last years tightening are not fully through the system yet. We also believe that energy costs have peaked. However, it takes a long time for increased energy costs to filter through the economy, and that process is not complete yet either. Considering this and that the fed has been slow to ease its monetary policy, we suspect that a turn around will not be seen till late in the year. Having said that, remember it is always darkest before the dawn.
When all hope seems to be lost and everyone seems certain that we are in for a continued recession, chances are you are seeing the best signs of a turnaround. So all this bad news may not be a bad thing. We think that a year from now all this will be forgotten and the record expansion will be continuing again. Actually, the only thing we are not sure of is the timing part. We are very confident that the current doom and gloom will end, it might happen tomorrow, or maybe not for two years, but probably not for a few months.
In the mean time, we are being presented with a buying opportunity, although, it is our belief that it is nearly always a buying opportunity for something. So our approach stays the same. Or as one good friend often says to us, "Nothing Changes." Stick to our four IFC Investment Principles and do not let the current situation dictate your strategy. A good quality balanced diversified portfolio is still the best way to go.
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As for the market perspective, we have indulged ourselves in some technical analysis of the markets and found some interesting results.
Note: The next few paragraphs refer to some charts that we have created using Big Charts. To view these charts in a separate window, right click this link, then select "Open in New Window." A link has also been provided to Big Charts web site, in the Interesting Web Sites section of this letter.
First, using Big Charts we created a chart of the Dow Jones Industrial Average since about 1970. You will note that we drew a long-term line of resistance and support on the chart. Resistance is a point where prices cannot seem to go any higher while support is a point where prices seem to stop going down. These two lines form a trading channel that has been maintained since about 1978. As you can see, we are currently in the middle of the range of the channel and the Dow could drop as low as 8,000 without breaking out of it. So, while we seem to be going though a significant correction, the chart shows this to be a fairly mild correction after a significant expansion. As a matter of interest, the slope of this channel represents an average growth rate of approximately 13% per year. Historically, this is an exceptional return.
Next, using Big Charts we charted the TSE 300 from 1992 to current. We could not go as far back as Big Charts only provided information back to mid 1991. Here again, you can see a trading channel that started around 1992. Depending on how you draw the line, the channel might have been temporarily broken a couple of times, but in the end, prices returned to the channel. We also noticed that from late 1999 to mid 2000, a head and shoulders formation was created. This is a bearish formation that in this case suggests that the TSE 300 could drop to the mid 6,000 range. So far it has dropped to about 7,400. However, even a drop to 6,500 would not necessarily break the channel. Therefore, while the market has been seeing some wild gyrations lately, as you can see, it has not broken its general upward trend and is not showing any signs that it is likely to either. As a matter of interest, the slop of this channel represents an average growth rate of approximately 12% per year. Again, an exceptional return from a historical perspective.
The final chart prepared using Big Charts, shows the Nasdaq Composite from 1974 to present. It shows a very definite trading range from early 1975 to present. Except that in 1990 it temporarily dropped below the support line then in 1999 it significantly broke the resistance line. However, as can be seen by the chart, neither breakout was sustained. Now the Nasdaq is back in the same trading channel that it has been in for about 26 years. The Nasdaq could fall as low as 1,500 without breaking out of this channel. As a matter of interest, the slope of this channel represents an average growth rate of approximately 13% per year. Again, historically, this is an exceptional return.
So as you can see, we seem to be in a very healthy long-term trading channel. Yes there are severe gyrations and rotations in and out of sectors. While the timing of these is near impossible to predict, the overall long term result seems to be very steady. So once again, we must continue to stress our four IFC Investment Principles. If you stick to these principles and avoid trying to pick the next hot sector, stock or short-term trend, we believe you will do very well in the long run.
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In the long run, both of these are attitudes that will rob you of good returns. Those who are swearing off stocks will be selling when they should be buying or holding, which will rob them of the sound long term returns that a good stock portfolio should provide. But it gets worse, many of them will repeat the cycle by not being able to resist and jumping in again at the next peak. Those who are waiting for the next tech wave are also making an error. There may be many other sectors that come and go before the technology stocks have their turn. Not to mention that this approach might keep them on the sidelines until the next peak. Also, the biggest benefactors of technology are usually those who use the technology, not those who produce it. After all, if no one benefits from it, then it must be worthless. Right? And then there is that pesky thing called profits. Like it or not, that is what companies are in business for, and in the end, despite short term fluctuations, that is what will drive stock prices. So here we go again.
Funny how our market discussions continually lead us back to our four IFC Investment Principles. Soon, this bear market will wake up and turn into a bull. Soon might not be for a couple of years, however, we think that by the end of the year the markets will be higher than they are now and that by next summer, the bull will be raging again. We also want to remind you that on average, sound long-term returns of 8 to 12 percent are what a reasonable investors with a well-balanced portfolio of high quality stocks can expect. So you can chase rainbows if you like, but we believe that if you stick to our four IFC Investment Principles and keep your expectations reasonable, in the end you will be a successful investor.
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The baby boomers are in their peak earning years, are eliminating their debts, saving and spending. Many governments have eliminated their deficits and are starting to pay off their debts. We are in, and likely to stay in for some time, a low inflation, lower tax and low interest rate environment. Finally, we are moving into a very global market that has and will continue to improve the standard of living for people all over the world.
Many feared that after September 11, the world borders would be closing. We doubted that all along, and we believe that the early indications point to an increased commitment to open markets, especially within North America. For a short time, cross border activity will be slowed, however, we expect to see increased trade, with tighter security in the long run. The simple fact is that we (all nations) need each other, can help each other and in the long run will improve each other's standard of living; a fact that does not seem to be lost on most of the world's leaders. As for Canada, while we would prefer this were not the case, in the Eastern United States, one way or another, there will be some massive construction projects going on for some time. These projects are bound to require a lot of Canadian resources, including technical, personnel and physical.
Simply put, Canada is an important part of the solution, not part of the problem, and the powers to be in both Canada and the United States recognize this. Will the recent events have an enormous cost to society? Of course they will. This was truly a disaster. Should we all feel greatly grieved by the events? Yes, and we are. However, we will get past this and move on to better things. There is also an opportunity here. We are seeing a degree of global unity, co-operation and support that is unlike anything we have ever seen. While it is unlikely that we can stamp out bigotry and hatred, and to some extent recent events will fuel them. There is a genuine opportunity to significantly reduce them and promote human unity, cooperation, support and trade.
So what is an investor to do? First and foremost, do not panic. You are bound to be holding some investments that will be genuinely hurt by recent events. However, the damage is done and chances are that the market has over-reacted, so sit tight. If you are holding a balanced and diversified portfolio of high quality investments, then you should weather the next while with limited short-term damage, and little or no permanent damage. If you have excess cash to invest, we believe that over the next while we will experience an exceptional buying opportunity. Just be sure to stick to our IFC investment principles and put a little extra emphasis on quality.
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In our May & June 2001 issue, we posted some charts of the last couple decades and noted that for the most part we were in the middle of an upward sloped trading channel. We indicated that in our opinion, in 2001, the Dow Jones Industrial average could drop as low as 8,000 without breaking out of the channel. It is interesting to note that the Dow bottomed out in 2001 at 7927. We have redrawn the chart, again using Big Charts (see link in the Interesting Links section below) and note that the Dow has now climbed up to just the below the middle of the channel. We also noted that for the Toronto Stock Exchange, based on the last decade (the information available using Big Charts) that depending on how you draw the line, the channel might have been broken a couple of times, but in the end, prices returned to the channel. We also noted that from late 1999 to mid 2000 a bearish head and shoulders formation was created, which suggested that the TSE 300 could drop to the mid 6000 range, but even that would not break the channel. It is interesting to note that the TSE 300 bottomed out at 6513 in 2001. We have since redrawn the chart and find it interesting to note that the way we drew the lines suggest that the TSE did briefly fall slightly below the support line but that it closed the year in the bottom quarter of the channel. So, where do we go from here?
We believe that the charts support our position that nothing has changed. From a market and economic perspective, nothing unusual has happened. Both are growing, but there will always be ups and downs along the way, and some of them will come as complete surprises, while others will sneak up on you and by the time you recognize them, it will be too late. Overall, ten years from now, the last couple of years will blend into the charts and appear as just another blip along the way. In the short run, we believe that we are experiencing another one of those buying opportunities that keep cropping up, however, remember, "It is really a market of stocks, not a stock market." Many companies will flourish, and in the long run, most of the quality ones will, while many of those of lesser quality will eventually disappoint you. Also, even with the good companies, the road will not be a smooth or totally predictable one. So our advice stands. Stick to our four IFC Investment principles. As hard as it may sometimes be to do that, we are confident that in the long run you will be glad you did. We know we have been.
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Over the long run, which is what counts, there is a lot of reason for optimism. Increased globalization, maturing baby boomers, improved efficiencies and decreased tax rates will drive the economy on to bigger and better things. Where we are going is not the major question, it is more a matter of at what speed and the route that we will take, and the route is bound to be choppy. So what is the best strategy?
Overall, we recommend that you stick to our four IFC investments principles as in the long run we expect they will serve you well. On a more micro base, we have been using this strength as an opportunity to dump some of the stocks we no longer like or are not as fond of. This is also freeing up some cash for future opportunities and providing cash to pick up or increase our holdings in a few stocks that we do like but have been showing some weakness. However, this is only tinkering as our core portfolios are remaining in tact, and this tinkering is after all something we do anyway as opportunities present themselves.
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What often happens is that the market gets hotter and hotter with all facts, warning signs and reason being ignored. Then when the most pessimistic bears decide they cannot stand being left out any longer and jump aboard, reason suddenly prevails. Usually as a result of some major event or series of events, which cause the markets to start to slide. This can happen quickly or gradually. Eventually people start bailing and selling. Then over time the attitude becomes so pessimistic that no matter how good the news, the markets read it all as bad. Sound Familiar.
We believe that we are at the point where the markets are irrationally pessimistic, which makes for a good buying and/or holding opportunity. It is at this stage where markets bottom out and eventually change direction. It can happen quickly or slowly. In this case we expect a slow reversal of the trend and it may be very subtle. Then one day in about a year, we will suddenly realize that the turnaround has happened and that the recovery is well under way. Then over the next few years we can go into the next round and do it all over again. What is an investor to do?
Again, nothing changes. Build a well-diversified portfolio of high quality stocks, balanced with safe securities (high quality bonds, GIC's T-Bills etc.) in such a way as to suit your personal circumstances. The balance should suit you, not the market nor your financial advisor. Quality is as important as ever, as crap is still crap. Sound companies with a good earnings history, good prospects and good management will weather the storms and prosper in the good times. Poor ones will usually fail, not necessarily immediately, but eventually. Finally there is the diversity issue. Different sectors, different regions and for that matter different companies tend to prosper at different times, and the timing has a funny way of surprising us, so diversify.
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The market is low and it will eventually recover and move on to new highs, most likely climbing a wall of worry. It will probably be an uphill battle with trials, tribulations and setbacks along the way. In fact, years from now when we study the charts of the 1990's and the first decade of the twenty-first century, this bear will resemble a setback, maybe a major setback, but a setback in a much larger bull market. This leads us back to our standing advice that we believe is especially important right now.
First and foremost, balance your portfolio according to your personal circumstances. Ignore the market or timing as in the long run they will probably cause you to buy high and sell low. So decide what your mix should be and stick to it. Remember, at times like this when markets are low, it is a result of people being more interested in selling than buying, and when the market is low they should be buying not selling. It is fair to say that it takes a lot of courage to buy low, which explains why the majority are often wrong.
Stick with quality companies. While we believe that a recovery is imminent, many of the lower quality companies will be left behind to either fail or survive but never amount to much. Regardless of where the market goes, a portfolio of speculations is just that, a portfolio of speculations that might come true but most likely will wither away.
Diversify, diversify, diversify. We will say it again for good measure, diversify. It is highly unlikely that all sectors or geographic regions will recover together. Different sectors will recover at different rates and times. If you stay diversified, chances are you will always hold some stocks in the right area. We have seen this in the last couple of years. While the markets have dropped approximately forty percent from peak to bottom, some sectors and some companies have gained and some have dropped a lot more than forty percent. There is no telling which ones will move first, but rest assured, the more certain we are that we know what will move next, the more certain we are that we are wrong. On the same thought, we must warn you about being overweighted in technology stocks. While it is prudent to have some holdings in this area, we are concerned about the general preoccupation with when technology will recover. This is only a small part of the market and should be reflected as such in your portfolio. Further, even if the market recovers, technology might not recover with it. Our suspicion is that a technology recovery could be years away and that it may not include many of the companies that currently make up that sector.
Finally, there is our final principle, to invest regularly and gradually. A disciplined investment program will help you to build a sound portfolio over time, taking advantage of opportunities and limiting the damage caused by the inedible market peaks.
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Eventually the economy will improve and corporate profits will rebound. This will result in higher share prices as ultimately a company's long-term profitability is reflected in its price. In the short term, anything can happen. However, in the long term, on the whole, the best companies will prosper and so will their owners. The thing is, it can take a lot of patience to get there.
We believe that those with patience who stick with our IFC investment principles will eventually be rewarded and glad that they did. Many of those who do not follow (and stick to) a similar philosophy, or who allow themselves to be scared out of their best stocks, will ultimately be dissatisfied with their investment experience as they will probably have managed to buy high and sell low.
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If you have stayed out, then start a regular investing program that will bring you to your objective investment mix over a period of time, perhaps two years. Then maintain the mix. While in theory it is likely that you would be better off to jump right in now, it is usually wiser to invest gradually over time. Markets never travel in a straight line, so investing gradually will allow you to take advantage of the regular setbacks that we will go through. Further, and perhaps more importantly, unexpected events do happen and can result in serious setbacks. Investing gradually will ensure that you do not do all your investing at a peak just before a significant pull back, which could be devastating, at least psychologically if not financially.
So we believe that we are through the worst and that the markets are headed higher over the next few years. However, even if we are right, we are certain that the ride will be a bumpy one and that somewhere over the horizon are some serious drawbacks followed by some more bull markets. And that is how the markets manage to grow at an average rate of around 10% per year over the long haul.
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Last year was the first good year following the longest and deepest market setback since the forties, so the upward trend is likely to last a while. Also, we believe that there is still a lot of pessimism and as a result, a lot of money on the sideline waiting to come into the market. While there are concerns about the low U.S. dollar, it will make U.S. companies more competitive and since the U.S. is the biggest economic driver in the world, this energy will filter down. Next, there are economic drivers like the maturing baby boomers who are coming into the most affluent years of their life cycle, efficiency is continually increasing, globalization is ultimately good for everyone, and recent tax cuts are still a positive factor. Finally, this is the year of the U.S. Presidential election, so there is a lot of incentive for those in power to ensure that overall the news is good. So baring any significant unforeseen events, we believe that 2004 will be a good year for the markets, but our advice remains the same.
If you have been following our IFC principles, odds are that you held up reasonably well through the set backs and did well last year. Regardless, these principles still stand. They will help you to weather the bad times and profit from the good, and since predictions are usually the weakest part of investing, we urge you to stand by solid principles regardless of any predictions, no matter how sure you are of them.
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Heinze: Probably the most relevant is the performance on my own portfolio, as it resembles a Canadian Equity mutual fund. For the 9 years ended December 31, 2006, my portfolio had an average annual return of 11.5%. This beat the TSX composite and the Dow Jones Industrial Index's that had average annual returns of about 9.3% and 7.0% respectively. Here is a chart in pdf format of the respective performance of $1,000 invested in all three to the end of September 2007.
I only have records that can be used to get these numbers for the last nine years. However, from the information I have, chances are my ten year return would be slightly better than my 9 year performance at the end of 2006. Based on GlobeinvestorGold information, compared to the funds that survived the last ten years, 11.5% per year average return would be in the top 7% of all mutual funds in Canada and the top 13% of Canadian Equity funds. If I deduct 1.5% for management fees, my return puts me in the top 14% of all funds and the top 35% of Canadian Equity funds.
Editors note: January 23, 2008: For the ten years ended December 31, 2007, Dave's portfolio returned 11.07%. Based on the GlobeinvestorGold information, this put him in the 10% of all funds and top 15% of Canadian Equity funds.
FI: What do you mean by funds that survived?
Heinze: Well a lot of funds have disappeared over the last 10 years. I cannot seem to find good information on how many funds disappeared, however, it appears that in Canada there were around 2,000 funds over ten years ago. As of December 31, 2006, there are over 6,000 funds listed on GlobeinvestorGold, of those only 1060 funds were over 10 years old. For Canadian equity funds, there were 617 funds listed, yet only 104 were over 10 years old. It is evident that a lot of funds that existed 10 years ago, perhaps even the majority did not survive, and those funds are not included in any comparisons.
FI: So what happened to the ones that disappeared?
Heinze: Good question. I suspect that while some dissolved, the vast majority were merged with other funds. But lets be fair, very few, if any of the new merged funds would have taken on the name and record of the poorer performer. So the question is, if you bought a fund 10 years ago and held on to it through whatever mergers etc., what is the chance that you would have realized a return as good as the top 50%. You might assume that there would be a 50% chance that you would hold a fund with a 10 year track record in the top 50%, but I suspect that the odds are more like 25% that you would have realized that return on your fund.
FI: What about your shorter term performance?
Heinze: Well that depends on the period. I had a very good year in 2006 with a return of 19.0%, and I beat the TSX that year. But this year while I should make money, I expect that my return will be a little less that the TSX, mainly due to currency losses. All portfolio managers have good years and bad years, I am no different. If you meet one that thinks they will not have bad years, or bad years relative to the indexes, run away.
As a general rule, I do well during the good times, but not exceptionally well, I do better than average in the average times and very well relatively in the bad times. I must stress the word relatively. In other words, I may still lose money in a down market, but I usually do a fair bit better than the indexes during those times. I am happy with that mix as it is reasonable and should be fairly sustainable.
FI: You mentioned Currency Losses this year?
Heinze: Yes, the Canadian dollar had an exceptional year. This can be and is both a blessing and a curse, but that is a whole other discussion. In terms of portfolio performance, like any portfolio holding U.S. stocks, while the U.S. stocks might have made money or stood still in U.S. dollars, they may have lost ground in Canadian dollars. Of course, the TSX is all Canadian, so it would not be affected by this.
FI: Okay, so back to your performance. You seem to have pretty sound returns, is there a secret to your success?
Heinze: No secret, no magic, no great insights. I do not know the future. Well maybe that is the secret; I know I do not know the future and that I will make mistakes. I also do not expect to make a lot of money fast. That could be an advantage.
What I can do is build a well diversified portfolio of high quality stocks that I intend to hold for years, maybe decades. You see, I do know how to pick a good high quality company with a good earnings history and good potential, and, I can be right about that most of the time. Not all the time, but most of the time. I can also calculate a reasonable intrinsic value for a stock. This will not help me time the market, but will help me satisfy myself that I am holding good value overall. Finally, I can build a good well diversified portfolio of these stocks. The rest should be no more then tinkering. My approach is not a secret, but you could say it is a sound formula.
FI: Where do you get your ideas about companies to pick?
Heinze: A great person once said that everyone needs a hand from time to time. Or maybe I said it, but I am sure I was not the first. There are many publications readily available; the trick is to find the good ones. Obviously I believe those are the ones that think like I do. I will not say they are the best, but two major sources that I follow are The Investment Reporter, put out by MPL communications and Pat McKeough's The Successful Investor. Actually, I get all of McKeough's publications, and he is my favourite. Both of these publications have followed a similar philosophy for years. The Investment Reporter has been around since the forties. McKeough used to write for them, I believe in the eighties.
These publications give me sound ideas, help me stay abreast of current affairs regarding my companies without overreacting, and in general give sound investing advise. Then I do my own analysis and make decisions that I believe are most suited to the circumstances. It is worth noting that I do not always agree with these publications, hell, I do not always agree with anyone, not even my wife. For that matter, I may not even agree with myself sometimes. Also, just like me, these publications are not always right. But, their information and recommendations are generally sound and their philosophy is very similar to mine. Or maybe my philosophy is similar to theirs, who knows.
FI: Are there other references you use?
Heinze: Obviously there are the financial statements of the companies. Also, there are lots of places (including broker research) where I can get information. In those cases I pay attention to things like the financial statements, historical numbers and general information, but put little reliance on the opinions.
FI: Why is that? I would have thought that the opinions are the important part?
Heinze: Well, as a general rule I do not feel they are that reliable. This can be for a number of reasons; like being too close to the action, over reacting, the all to human inclination of trying to outsmart the future, fear of being wrong, inflated egos, short term emphasis, and even conflicts of interest. I am sure that this does not apply to many sources; the trick is to find the ones you can trust. So I use these mainly for the factual information, mainly the numbers and sometimes the news.
FI: What is your thought on investing in trends?
Heinze: Have fun and count me out. Personally, until I get my crystal ball working, I will ignore trends. If anything I would invest against the trend, but that is probably my contrarian nature poking through. Or maybe I am just negative.
FI: Are you generally negative?
Heinze: I do not think so. My mother used to say that I was the last of the great optimise. I think that was and is true. I am a glass half full kind of guy. I would not be where I am today if that was not true.
FI: How does that effect investing?
Heinze: I think it has served me well. I build a well diversified portfolio of high quality companies with good prospects that I can hold for a long time. And I do hold most of them for many years, sometimes decades. Most years I only turn over about ten percent of my portfolios. You have to be an optimist to do that, especially during turmoil and negative events. There is almost always some reason to panic, but these events, even the worst of them like Black Monday and 911 for example, nearly always turn out to be blips from an overall long term economic point of view.
FI: Is that Optimism or steady nerves?
Heinze: Probably both. You have to be able to sit through the inevitable bad times and to some extent use them as opportunities when you can. That takes steady nerves, but if you are not optimistic, then I do not see how you can do that.
FI: So to sum it up, you're an optimist whose approach is to build a good portfolio of high quality companies that you can hold for many years, or even decades. It is that simple.
Heinze: Yes it is really fairly simple. If I were to add anything else, it might be to avoid the popular and fancy investments, especially ones with special bells and whistles. In the end holding hot or fancy stuff, flipping investments or regularly changing approaches will probably kill you, investment wise. But you might make your broker rich.
FI: Thank you.
Heinze: You're welcome.
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Heinze: I definitely would not change my approach. It is because of times like these that I stick to my approach. To follow up from last year, for the year 2008 my personal portfolio lost 28%. I believe that was my worst year ever. But that still beats the market and most Canadian Equity mutual funds. Also, to put it in perspective it was equal to giving up the last 3 to four years returns. That may sound bad, but after 30 years of investing it is not really a big deal and it is bound to happen from time to time.
IFC: So that is like giving up some previous gains. Do you wonder if you should have sold high and avoided the loss?
Heinze: If my crystal ball worked, I would be much wealthier than I am now, but it does not. Yes I gave up some gains, but if I got out of the market every time there might be a setback, I would never be in the market and I would not have any gains to give up so I would be a lot poorer today. Reality is that it is three steps forward, one back, two forward, one back, five forward three back kind of thing. But at the end of the day, or decade, my approach provides good returns with minimal losses.
IFC: Last time you compared you returns to Canadian Equity mutual funds. How do you measure up now?
Heinze: I am happy with my relative performance. Of course while I know my numbers, comparative information as at December 31 is not yet available. As of December 31, for the year 2008 my portfolio lost 28%, for the ten years ended December 31, 2008 I had an average annual return of 6.4%. However, we can compare the period ended November 30, 2008. For the 12 months ended November 30, 2008, I lost 26.8%. For the 10 years ended November 30, 2008, I had an average annual return of 6.8%. Based on Globe Investor Gold funds reports, that puts me in the top 22% for one year returns and top 20% for 10 year returns for Canadian Equity funds, which is the best comparison I have. I also want to point out, as I did last year, that is of the funds that survived, as not all the funds in existence at the beginning of the period were still around at the end.
IFC: You talked about funds that disappear last year so we will not rehash it today. If readers wish more on that they can scroll down to that conversation which is reprinted below. In light of the economic times, perhaps we can talk about some economic issues. First, have you ever seen anything like this before?
Heinze: This actually reminds me a lot of 1982. When I look at a log chart of the TSX going back into the seventies, I see striking similarities. The drop is similar to the one that happened in 1982. At around 9000 the percentage drop was almost identical, so we have dropped a little more from top to bottom, assuming we have seen the bottom, but really it is a very similar chart. I lived in Calgary in 1982 and the current housing market in parts of the United States really reminds me of that time in Calgary. I think this is very similar to 1982 and the market recovered and thrived after that. It worked out very well for us, in 1984 we bought our first house and as luck would have it we could not have planned it better. I talked about that in the January 2000 issue of Financial Insight that is reprinted on our web site.
IFC: Are there differences?
Heinze: Yes there are some positive differences. In 1982 we were facing runaway inflation and runaway interest rates. Today, interest rates and inflation are both under control. Also, it appears that most of the economic powers are working together. If they continue and resist the urge for protectionism, then we may be about to witness something unprecedented, global cooperation. The other difference is in the approach of government, or at least in the Canadian government. In 1982, the Liberal government tried to spend its way out of the recession, something we could not afford, especially given the runaway inflation and interest rates of the time. This created huge structural deficits that took years and two different governments to bring under control. Today, inflation and interest rates are under control and we have a healthy fear of deficits.
IFC: Do you oppose Government stimulus at this point?
Heinze: I am concerned. One of the most dangerous things an investor can say is "this time it is different." But there are differences. Inflation and interest rates are under control and there is a very real understanding of how dangerous deficits can be and what they will cost. But yes, I am concerned. However, there is a lot of infrastructure that needs tending to and sooner or later we will have to pay for it. It seems to me that this is the time to do it, while costs are lower and labor is more available. We get the job done, cheaper, get some stimulus and wind up with a better infrastructure that helps position us for recovery. As long as we only do what needs to be or should be done and do not do projects for the sake of doing projects and once they are done we stop.
IFC: How do you feel about corporate bail outs?
Heinze: Fundamentally I oppose them. It has been said that subsidy and government bailout are the Canadian way. I refer to this as pulling everyone down to the lowest common denominator. It is far better to create an environment that encourages competition and rewards success which in the long run will create more jobs and opportunity and pull everyone up to the highest common denominator. That is the Canada that I would like to see and I like to believe it is achievable. Having said that, I am more sympathetic than I normally would be. The financial crises created a situation that no one could have reasonably been expected to be prepared for. However, I am worried that in the long run, we may do more harm than good. Probably the best thing governments can do is to try to grease the wheels of the financial system the best they can and get things going again, this will create an environment for success.
IFC: What about the auto sector?
Heinze: The same holds true for them. It may be necessary to give a temporary life line but in the end the best thing that can be done for them is to get the economy and the money flowing again. At the end of the day, there will be an auto sector, as people will still be buying cars. However, I expect that the sector will be very different then it is today and I hope that by throwing them a life line we are not just deferring the inevitable.
IFC: Well it looks as though 2009 will be a very interesting year. I look forward to seeing what happens. Thank you.
Heinze: I look forward to it too, and you are welcome.
Editors Note: Here is an updated chart in pdf format of the respective performance of $1,000 invested in Dave's portfolio verse the TSX and the DOW from January 1, 1998 to the end of January 2011.
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So where are we? We use to have a recession every few years; now we have not had one in nearly 20 years. If you had told me in 1990 that we would go nearly 20 years without a recession, I would have laughed at you. Yet here we are. It has often been said that market based capitalism is not a perfect system, but it is the best we have. I concur. It might be nice if we had a system where we all got the same rewards and we would all work hard for the benefit of the world. Yes that would be nice, but we are not ants, and we are not wired that way. Yes most of us believe in doing the right thing, have a high moral character (although our individual definitions of morality may vary) but we are wired to first look out for the interest and well being of ourselves and our families, then those close to us, then those of the same religion, then our country and somewhere down the line maybe the benefit everyone on the planet. For everyone the list and order will be little different, but you get the point. If you do not believe me, ask yourself: Would you sacrifice the five people most important to you to save a hundred strangers who live on the other side of the planet? How about a thousand?
Market based Capitalism has brought the world many innovations. However, it is not perfect and it does need a certain level of checks and balances. The markets greatest weakness is that in the short run it is driven by greed and fear. On the other hand one of its greatest strengths may be that it is driven by greed and fear. As a result, every so often a correction or recession becomes necessary to shake out inefficiencies, realign things and to bring us back to reality.
So what happened? Well, aside from being overdue, a number of things. However, it appears that the most significant was a financial crises brought about by a thing called sub-prime mortgages. As I understand it, it went sort of like this. The economy was doing very well. Governments (especially the U.S. government) believed it would be nice if more people could own their own homes. Their hearts were in the right place. Since interest rates were low and house prices were climbing, at the time it seemed like a good idea to let people borrow 100% of the value of their home (nothing down) and then only require them to make interest payments. Since values were rising, people would accrue equity through the inflated house values. And inflate they did as people who could not really afford to buy their own home entered (maybe flooded) certain markets. Of course this also had to be financed. Some of this came from traditional sources, but then clever financiers decided to package the loans into investment vehicles and sell them as sound mortgage backed securities. Of course most of the investors did not really know or understand what they were investing in and it did not help when rating agencies gave the vehicles high ratings. This might not have worked so well had there not been a lot of investors reaching for yield, something we have discouraged. In our opinion, reaching for yield, or looking for higher and higher returns from fixed income securities has become a problem since the days of high inflation and high interest rates. Investors remember when they could get 10% plus interest on secure investments like government bonds and GIC's etc. They have this misguided idea that they should still be able to get these high rates without risk and go looking for them. Brokers and advisors who want to please their clients then promoted vehicles that we considered inappropriate like junk bonds, income trusts, sub-prime mortgages and hedge funds to name a few, without due regard for risk. Everything was good until the inevitable hick- up and then the whole thing unraveled. Few saw it coming. While we always thought that things like income trusts and hedge funds were ill-conceived, inappropriate for most investors and would burn their investors, we never saw this coming.
So what happens next? Well only time will tell. I recently called the bottom, but as I like to say, it is only about the fourth time I called the bottom, and eventually I will be right. Personally I think that we have seen the market bottom and that sometime in late 2009 the economy will turn too. But it could take longer. The road back might only take a year or so, but it could take a few, but I am confident in the long term future. Globalization, technology, the internet and automation are wonderful things that should ultimately benefit people around the world and in time bring us all closer together. But the road is bound to be a bumpy one. If you strip away the money and financial terms etc. what you have left is a finite amount of resources. By resources I mean work force, infrastructure, buildings, plants and natural resources etc. This is not a physical disaster like the flood's of New Orleans's where physical assets/resources were destroyed. It is an economic recession and it does not change the amount of resources available. What it will do is change how those resources are owned and how and where they are deployed. In the end, that will probably mean that they are used more effectively, resulting in a stronger economy, a better standard of living for more people and hopefully a greener economy as the shakeup will provide opportunities for change.
So what is an investor to do? We believe that our principles are more important than ever. Panicking will only cost you. Hopefully you have a diversified portfolio of high quality stocks. Both quality and diversity are very critical at this juncture. A friend asked me the other day what sectors he should emphasize now. I pointed out that there are more ways to be wrong then right and I believe that being diversified is extremely important, especially right now. More importantly, you need to be sure not to be overexposed in any sector or company. Second, I cannot stress quality enough. Most of the best companies, many of which remain profitable will benefit from the shakeup and eventually flourish. Many of the lower quality ones will disappear. On closing, be patient and remember Marian's words "we have been through this before when we had far less and we will come out of this again and in a few years have far more than we have today."
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1. Balance your investments according to your personal circumstances.
2. Always diversify your investments.
3. Invest in quality.
4. Invest regularly and gradually.
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