Dirt Simple

An article by Lex Kerkovius in Globe Investor Magazine offers 10 reasons to suggest that the stock market has bottomed.

I never suggest that anyone should time the market, but as I’ve mentioned before, there are times when stocks are cheaper, and adding to your holdings during those times can have a dramatic impact on your overall return. If you follow a prudent asset allocation strategy, you’ll end up doing this automatically when you re-balance your portfolio once or twice a year.

If stocks take a tumble, they will represent a smaller percentage of your portfolio’s total value. So, when you rebalance, you would add to your stock holdings to bring their proportion back to your desired weighting. By default, you end up buying stocks when they’re cheaper.

Is this the bottom of the pullback? Is it the start of another bull run? I don’t know, but this article cites some valid points which certainly indicate that a recovery may be building.

The Dow Jones Industrial Average is an index composed of thirty of the largest companies in the United States, and according to an article by Fabrice Taylor in The Globe and Mail [The Dow: Three reasons why it may be time to buy], the stocks in the Dow index are starting to look like good value, particularly for Canadians.

One of the reasons cited in the article is the fact that the Canadian dollar is roughly at par with the US dollar right now, so on a historical basis, US stocks are now cheaper for Canadians to buy. Predictions right now seem to indicate that the Canadian dollar is likely to give back some of it’s gains as commodity prices retreat a bit. If that proves true, Canadians holding US assets will benefit from a currency gain, in addition to any possible gains in the value of their stocks.

The Dow is one possible avenue for investment, but if you’re a small investor, and prefer index funds to buying the individual stocks, there aren’t many Dow Jones Index mutual funds available in Canada. In fact, I was only able to find one: the TD Dow Jones Average Index. Another option is the Diamonds ETF, which is a Dow Jones Index Exchange Traded Fund. It trades on the American Stock Exchange under the symbol DIA. You’ll need an account with a brokerage firm in order to buy them.

In parting, it’s worth noting how big an impact currency exchange can have on your investments. For example, a $10,000 investment in the TD Dow Jones Index fund made in April 1998 and held continuously to the present would have resulted in a loss of around $500. That’s right, holding the index fund for ten years would actually have resulted in a loss. This is due to the decline in the US dollar. That decline completely offset any gain in the value of the underlying stocks when valued in Canadian dollars.

So, if you believe that the US dollar is likely to regain some of its lost ground, and that US stocks are fairly value now, this may indeed be a prudent point to add US holdings. Just be aware of how big an impact currency moves can have when they move counter to your expectations.

I’ve seen one of these new Zenn electric cars around town here, but didn’t realize until today that this was a Canadian product. Here’s CBC’s Rick Mercer getting the low down on the (Z)ero (E)mmission (N)o (N)oise Zenn:

Now this spot didn’t make mention of the fact that this is a low speed vehicle. It tops out at 25 mph, so this isn’t going to replace regular cars for long distance travel. But for inner city transportation, a vehicle like this makes a whole lot of sense.

If you read through the financial press today, you’ll find no shortage of doom and gloom articles. There’s the Fannie May/Freddie Mac debacle, the failure of Indy Mac bank, and lots of talk about stagflation (stagnant economic growth, coupled with rising inflation). The stock markets have reacted with sharp declines, and a lot of people will be looking at their investment accounts and wondering if it’s time get out of the market.

That would be one of the worst reactions a person could have right now. In fact, all this doom and gloom signals a buying opportunity to me. Lots of good, solid companies are seeing their stock prices driven down right now because of the overall negative sentiment in the market. The media has pounced on these negative issues with abandon, as usual, and created the perception that this is a horrible time to be in stocks, and that it’s only going to get worse.

I watched a clip on Bloomberg the other day in which some economist said that not all parts of the economy were bad, and there was actually some evidence that the U.S. might not even be in recession as many are claiming. The news guy then ended the report by saying, “Alright, blood on the streets.” What? Huh? At no time did the interviewee suggest that things were that horrible. The media guy with that one comment, spun the whole segment to give it the negative tone that he and his producers apparently wanted. I can’t seem to link to the video now, but I’m sure you can find similar examples all over the financial press.

You don’t have to be an economist to know when the economy is a little sour. And similarly, you don’t need to be a financial analyst to know when it’s a good time to buy stocks. When people are getting to the point where they won’t touch stocks with a ten foot pole, you know it’s a buyer’s market. It’s hard to wrap your head around it when you have talking heads on the TV saying things like “blood in the streets,” but this is the time to be adding to your retirement savings.

I don’t pick individual stocks, so I’m not going to tell you that this is a great time to pick up this stock, or that stock. If you want to try to pick individual stocks, be my guest. I just see this as a fantastic time to start buying the market as a whole by way of index funds, or exchange traded funds. If your retirement plan only offers regular (non-index) mutual funds, you will still reap the benefits of buying stocks while they’re on sale. Is it the bottom of the market? I have no idea. Neither do any of the financial gurus. But if you gradually add to your holdings at times like these, you will “dollar cost average” your way into the market, and enhance your overall return down the road.

I’ve quoted Warren Buffett before, but it seems even more apropos now.

“Be fearful when others are greedy, and greedy when others are fearful.”

I read in the Globe & Mail today about the release of the iPhone in Canada, and the whole thing strikes me as just a little absurd.

I’ll be the first to admit to being a bit of an internet junkie. I love the internet. But for some reason, I don’t feel any pressing need at all to have it “in the palm of my hand” everywhere, all the time. Especially not enough to stand in line for twelve hours to get a $350 iPhone, and then to pay $80 plus per month for the service, on top of my regular internet service.

I literally had to laugh at some of the quotes from buyers, who were either ecstatic about finally being able to possess such an “amazing, amazing device,” or who couldn’t get a phone due to shortages, or were displeased with the cost.

Some quotes from the article:

“It’s a little weird,” admitted Mr. Meagher. “I don’t remember my first kiss but hopefully I’ll remember this.”

“I feel so happy I’ve finally got hold of one of these. I’ve never felt an iPhone before,” Mr. Brown said, gripping his new phone.

“I feel let down by the company I already pay way too much money to,” he said. Mr. Smith, who works for a web-design company, booked the day off a month ago.

Noah Kirschenbaum, 23, said he was “disgusted” that he may not be able to get an iPhone even though he had been in line since 4 a.m.

“I’ve been misled,” Mr. Kirschenbaum said.

Maad Mian, 19, waited in line for almost 13 hours. He said he was irked that Rogers was not offering an unlimited data plan.

“I do have a problem with it, but what can I do — I really wanted the iPhone,” he said.

Oh, the humanity. I do hope all these people will eventually find satisfaction with their iGadgets.

Meanwhile, in other news…

Summer weather has finally arrived in the Pacific Northwest, and I’ve been spending more time outside and neglecting the blog a little. I ran across an article in The Guardian the other day though and thought I’d share it. It’s about the food being served at the G8 food shortages summit. It’s funny and tragic at the same time.

From the article:

After discussing famine in Africa, the peckish politicians and five spouses took on four bite-sized amuse-bouche to tickle their palates. The price of staple foods may be soaring, but thankfully caviar and sea urchin are within the purchasing power of leaders and their taxpayers - the amuse-bouche featured corn stuffed with caviar, smoked salmon and sea urchin, hot onion tart and winter lily bulb.

The Toronto Star ran an article today entitled, U.S. dollar mighty no more. This isn’t really news anymore, but I wonder how many Americans really grasp the significance of it.

As a Canadian living in the U.S., the impact of the declining dollar is immediately relevant to me because a lot of my savings are still in Canada. There’s an impact on me in terms of bringing those savings into the United States. On the one hand, the conversion rate is pretty favorable to me now, but on the other hand, if I intend to return to Canada at some point in the future, do I want to have my savings tied up in a declining currency?

It used to be that people warning of a collapse in the U.S. dollar were relegated to the tin-foil hat circle of wacky conspiracy theorists who were always predicting the end was near. Now it seems that the credibility of those doom and gloom theorists is growing.

Washington has been talking up the dollar a lot lately, with both the President and the Federal Reserve Chairman going on about a strong dollar being a top priority. But it seems that talking is about all they have done.

The Federal Reserve’s hands are tied at this point because the economy is largely in the toilet and waiting to be flushed. Raising interest rates, which would support the dollar, would essentially be hitting the flush lever on the toilet. Buying U.S. dollars in the currency markets to prop up the dollar might be seen as desperation and greeted with more selling.

The one thing that wasn’t mentioned in the article was the financial bleeding caused by the war in Iraq. Regardless of your standpoint on the war, you can’t deny the vast sums of money it has been sucking out of American taxpayers, present and future. I’m just a lowly individual, but this certainly affects my outlook on the stability of the U.S. as a nation in which to invest. How do you think it appears to the people with the real money? At some point, the proponents of the war have to ask themselves if bankrupting the nation is worth whatever perceived payoff they expect to get from continued presence in Iraq.

If I’m investing in a company, I might be impressed by the decor in the lobby of its head office, but in the end, it comes down to what’s on the books. America needs to get its balance sheet in order if it expects to regain its status as the world’s reserve currency. In other words, quit spending more than it earns, and pay down the national debt. This doesn’t even seem to register as an option in Washington. Until it does, I don’t expect much from the greenback. Just my two cents.

When evaluating mutual funds, we often spend a lot of time looking at past performance. The assumption is that a fund which has performed well in the past, will continue to perform well in the future. We tend to assume that this past performance was due largely to the skill of the manager running the fund. But how do you distinguish between skill and luck? Can a fund perform well in a number of consecutive years purely as a result of luck?

The short answer is, yes. Statistically speaking, it’s entirely possible that a fund manager could have a winning streak that lasts several years, due in large part to luck.

I read a story somewhere ( I can’t remember where now) about a finance teacher who used to impress this point upon his students with a simple exercise. Everyone in the class would stand up. The teacher would then toss a coin, and the students would call it. Everyone who got the call wrong would sit down. Inevitably, with each toss, a large portion of the class would sit down. But there would always be a few individuals who remained standing for a long time, and one would often outlast them all, correctly calling ten to twenty coin tosses, or more.

What this illustrates is that it’s statistically possible for a mutual fund manager to have a series of consecutive winning years which are attributable in whole, or in part, to luck. Determining whether performance is attributable to luck or skill is next to impossible in the short term. When a fund has a good year, the management can point to all the decisions they made, and seem prescient, as if they knew all along what was going to happen in the market. When things don’t go so well, they can point to “unforeseen factors” which adversely affected returns. We might forgive them their failure because, after all, even the best can’t be right all the time.

But skill can’t be discounted entirely. Calling coin tosses doesn’t involve any skill at all, so it’s actually not an entirely fair comparison to stock picking. If I stood in front of a basketball hoop, there’s a statistical chance that I could make twenty free throws in a row. I would venture a guess that the odds are somewhere near one in a million, but it’s possible. If Michael Jordan were standing in front of the hoop, the odds of twenty baskets in a row would be a lot better.

Similarly, knowledge of the markets, economic trends, accounting, and company management, are all special skills that will give a fund manager an edge in picking stocks over a complete amateur. However, the difficulty is, picking stocks isn’t like making free throws. Picture Michael Jordan in front of a basket that moved in a random direction every few seconds, and you’ve got a good idea of what a fund manager is up against.

So what do you do as a mutual fund investor then? Well, one solution might be to hedge your bets, and put the greater portion of your stock investment money into an index fund which passively tracks the entire market. You will never outperform the market, but you won’t significantly underperform it either. If you must pick an actively managed mutual fund, the best you can do is to look for a track record of superior performance, and hope that the greater part of that performance was due to luck, and not to skill.