Pathways Investing certainties in an era of doubt

I thought I would pass along a great article from the Globe and Mail from Saturday, October 1, 2011, in case you did not see it. The columnist is Tom Bradley who has a recurring column in the Globe. Tom is past CEO of Philips, Hager & North, an investment counselor from BC which was recently sold to RBC. Tom now runs a small mutual fund company called Steady Hand. Tom always provides some great insights. I hope you find it interesting

In calmer moments, investors recognize their inability to know what the future holds. In moments of extreme panic or enthusiasm, however, they become remarkably bold in their predictions: They act as though uncertainty has vanished and the outcome is beyond doubt.
These words are from the late Peter Bernstein analyst, strategist and author of Against the Gods: The Remarkable Story of Risk. When we look at todays investing landscape, theres a lot we shouldnt be certain about in the political, economic and business arenas. But at the risk of ignoring Mr. Bernsteins counsel, the current market fray does make me more confident about some things. Bond returns will be poor With a further decline in yields, the math for bondholders is even more dismal than it was just a few months ago. If yields stay at these low levels, investors are going to earn 2 per cent before commissions, fees and taxes. If rates rise, theyll eventually achieve better returns, but not before experiencing capital losses on their existing bond holdings. Expect more from stocks Stock prices always take a more winding path than do the company fundamentals that underpin them. With a recession looming, the outlook for corporate profits in the short (and perhaps medium) term has worsened. But true to form, stocks have more than reflected that and price-to-earnings multiples are now down to attractive levels. This has occurred despite the fact that only a small part of any stocks value is derived from near-term earnings. At client presentations in January, I suggested that stock returns over the next five-plus years would be between 5 and 8 per cent. I arrived at that intentionally wide range (Im uncertain) by adding dividends (2 to 3 per cent) to corporate profit growth (3 to 4 per cent) and assuming no change in valuation multiples. (Note: The growth number is well below the historical pace of 6 per cent). Today, however, my range is 7 to 10 per cent. To get there, Ive left the first two variables unchanged (although dividend yields are higher now) and built in an improvement for future valuations, which will produce higher returns.

Pathways Investing certainties in an era of doubt

Relax, everyone is bearish An investor was recently heard to say, The market may not have bottomed yet, but I have. Ill resist quoting Warren Buffett, but suffice to say that when everyone is beaten up, discouraged and fearful, risk in the market is substantially reduced and opportunity is greater. Thats because when people are negative, most of the selling has been done and the bad news is largely factored into security prices. A bearish consensus is a prerequisite for a market bottom and sets the stage for above-average returns on the way back up. Moving from market generalities to portfolio specifics, there are a few other things Im more certain about. First, investors in the accumulation phase who have a long time to invest are being given a gift. At current prices, they can buy more shares with the same amount of money. Second, investors who havent yet rebalanced their portfolios have a lower percentage in stocks than they did when the market started its decline six months ago. If they want to ride the market back up with as much as they went down with, then its a mathematical certainty theyll need to do some buying. And finally, this is a time when investors should lean on their long-term plan, not rewrite it. Its tempting to make changes that match the magnitude of the market declines, but whats called for are small, incremental moves (that is, rebalancing). With emotions running high, the chance of a major overhaul going seriously wrong is also high. Mr. Bernstein says market bottoms are defined by a switch from doubt to certainty. On that measure, I dont know if weve seen the lows yet. Certainly, Im guilty of being more confident about some things, but be assured my list doesnt include whats going to happen to Spain, interest rates, gold, Swiss francs, credit spreads, correlations, GDP growth, copper, volatility, the U.S. dollar, profit margins, Chinas real estate market, natural gas or where the market will be next month.
Tom Bradley is president of Steadyhand Investment Funds Inc.

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