Archive for December 5, 2011

| December 28, 2011
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Market Outlook December 28, 2011

Inflation expectations are rising, which doesn’t bode well for the economy. On the other hand, interest rates are extremely low, which is generally stimulative of the economy. The stock market had a good week, rising almost 2%. That doesn’t make up for the poor performance earlier this year, and it looks like the market will finish the year around -10%. Good thing for dividends.

Bonds continue to show better momentum than stocks, simply by virtue of being positive over the past year. Even gold has turned down, so I’ll continue to own a real estate index (XRE). Hopefully that will get me through the end of the year, since my accounts are being transferred from my prior employer to a self-directed account.

I’ll be back in the new year.

Category: Uncategorized |
| December 24, 2011
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Market closure

Merry Christmas!

The TSX is closed on December 26th and December 27th. It will be a very short week, and I’ll post my market outlook on December 28th.

Category: Uncategorized |
| December 19, 2011
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Market Outlook December 19, 2011

The good news is that the VIX continues to fall. It is now below 25 (a little), and hopefully it will continue to fall below 20. This would mean that the popular outlook is becoming more tempered and less expectant of surprises. That doesn’t mean the market will necessarily improve, but when investors have less uncertainty, they’re more likely to invest. As they do, increased demand tends to push up prices. This, in turn, feeds the perception that markets are a good investment, further feeding the “virtuous cycle.”

We’re not quite there yet, though. Last week was negative for stocks, while it was positive for bonds. Bonds continue to be favoured by the market, with super-low yields and high prices. Stock markets, on the other hand, continue to display negative momentum, and appear more and more undervalued. This week, the stock market appears almost 9% undervalued, while my fair value estimate has remained virtually unchanged.

I was pleasantly surprised this week by the relative performances of gold and real estate stocks. Since selling gold to buy real estate (XRE), I watched closely to see if it appeared to be the right decision. This last week, gold dropped over 5%, while real estate rose 0.33%. You can view the comparison on Google Finance. This week, I will continue to own XRE.

Category: Uncategorized |
| December 14, 2011
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What Does the VIX Mean?

In a couple recent blog posts looking at the state of the stock market, I have referred to the VIX. It has occurred to me to dig a little deeper to find out what the VIX measures and how it can be interpreted. The results were a little disappointing, but not altogether unsurprising.

First, the VIX is a measure of expected volatility, when I thought it was a reporting of experienced volatility. I didn’t realize that the VIX is quoted in percentage points.  That makes sense, since it’s a measure of the implied volatility found in S&P 500 option contracts. According to Wikipedia (fount of all knowledge), the VIX “translates, roughly, to the expected movement in the S&P 500 index over the next 30-day period, which is then annualized. For example, if the VIX is 15, this represents an expected annualized change of 15% over the next 30 days; thus one can infer that the index option markets expect the S&P 500 to move up or down 15%/√12 = 4.33% over the next 30-day period.”

It was pointed out that volatility doesn’t necessarily mean that markets are expected to fall. A market that is expected to quickly rise will also translate to higher volatility. But what the VIX is reporting is people’s expectations. When people expect the market to rise, they expect it to rise consistently and orderly. When people expect the market to fall (continue falling), they expect the worst.

So the VIX turns out to be similar to a measure of sentiment. During the market crash, sentiment was poor and the VIX was high. Alternatively, when the market appears to be rising, sentiment is good and the VIX is low. But since investors, even professional traders who deal in S&P 500 futures, have been shown to be unable to predict the market behaviour over the coming 30 days, the VIX reflects current sentiment and is unuseful as a predictor of future market returns.

 

Category: Opinion |
| December 12, 2011
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Market Outlook December 12, 2011

First, what really concerns me is that interest rates have fallen lower than I have seen them. Going back to the crisis of 2008, interest rates have not been lower (and they were far higher before the market crash). In fact, I have data back to 2001 on Government of Canada bonds (10 year, 3 year and real return), and this is the lower yield quoted for bonds. The 10 year yield 2.49%, a ridiculously low rate; the 3 year yields just 0.93%. What does it mean? Governments can borrow cheaply, and we’re certainly not at the top of the economic cycle. It means that bond prices are really high, even higher than last time (early 2010) I recommended against buying bonds. In fact, prices are 7.8% higher now than when I wrote that post. (For context, the TSX is exactly flat over the same period, and gold is worth 50% more).

So even though bonds didn’t look attractive 18 months ago, they were a better investment than the stock market. That continues to be the case, although it appears that may reverse next month. When that happens, it will be time to take profit from bonds and start buying stocks again. In fact, in a portfolio diversified between more asset classes than just stocks, bonds and cash, real estate (XRE) appears to have the best momentum. I sold IGT and bought XRE last week (Tuesday morning, unfortunately). XRE performed better than other asset classes over the course of the week, and I will continue to own XRE this week.

My fair value estimate for the stock market rose again this week, although the market price dropped slightly (less than 0.5%). The market now appears to be quite undervalued (almost 6%). Although momentum doesn’t yet favour stocks, the market appears to be attractively priced.

Category: Stock Market Outlook |
| December 7, 2011
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There’s Always Something to Do

Peter Cundill passed away in January 2011 at age 77. A biography was written about him, called There’s Always Something to Do: The Peter Cundill Investment Approach. It was completed while Cundill was still alive, but arrived in the library after his death. I just finished reading it (I had to wait my turn for the only copy) and I thoroughly enjoyed it. I found the title to be ironic, however.

I am personally partial to the value style of investing. It matches my upbringing and training, and it’s familiar to me. I also appreciate the idea that investing is like a puzzle and work in research will be repaid with profits in the stock market. The many anecdotes, of successes and failures, were fascinating.

I immediately noticed two characteristics which seem to account for success. First, Peter Cundill’s heritage was described, and he came from a family who, after they immigrated from Britain to Canada, were entrepreneurial and amassed great wealth. The fortune was lost while Cundill was young, but it is very apparent that he benefited from connections. He was able to begin work with people who were well placed to mentor him and provide him with opportunity. He also had an ability to form a network of people who gave each other mutual help in their work. This is a phenomenon that I have heard and read about, but which I don’t yet understand myself. I believe it’s one of the main advantages that influential people have, which they probably learn in their families.

Second, Cundill continually preached patience. Many of the companies in which he invested took two years or longer, during which the share price sometimes continued to fall, before his decision was vindicated and his investment turned profitable. Given the repeated exhortation to patience, the title may mislead. In life, unlike in investing, there’s always something to do. Cundill was a man who was curious and had many interests. When he wasn’t engaged in investment research, he ran, he exercised, he attended museums, ballets and operas and he read voraciously. But as the investment anecdotes showed, especially in the case of selling the Japanese market short during the mid-1980s, sometimes there’s nothing to do but wait for the market to realize its mistake and adjust prices.

As the biographer pointed out, Cundill paraphrased John Maynard Kaynes’ well-known adage: “Markets can remain irrational a lot longer than you and I can remain solvent.” So I would say that in investing, there is always something to do, if you count patiently waiting for the market to realize its error as doing something.

Category: Opinion |
| December 5, 2011
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Market Outlook December 5, 2011

The stock market surged this week, rising over 5%. To put that in perspective, two weeks in a row like that would provide a year’s worth of return (10% growth). But coming after four negative weeks in a row that together saw the market fall -9%, this only starts to repair the damage. Stocks continue to display negative momentum, indicating that the market is not prepared for a sustained upward trend. The VIX, at 27.52, has fallen below the range of 30-35 where it has spent the last few months. This is the first positive sign that the market may continue to rally into the end of the year.

Bonds also rose on the week, despite the fact that they normally move opposite to stocks. The price, when it isn’t influenced by interest rates, which have held steady for months now, responds to shifts in supply and demand. My guess as to why stocks rose and bonds rose slightly at the same time would be that investment managers were moving money from cash (equivalents) to stocks, without selling bonds. For a portfolio balanced between cash, bonds and stocks, I still suggest that bonds appear to be the most dependable holding. For those willing to take more risk, real estate (XRE) now shows more momentum than gold. I will be selling my gold ETF (IGT) and buying real estate (XRE) instead.

Despite the impressive stock market rally of the past week, the market still appears to be undervalued. In fact, my fair value estimate for the market rose, also. This means that even without any earnings growth, the coming year should provide a reasonable 5% – 10% of market growth, as pessimism fades and optimism returns. That’s not a prediction, but from this market level, it’s a possibility. From my experience, the market tends to appear overvalued as long as optimism reigns, as it did from late 2009 to early 2011. While there is always a risk that the market could fall further, it seems more likely that the bad news is factored in and good news will result in positive performance.

Category: Stock Market Outlook |