So much for the market

The first of a six-part series on investing after the fall. After a lost decade, are there any safe investments?
So much for the market
Giovanni Rufino/CNBC/ Richard Drew/AP/ Aly Song/Reuters

With his pink shirt sleeves rolled up past his elbows, Jim Cramer, the hot-headed host of CNBC’s popular Mad Money program, hit the airways last summer just as the stock market rally began to sputter and offered viewers a tip on fixing a shredded portfolio. “Stocks as an asset class have become tarnished,” he said, referring to the gut-wrenching roller-coaster ride that average investors have endured over the past two years. “And I, as a noted stock evangelist, know that better than anyone. But, at the same time, I also know they are your best shot for making back all the money you lost.”

After plugging his book and punching up a few sound effects, the former hedge fund manager went on to suggest that investors “unlearn” the buy-and-hold philosophies made popular by billionaire investor Warren Buffett and start thinking like traders. That means buying on weakness and selling when things get too hot, taking advantage of short-term market fluctuations—just like the pros.

Admittedly, it sounds daunting—which it should, given that the odds are stacked against the average investor trying to beat the market—and somewhat self-serving considering it comes from a guy who makes a living ranting about stocks on TV. But there’s a glaring truth amid Cramer’s bluster. After experiencing a “lost decade” in the equities markets—the Dow Jones Industrial Average ended 2009 at roughly the same level as it was in 2000 (the S&P/TSX Composite Index fared only slightly better)—investors are left with precious few other options to grow what’s left of their savings. Bonds, although promising a stable source of income, are entering what some consider to be bubble territory. Meanwhile, other so-called safe investments like Guaranteed Investment Certificates, or GICs, are barely keeping up with inflation.

The idea of loading up on more stocks so soon after the crash, and in what remain uncertain economic times, might make some people’s stomachs churn. A recent poll conducted by Knowledge Networks for the Associated Press and CNBC found that average investors are growing more concerned about the market’s ability to provide for their retirements, with 61 per cent saying recent volatility has made them less confident about buying and selling individual stocks. A majority of those surveyed said they viewed the market as being fair only to some investors. But experts say investing in stocks right now needn’t be a sickening experience as long as one is selective and paying close attention. Think of it as a hair-of-the-dog elixir for a financial hangover.

The good news is that, if you’re relatively young—say, in your 30s—you have plenty of time to buy and hold until the markets fully recover, which they eventually will. If you’re closer to retirement, however, navigating the stock market requires a hands-on approach. Those who heeded the advice of their financial advisers and avoided selling as the markets plunged in late 2008 and early 2009 were rewarded with a nice rally. But with concerns about the possibility of a double dip recession coupled with deflationary fears, the markets have become choppy, raising fears of another portfolio-killing free fall just around the corner.

But market swings don’t tell the whole story. While the Dow may have begun and ended the decade under 11,000 points (after marching to a high of more than 14,000 and plummeting to a low of about 6,000), that doesn’t mean that everyone earned nothing on their equities during that period. Like other indexes such as the S&P/TSX, the Dow only records a selection of corporate stocks—in this case, 30 large publicly owned U.S. companies. And it only tracks the price of stocks, not what investors actually take home when dividends are factored into the equation. While companies of all stripes cut their dividends during the recession, they are expected to collectively raise the payouts as much as 20 per cent over the next two years, according to a survey of analysts by Bloomberg.

As a result, dividend stocks, once considered stable but sleepy parts of a portfolio, have drawn much more interest in recent months as investors look for alternative income streams over simple capital appreciation. “Dividends have meaning,” says Thomas Davidoff, an assistant professor at the University of British Columbia’s Sauder School of Business. “I think dividends are probably favoured over a growth story.”

The challenge is finding companies with good cash flows, decent yields and good long-term growth prospects. Utilities, financials and oil firms—companies that have consistent demand for their products­—have typically been favourites, but a flood of new investors could push up prices. Instead, some analysts are recommending that investors also look at sectors like drug companies, mobile phone makers and some European car companies. The thinking is that these firms came out of the recession with surprisingly healthy balance sheets—the result of stiff cost-cutting—and may be looking to reward shareholders.

Another area where investors can make a big difference in their returns is simply by paying more attention to fees. Several studies have shown that Canadian mutual fund investors pay some of the highest management fees in the world, eating into potential returns. There are also trailer fees—essentially sales commissions—paid to financial advisers, a practice that has come under scrutiny in recent years. “In investing you can only control what you can control,” says Matthew McGrath, the president of Optimize Inc., which is rolling out a Web-based financial advisory service to investors in Canada and the U.S. The service, which is supported by advertising on the site, will make recommendations to investors after analyzing their mutual funds and other banking products based on returns and fees. “As long as you can minimize your fees and build a relatively balanced portfolio, you’re 95 per cent better off than the next guy who’s out there trying to pick a winner.”

Still, many have opted to shun stocks and instead rush into bonds. Nearly US$57 billion was withdrawn from U.S. stock mutual funds between May and August, the most during any four-month period since 2008, according to data from the Investment Company Institute.

Meanwhile, US$100 billion was funnelled into bond funds. Canadian investors have shown a similar appetite. The shift comes as deflationary fears are on the rise. Central bankers are considering another round of printing money to juice the global economy, having run out of interest rate trimming ammunition. If they are unsuccessful, then bonds suddenly become a lot more attractive, with their guaranteed returns. Stocks, on the other hand, will be at risk as consumers rein in spending on everything from cars to dishwashers, knowing that falling prices mean products will be cheaper down the road.

But some experts say it’s a risky gambit. William De Vijlder, the chief investment officer at BNP Paribas Investment Partners, says government bonds in particular offer thin yields and tend to be long-term investments, exposing investors to significant pain down the road if central bankers are successful and the economy begins growing again, putting rate hikes back on the agenda. Higher-yield corporate bonds and convertible bonds, which can be converted into company stock, could be less drastic options, he says. He also likes stocks with a high-dividend yield. “In a large number of markets, the dividend yield is higher than you would earn on a coupon bond,” he said in an interview with Maclean’s. And he tells investors to be wary of gold, which, although usually seen as a hedge against inflation, has enjoyed a massive price surge as investors search for safety.

Peter Schiff is one of those investors. A noted stock market bear, the president of Euro Pacific Capital Inc. accurately predicted the bursting of the real estate bubble and the financial crisis of 2008 at a time when few people wanted to listen. Now, he says the U.S. is hurtling toward another disaster of its own making. He not only anticipates inflation, but hyperinflation caused by all that extra money that’s being poured into the system. “We’re not going to die from disease, but the government cure,” he warns. He also points to what some have described as a brewing global currency war as countries try to give their exporters a boost by taking steps to devalue their money. Japan has already sold off yen in favour of U.S. dollars, which caused the value of the dollar to rise, threatening to further aggravate the standoff between the U.S. and China over the Asian giant’s policy on the yuan. Schiff says he’s telling his clients to get out of U.S. assets entirely, fearing serious damage to the U.S. economy. “They’ve got to take refuge wherever they can.” For Schiff, that includes investing in commodities, which tend to do well during inflationary periods, and, of course, gold. He also believes Canada and its resource-based economy is a good place to wait out the storm. “Keep your money in Canada,” he advises. “And if you really want to invest abroad, invest in Asia.”

It’s a dire scenario, but given the events of recent years, caution is now the name of the game. De Vijlder, too, says it’s imperative that North American investors shed their “home bias” when picking equities, a reference to the average investor’s tendency to load up on companies with familiar names. That’s because the global economic recovery is expected to be uneven, with the world’s developed economies experiencing significantly lower growth as they battle their way back from a crisis that hit them disproportionately hard. Emerging markets, meanwhile, are generally riskier, but are poised to do better and could yield more impressive returns. “We have a globalized loss of momentum, but the speeds of momentum are different and ultimately that’s what counts,” he says. “You must have a truly global portfolio with global exposure.” The only caveat is that investors have to remain diligent and be prepared to sell if they suddenly find themselves outside of their comfort zone.

You don’t really need the skills of a hedge fund manager to rebuild your portfolio, but Cramer is right about one thing: a buy-and-forget investing strategy, though it may have worked during the boom, could be a recipe for disaster following the crash. And a sure way to lose money is to do absolutely nothing at all.