Time to Put Readers to Work ... and There's a Reward!

There isn't only one answer or source of information when it comes to investing. A diversity of views and good ideas can come from many sources, both professional and amateur.

This blog would like your input and as a reward, two people selected randomly from those who answer, one for each category, will receive a copy of Dr. Sherry Cooper's well-regarded recent book The New Retirement. See reviews on Chapters Indigo, Amazon, CanadianFinancialDIY.

Your task: in a Comment at the bottom of this posting, either,

1. Name either your favorite investing book and a one line summary on why it is useful to you as an investor, or
2. Name and provide a link to your favorite online investing website, whether it's a blog, news site, data site etc and again say in one line why it is useful.

That's it.

I will use the responses to build some permanent lists and links to make this blog more useful for everyone.

Use something other than "anonymous" as your comment name so I can get in touch with the winners and mail out the book, which will require having the winners' postal address. You will not be put on a mailing list or be receiving ads, junk mail or anything else except the book. The contest closes in a week from this post on November 13th, i.e. midnight on November 20th.

Not Everything is Down! Some Stocks are Up!

The seemingly unceasing gloomy financial news and plummeting stock markets could easily cause one to conclude that every stock has lost ground. Take heart, there are some winners in the markets!

The two screenshots below show the results of searching through the Toronto and New York stock exchanges for any stocks that have not gone down over the past year and for 2008 to date, i.e. that have survived the general meltdown. In both cases, I also specified that the company would have to be a reasonable size with active trading to eliminate the wacky, probably anomalous holdings.

Canada


USA (NYSE only)


In both markets, there are many companies, though they are decidedly a small minority compared to the overall number in the market, that have held their ground or even advanced significantly. Moral of the story - even in the worst of times like right now, there are still winners. And some may surprise - note some financial companies doing well, like Bank of America (NASDAQ symbol: IKL) in the US and Fairfax Financial (TSX symbol: FFH) in Canada.

The trick is, of course, finding them in advance (since finding them after the fact is like getting to the scene of a great dinner party the morning after - there may be a few leftovers but the good stuff has already been eaten).

Finding the winners requires research. A good way to start is to use the stock screeners with which I zeroed in on this year's year-to-date winners. Stock screeners let you specify criteria, for price, company size, sector, growth rates, profitability, usually along with analyst ratings. They allow searching through ETFs and mutual funds too. The best free one I know of for the Canadian market (it covers US markets too) is at GlobeInvestor. For US markets, an excellent free screener is Google Finance's, which has visual sliders that tell you how many companies are left as you go along. When you sign up with a discount broker, there is a screener tool available online as part of the package. In the today's example, it is BMO Investorline's, where I happen to have an account. BMOIL uses the enhanced Gold version of GlobeInvestor.

What your research aims to uncover in order to identify those winners is the million dollar question, easy to say in principle but very hard to assess in reality and a fine topic for future posts. For today, it's enough to remind ourselves to stay the course and not lose heart.

A Falling Canadian Dollar Can be An Investor's Friend

The week of October 6th to 10th was remarkable in several respects. Stock markets around the world suffered horrible record-breaking declines as government attempts to deal with the credit crisis seemed not to be working. No market was immune. The Toronto TSX Index fell 16% in the week, the US S&P 500 Index dropped 18%.

The Canadian dollar (CAD) also fell off a cliff compared to the US dollar (USD). From a value of about $1.10 Canadian on Oct.3, by the end of the day on Oct.10th, the USD rose (i.e. CAD fell) to $1.19, an unprecedented 9% shift. But that fall in CAD was actually beneficial to the Canadian investor with foreign holdings.

Here's how this benefit worked. In the chart below, I've taken a popular Exchange Traded Fund similar to the S&P 500, the Vanguard Large Cap Index Fund (with NYSE trading symbol VV) and graphed it in its original USD value as well as its value converted to CAD. The result - instead of the 18% drop, a Canadian owner of VV would only have lost 9%.

On October 10th, the value of VV in Canadian dollars actually rose despite the continued decline of VV in US dollars because the currency effect was stronger.

Naturally, the effect can work the opposite way too. As the Canadian dollar rises against the US dollar or any foreign currency, as has occurred more gradually over the last several years, the value of foreign holdings will be reduced. The net effect depends on whether the currency shift is greater than the stock market movement.

The currency effect extends to all currencies, not just the US dollar. An investor with a holding such as iShares Europe, Australasia and Far East Index Fund (traded in the US on AMEX under symbol EFA and available to Canadian investors) sees its value change according to foreign stock market results in those countries as well as the movement of the many national currencies such as Great Britain's pound sterling, Japan's yen, Europe's euro etc against the Canadian dollar. Note that EFA, despite being sold on a US exchange in US dollars, is actually not influenced by the US dollar, only the Canadian dollar and the other foreign currencies. CanadianFinancialDIY explains why this is so.

In the past year, the Canadian dollar has gone down simultaneously against most currencies. The chart below shows CAD vs other currencies from the RatesFX website.

This has helped cushion the brutal declines in stock markets around the world for an investor with internationally diversified holdings.

Although it is possible to buy funds that remove the fluctuations due to currency by hedging - an example being the iShares Hedged EAFE Index Fund (symbol XIN on the TSX), which is the same as EFA except with currency effects removed - most professional fund managers do not think the costs of hedging worthwhile. Currency swings tend to run out of sync with market moves and reduce the volatility of a portfolio with international holdings. This is a benefit to the investor, as seen during the gut-wrenching week of October 6th to 10th, 2008.

Seeking Safety: Assessing Default Risk

How safe is safe? The current market turmoil and the spectre of numerous failed, acquired and bailed-out banks in the US, the UK and Europe, though not in Canada, raises questions about the safety of investments, even those considered the least risky.

When looking for "safe" investments, most people have in their minds whether or not the invested capital and any interest owing will be paid back, which is termed credit or default risk. But any guarantee is only as good as the strength and reputation of the party making it, which may or may not be the institution where you invested the money. So what are the assurances or guarantees and who are the backers for some common securities?

Equities are very high risk in terms of default risk since no one makes any promise to pay anything back.

Brokerage Account Cash - the industry-funded body Canadian Investor Protection Fund (CIPF) promises to reimburse investors up to $1 million in cash (or other holdings) per account at member companies in case of their insolvency. This includes US dollars or other foreign currency, unlike CDIC coverage. At the end of 2007, CIPF had over $500 million available, which seems like a lot but it has to cover $1.3 trillion of assets at brokerages, most of which is invested in federal and provincial bonds. Is that enough? Since 1969 CIPF has had to pay out only $36 million in total. Is that past a guide to the present? The FAQ answers many questions about coverage.

T-Bills, Federal/Provincial Savings Bonds, Real Return Bonds, Federal/Provincial Bonds - their safety all depend on the credit-worthiness of the federal or individual provincial governments. And they are not all the same. In addition, there are numerous federal and provincial agencies and crown corporations (e.g. Ontario Hydro) issuing bonds and their riskiness is unique to each organisation.

Corporate Bonds - they all depend on the strength of the individual company but are almost always below government bonds.

Obviously, it is impossible for any investor to keep track of and perform risk assessments on all these issuers. Enter the ...

Credit Rating Agencies - companies that assign credit ratings on the issuers of debt as well as the obligations themselves. The main ones are:

• Dominion Bond Rating Service (DBRS)
• Standard & Poors
• Moody's

Each has a number of classes according to the level of risk but they may give different ratings for the same organisation - after all it is estimation of what will happen in the future and there is judgment involved. Despite their best efforts they can be wrong. The government of Canada's is in the very best class but various provinces are rated lower, though still considered to be high quality. DBRS rates the City of Montreal the same as Enbridge Pipelines at A+ (high).

Like many things in life, safety is a relative and shifting measure.

Investing in a Recession and Avoiding Depression

Recession talk is common these days. The CBC reports that the OECD has forecast minimal growth for Canada in 2008 and is heading for a recession, while in the USA the Boston Globe says Economic Data Point to Recession.

Stock markets have suffered accordingly and you may be feeling like this man contemplating the decline in the Toronto Stock Exchange Index and the US S&P 500 (chart from Google Finance and photo from the Santa Barbara Independent).


So what can an investor do to minimize losses and take advantage of opportunities?

Stay in the Game - that may sound ironic, a prescription to lose more money and go down with the ship but ... is the ship really going down? The market may take years to recover but it almost surely will. When stock prices have gone down and negative sentiment prevails, it is an even better time to invest than when markets are rising and high. Buying now is buying low, maybe not the absolute lowest but getting attractively low, especially in the US and the UK. I strongly believe that someone investing for retirement years away should continue with a regular saving and investment plan.

Own Sectors with Staying Power - some types of companies and investments tend to hold up well even in bad times. Products and services that are essential will continue to be bought. Others may even leap ahead, either because they are a cheaper substitute for more expensive consumer goods, or because they provide a diversion or small luxury to replace the big ticket items that people defer buying.

• Consumer staples - food, beverages, personal care and household products - see this Motley Fool article
  
• Utilities - power generation, pipelines
• Alcohol and tobacco
• Pharmaceuticals
• Bus transportation
• Entertainment
• Precious Metals, Timber and Commodities - see NuWire Investor
• International markets - not all countries are equally affected by downturns; diversifying with the addition of foreign holdings will lessen the downward drops
• Fixed Income in general and High-yield aka Junk Bonds - read this SmartMoney column to find out why
  
• Banks!! - this may seem strange since this recession is due to the banking crisis. Bank stocks have been hammered in consequence so why buy? The opportunity stems from the fact that good bank stocks have been dragged down with the bad so this is an opportunity to buy low. The challenge is figuring out the good banks from the bad. Research and thought will be required. Check out Canadian Banks and Insurance blog for data, news and analyst reports. Online brokers like BMO Investorline and others have plenty of data and research reports on banks in Canada and the US.

Diversify - In my opinion, the most important strategy is to hold a diversified portfolio of investments and to exercise patience for the economy and markets to recover. It is well-nigh impossible to tell in advance when markets will recover from recessionary losses. By the time you can be certain of a recovery, it will already have happened (see a table of past US recessions and how variable they were in Wealth Daily's Recession-Proof Investments).

With wise action by the authorities, the economy should avoid depression (see CBC's report Replay of Great Depression Unlikely: TD Bank Says). With wise investing, there's no need for an investor to suffer depression either.

Riding the Investment Roller Coaster

If you are a stock market investor, lately the ride has felt distinctly like a roller coaster - gut-wrenching daily swings up and down, things going topsy turvy as major financial market players with long histories go bankrupt or get acquired in distress sales. It would be no surprise if you feel like the "I can't look" mother and terrified daughter on the real coaster in the photo.

In the last year, markets worldwide have suffered significant losses, as the chart below from Google shows (the blue line is the Toronto TSX Index, the red line is the US NASDAQ, the orange line the US S&P 500 Index and the green line the Exchange Traded Fund from iShares that tracks the EFA Index representing Europe, the Far East and Australasia).


What, therefore, should an investor do to make the ride less stressful, since unlike a roller coaster, which is just a trivial amusement, serious savings for retirement, a house or education are typically at stake?

Short-term Tactics

• Protect against drops (hedge) with options - e.g. buy put options (see Put on Investopedia); like all insurance, there is a premium so this can get expensive
• Protect against drops in stocks you own using various types of Stop Orders (see BMOIL's FAQ on Stops)
• Do the "buy low" part of the old dictum Buy Low, Sell High - the survivors of the current financial debacle might well get stronger; the challenge is figuring out whether an individual company is a winner or a loser. Diligent homework and perhaps a bit of luck is required.
  

Long Term Strategies

• Acknowledge the difference between short term swings and longer term market upward movement and stay in the game. The Google chart below shows the same market indicators since 2002, a mere six years ago - they are still significantly positive. Cast your mind forward six years, or better 10 or 25 years, and ask yourself whether the markets will be up. Nothing in life is guaranteed and markets could stay down a long time (Japan since 1990 being an example) and if you are convinced that is the case, pull your money and stay out. The worst thing to do is to try pulling out temporarily until better days arrive - many studies have shown that investors who try to time markets this way end up losing money compared to simple buy-and-hold (e.g. How to Handle a Market Gone Mad by Jason Zweig). The roller coaster always returns intact despite the scary ride. Trying to jump out of the coaster in motion is not advisable!
  

• Adopt a portfolio suited to your psychology - if your ride creates real fear, maybe you should be on a tamer coaster, i.e. with less volatile investments. Maybe the girl should not have sat in front. Note in the photo how the lady in the second row seems to be calm and smiling to her child and the kids in the back are whooping it up! Partly, I believe this is a matter of getting used to it - having gone through the tech slide in 2001/02 this downturn is much less stressful for me.
• Diversify your portfolio - as noted before in this blog in posts about portfolio design, having a number of stocks will dampen the swings and minimize the impact of disasters like the Lehman bankruptcy. Mixing in fixed income will further reduce variability and downward movements.

Ultimately, the stock market is not like a roller coaster - it does not return you to where you started out, it tends to end up higher.

Investments to Protect against Inflation

Inflation has been mercifully tame for years but the recent spikes in gas and food prices has raised the menace of this scourge, which eats away at savings and investments by reducing purchasing power.

What are some ways for an investor to gain protection from inflation in a portfolio?

Real Return Bonds: this is the surest and safest inflation-fighter. Such bonds (in Canada) are issued mostly by the government of Canada with a few offerings by provinces. They are thus ultra-safe. The critical component of inflation-protection is ensured by the continual adjustment of both the interest payment and the principal for Consumer Price Index inflation. RRBs do not pay a high return - the real yield is hovering around 1.6 to 1.7% currently. They are best held in an RRSP or other registered account since the interest is taxable. To buy them you would need to phone the bond desk of your brokerage, as they are likely not available online. Minimum purchases are usually $5000. Get more info from CanadianFinancialDIY, ByloSelhi and current yields at CanadianFixedIncome.ca.

Equities: in the short term, inflation will harm the stock market, driving down prices but in the long term (i.e. ten+ years) companies can and do increase their prices to restore their profits and stock prices recover accordingly. This is an overall effect and individual companies can suffer lasting harm so the protection is more at a portfolio level. To benefit from this protection you need to have a broadly diversified portfolio, more or less the entire stock market. I believe the best way to achieve this is through market index mutual funds such as these listed on ByloSelhi, or similar ETFs, some of which are traded in Canada on the TSX, such as iShares Canada's and others on US exchanges. Seeking Alpha has a comprehensive list of worldwide ETFs.

Commodities: The agricultural products, industrial and precious metals, livestock and oil / energy goods that make up commodities tend to rise in price along with inflation. Indeed, the current inflation surge comes directly from energy and food price increases. Gaining protection from commodities fortunately does not require storing a big pile of wheat in the garage since there are funds focused on commodities. To invest, there are US-traded ETFs such as:

• iPath DJ-AIG Commodity Index Total Return (DJP)
• iPath GSCI Total Return Index (GSP)
• Powershares Commodity Index Tracking Fund (DBC)

The Canadian stock market itself, apart from the financial sector, is about two-thirds composed of resource companies and most of the main commodities are represented within those companies. A company's profits do not exactly match resource price swings but there is nevertheless a fair degree of inflation protection from commodities in the TSX. To give more weight, consider these ETFs:

• iShares Canada - Energy (XEG), Materials (XMD) and Gold (XGD)
• Claymore Canada - Global Mining (CMW), Oil Sands (CLO) and Global Agriculture (COW ... nice to see a sense of humour with the symbol!)

There are other investments sometimes touted as inflation hedges - tangible assets like fine art, wine, land and real estate. Apart from real estate, such assets can be hard to buy/sell (illiquid) and difficult to diversify. Real estate often doesn't rise with inflation, now being a prime example, so it is not nearly as good protection as the main options above, which should do an effective job relieving you of the worry of inflation. It's annoying enough to drive up to a gas pump these days. Having a little gas in your portfolio can salve the pain.

As usual, these are my thoughts and opinions, not investment advice to you. Make your own choices.