Markets worldwide have led investors on a merry chase. It may be hard to gain perspective of what we may expect from here on.
Market experts have totally opposing views of what lies ahead:
Inflation, runaway inflation, deflation, gold goes to $3,000, gold goes to $300, markets will soar, markets will collapse and many more alternatives.
Delving into my past and trying to gain some insight of what it may tell us I have written a brief essay and that very subject.
Well, here is my essay, hope you find it useful.
SURVIVING THE INVESTMENT BATTLE
A brief essay on possible future market action
HISTORY
Over the past almost 4 decades of my life involved in and observing various markets, a few observations may be gleaned that will help us plot a course of action for the immediate future.
First of all it can be observed that stock market cycles in North America on average last about 4 years. Of this time the bull market phase (the period when securities rise) lasts about three years and the following bear market phase (the period when securities fall) last about one year. While these periods may vary considerably in duration from cycle to cycle they do tend to conform to the average over time. Not only do cycles vary in duration but also in severity. Also, the duration and severity of the bear phase correlates to that of the following bull phase. If the bear is longer and more severe than the average, the bull phase will be also.
On average, during the 3 year bull phase, a market will rise 100% to 150% from its starting point. For example if the TSX stands at 10,000 at the beginning of the bull phase it may rise to 20,000 or 30,000 over the life of the bull phase.
During the bear phase the market may give back 30% to 50% (more or less) from its starting point. Thus, if the TSX stands at 10,000 when the bear phase begins it will end at 5,000 to 7,000 when it ends. It is important to remember that when a security or a market falls 50% during a bear market it must rise 100% during the following bull market. So, when a bear market ends at 5,000 after falling 50% from 10,000 and then doubles it will be just be back at 10,000 where it started about one year earlier. It is then no great bonanza when I say a market (or security) may gain 100% during a bull market. Usually it does that during the first year to year and a half of a new bull market, before new profits are made. But these profits can be quite substantial.
SO, NOW WHAT?
Where are we now? Let’s look at the most recent bear market. It started in September of 2007 and ended March of this year, 2009. That is not one year but one and one half years. It was a humdinger, killed a few people, mauled many others and scared that pants of most of us and all legislators. They are the ones who went into a panic spending spree of historic proportions. Whether or not this was necessary to prevent a total meltdown of our financial systems is a moot point. What’s done is done. The important point is that we may assume to bear market ended in March and it may not have, otherwise.
The important question is: “What can we expect from this point forward?”
Since the bear market just past lasted 1 ½ years it is reasonable that the bull market which started in March will also last longer. The bear market lasted 50% longer than average it may be assumed the current bull market will also be longer by 50% or 1 ½ years. This will mean the bull market may last 4 ½ years, not three years. This is very important because the potential gains should increase by a similar amount. If the during a normal bull market we may expect gains of 150% we may now expect gains of an additional 75%.
In other words, the TSX dropped 50% from 15,000 to 7,500 during the past bear market. It should now gain 100% to get even to 15,000 during the present bull market. It should then gain an additional 50% to get us to 22,500 at the end of three years. But wait a minute we have an additional 1 ½ years to go and can expect the bull to give us an additional 75 %. This would bring the TSX to 39,375 by the end of the four and a half year bull market ahead.
Off course, there is not guarantee this will happen. However it looks more and more as if this bear – bull cycle will conform roughly to the long term norm. It will be nice to forward to a period of growth and gains without the bubble we have seen in the past.
HOW TO REALIZE THE PROJECTED GAINS – WITH MINIMUM RISK?
Well, as the saying goes, many roads lead to Rome. And you may have your own way which may work as well as, or better than any other. However I have my own ideas and feel they will work well for anyone who wants a simple, easy to manage, low risk alternative to the usual stock/mutual fund habits.
First of all I have found individual stock selection too difficult, too time consuming and too frustrating. Alternatively mutual funds are way too expensive, especially in Canada. In the USA mutual funds give their unit holders a break but even then they are too cumbersome and hard to buy and sell and require too much paperwork etc.
USING ETFs
My alternative is to use selected Exchange Traded Funds (ETFs). ETFs are really mutual funds but with significant differences. An ETF is usually based on a specific stock index such as the Dow Jones Industrial Index (DIA-N) or a sub index such the Oil Producers, Home Builders etc.. There are many. Also ETFs trade on different exchanges, just like stocks, making them much easier to buy and sell. Also the management fees are much, much lower than ordinary mutual funds. I have worked on a suitable method of using ETFs over the past two years. Finally it seems that a viable and profitable process is available. It may seem a little scary at first because most if not all the money available for this project goes into one ETF. Unlike the common wisdom which wants you to diversify and build a “Portfolio” which, of course, means more commissions and fees for the issuer.
Talking about diversification, let’s look at my choice for the ETFs covering the Canadian market. Managed by Barkley’s, it is the iShares i60 ETF (XIU-T). It covers all the stocks in the TSX 60 Index. This means 60 of the most senior, largest, most stable, dividend paying stocks traded on the TSX. It includes the major banks, energy companies and mining concerns.
One problem with concentrating on only one holding is the possible lack of liquidity. In fact many mutual funds in Canada as well as in the USA use this particular ETF because of the built-in diversification and the liquidity. Daily trading volume is more than adequate to serve the needs of most individual investors. The fund’s value is just shy of 10 billion Cdn. Dollars. And today this ETF for instance traded 15 million shares.
However, if you feel the need for another similar option there is also the Canadian Composite Index (XIC-T) which holds 207 stocks. This ETF provides a much larger diversification of Canadian stocks and therefore greater variety. You may want to own both, although their share prices are almost identical and share movements are also almost the same. One does not appear to be more volatile than the other.
Coincidentally, the top ten holdings in both ETFs are the same:
Royal Bank of Canada, Suncor Energy, TD Canada Trust, Scotia Bank, Encana Corp., Research in Motion, Manulife Financial, Canadian Natural Resources, Barrick Gold Corp. and Potash Corp. of Sask.
If you wish to see the full list of holdings for these two and all other iShares ETFs the web address is: http://ca.ishares.com/product_info/fund_holdings.do
SIMPLY BUYING AND HOLDING THESE ETFs will keep you even with the market for the next 4 years. Yes, 6 months have already past, my how time flies.
Why the preference for Canadian investment? Well known U.S. financial commentator Richard C. Young told his readers: “The future, my friends, lies to the north of you, in Canada. Where do you find the safest banks, a vital infrastructure, vast natural resources, all virtually untapped? Canada, of course. While the U.S. toys with protectionism, Canada is leading a stunning initiative to abolish trade barriers. And while the U.S. consumers spend less, Canada has found billions who want to spend more, In China. A strong currency, water, grain, gold, uranium timber, oil and gas, infrastructure and a burgeoning Chinese market make Canada the top destination for your investment dollars.”
Nothing – no market – ever goes up in a straight line. Over the next few years there will be a number of “Corrections”, some of which may provide a measure of heart stopping action. But these may also provide opportunities to increase profits by selling some or most of the ETF holdings at intermediate market tops and re-purchasing the same security at intermediate bottoms when a correction is over. Yes, it’s easier said than done. I am currently using three different indicators to establish suitable entry and exit points to take advantage of these corrections. These have been quite successful but, in my opinion, not quite successful enough. So I’m still working on refining this process.
However, for now I am using the 1/3rd option by investing 30% of the money available at 3 month intervals. This will help to reduce the risk of investing all the money at a possible market top. Conversely we may just hit a market low and gain a few points.
Good investing.
Ted Lagerway