Robert ‘Bob’ Walkden, a long-time chairman of this company’s investment planning committee and its last remaining direct link to our founder George C. Armstrong, died this month. Bob spoke often about the folly of hubris and the virtue of humility when it came to investing. How timely that The MoneyLetter’s behavioural finance analyst Ken Norquay recently chose the subject for his market strategy column.
In his book The Humble Approach, legendary mutual fund manager Sir John Templeton said: “As human beings, we are endowed with mind and spirit. We can think, imagine and dream. We can search for future trends through the rich diversity of human thought.” He went on to describe how, in order to make progress, we need to be humble. Humility is an important virtue.
If we are too proud to admit we have a lot to learn, we will not learn a lot. If we are afraid to be wrong, we can never learn to be right. Humility is essential to progress.
Stock market wisdom
This wisdom is particularly true in the tangled world of the stock market. Most stock market ‘wisdom’ is actually a carefully crafted sales pitch based on statistics. For example, we have been told that, on average, the stock market has gone up almost 10 per cent a year for well over 100 years. But if we look at the U.S. stock market in the twenty-first century, we see the S&P500 Index is up only 48 per cent in 16 years, less than half the 100-year statistical average. And the stock market has dropped by 50 per cent twice in those 16 years.
The humble approach to strategic investing
Clearly, investors who accept the standard salesman’s wisdom need to re-examine their investment strategy in light of these facts. Mutual fund salesmen themselves need to re-examine their beliefs. This takes humility. According to Sir John, humility is the key to progress.
The humble approach involves realistically re-examining your beliefs over time. Humble people regularly ask themselves: “Am I wrong?”
Will the humble approach help ordinary investors? Humility translates into stock market profits through strategy. Whenever we make decisions about buying or selling, we need to humbly ask ourselves: “What will I do those times when I’m wrong?” “What will be the consequence of an investment error?” Investors should continually ask themselves: “When I make a bad investment, how/when will I know it is bad, and what will I do about it?”
A bad investment
Definition: a bad investment is one in which you are losing money. You bought a stock and it went down. I’m sorry: I know this is painfully obvious. But value investors have another way of looking at things. I know a portfolio manager who bought Research in Motion (now BlackBerry Limited (TSX—BB)) for his clients after it had declined from $100 per share to $48. It was a bargain stock. Then it dropped to $35 and he bought more: it was an even better bargain stock. He bought the last tranche at $19. When it hit $12, he sold it, because he now believed it would go to zero. His error was not recognizing his mistake soon enough. This is the opposite of being humble. This is blind arrogance: a very expensive personality trait for investment professionals and for ordinary investors.
Humility and my investment strategy
Will the humble approach work for me, as an advisor to investors? The type of advice that I give is based on this simple strategy:
1. Buy only investments that are in up trends.
2. Sell those investments when the up trend ends.
Then I devote my time and effort to the analysis of relevant long-term economic trends. Investors who follow this advice will participate in up-trending markets and not participate in down trends. Humility helps me recognize when I am wrong about the trend. The sooner I discover that I am wrong, the sooner I can correct my errant advice. In the light of Sir John’s The Humble Approach, let’s compare our views on today’s financial trends with the actual performance of the various markets. Is our advice still valid?
The Canadian Stock Market: Our current view is that the TSX Composite peaked in September 2014 at about 15,685 and it is in a long-term down trend. As of August 2016, it is still about 5 per cent below that level.
The U.S. Stock Market: Our recent view was that the S&P500 Index peaked in May 2015 and was in a down trend. This month’s new high showed us that this was an error. Our revised view is that the U.S. stock market is in a trendless 18-month transition stage, going from a long-term up trend to a down trend—Feb 2015 to Aug 2016 so far. In last month’s article, I outlined a possible bullish and a possible bearish scenario, explaining how we will recognize when this trendless sideways stock market begins to trend again.
A trendless sideways drift
■ Canadian and U.S. 20-year+ interest rates: Our recent view was that interest rates bottomed in Jan/Feb 2015 and were currently in an up trend. However, following the UK’s recent dramatic referendum and pending departure from the European Common Market, long-term yields in both countries made slightly lower lows. It is more accurate to say that long-term interest rates in both economies have been in a trendless sideways drift for 18 months, coincident with the stock market. Our congratulations to both the Bank of Canada and the U.S. Federal Reserve Board for their brilliant handling of the economy at this very delicate time. If they are successful, they will execute the famous ‘soft landing’ of their economies. Their policies of holding interest rates artificially low and mercilessly printing money are continuing to work.
■ Precious metals: Our current view is that the price of gold reversed from a down trend to an up trend in Dec 2015. Nine months later, in August 2016, gold is 28% above that low. No error here. Gold is currently in an up trend. Investors should continue to emphasize precious metals mutual funds, ETFs or direct ownership of gold and/or silver coins or bullion. Investing in gold or silver mining stocks is more speculative: mining stocks follow both the trend of gold and the trend of the stock market. And they are volatile.
■ Oil prices and the Canadian Dollar: the dramatic decline in oil prices may have ended six months ago, in February 2016, when oil hit $26 U.S. per barrel. There has been a strong rebound to $51 in June and a decline to $45+/- into August 2016. It is not yet clear that the down trend is over. Normally we would expect oil prices to drop back to the vicinity of the old lows and stabilize. A rally after such a ‘test’ would indicate a long-term trend reversal.
Because the chart pattern for the loonie is so similar to that of oil, the term ‘petro-currency’ has been applied to the Canadian Dollar (CAD). However, the previous lock-step correlation is changing. The CAD bottomed in January 2016, and oil bottomed in February. The subsequent CAD bounce ended in April 2016, and oil’s bounce continued until June. The loonie is becoming a lead indicator for oil prices. We continue to acknowledge the long-term down trend of the CAD. If the loonie should decline towards its January low of 67-68 cents U.S., stabilize, and then rally, the long-term down trend would be over.
Snowbirds wishing to convert CADs into USDs for a vacation this winter are advised to do so now. Investors should continue to emphasize non-Canadian investments to take advantage of continuing weakness in the CAD.
■ The U.S. Dollar: Following the 2008 world banking crisis, the USD entered a strong 7-year up trend which ended in March 2015. Since then, it has been trendless, drifting sideways these past 17 months.
(Note for clarity: we measure the trend of the USD against a so-called ‘basket’ of non-US currencies. We measure the trend of the CAD against the USD.
An uneasy calm
The financial markets are in a quiet phase right now. Usually this indicates a healthy economy. Normally stability is good for business. But this time there has been a consistent decline in corporate earnings. This is not normal. The central banks’ aggressive stimulation is losing its effectiveness. What now seems like stability could turn out to be the calm before the storm.
The normal topping sequence I described in my book, Beyond The Bull, is not happening this time. Normally interest rates would bottom, then the stock market would top, and then the economy would turn weak. This time the economy is turning weak first; interest rates have not gone up and the stock market has not gone down. The last time this happened was in the late 1920s and 1930s. The wise should remember the title of John Templeton’s book, The Humble Approach, and err on the side of over-caution.
Ken Norquay, CMT, is the author of the book Beyond the Bull, which discusses the impact of your personality on your long-term investments: behavioural finance.
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