Navigating volatile markets

To avoid losing my shirt I exercise patience and calm

Well established findings in behavioural finance indicate that investors over react to negative news and under appreciate positive trends. Too many investors make sound long-term investments but check the price of their holdings every day and often more than once a day. They are also bombarded with analysts reports, inputs from talking heads on business news networks, advisors calls, and a plethora of articles in digital and print news media and Twitter tweets all with differing views on the direction of the economy, the price of commodities and the direction of stock prices.

It is easy to become anxious and react to these inputs. But, if you have invested wisely, the best reaction is to ignore them and do nothing but let your investments rise or fall with the tides but return to you a stream of income in the form of dividends over many years. The brokerage industry is often referred to as “sell-side” since their existence is predicated on persuading you to “buy” securities and then trade them in the belief that with their help you can pick “winners” and avoid “losers” but the reality is that incessant trading has only one winner - the brokerage firm - and one sure loser - their clients (in both cases taken as groups, since there will be individuals who make out just fine from the random course of events affecting the price of their investments).

The trick is to invest wisely, and that is a serious challenge. Peter Lynch, famous for his 14-year stint as manager of Fidelity’s Magellan Fund and his record of compound annual returns of 27% for that period, made it simple. Buy shares in companies whose products you use and admire and avoid investments in securities of companies you don’t understand. His book “One up on Wall Street” should be mandatory reading for all investors.

Oddly, investors are relaxed when share prices are rising and anxious when they are falling. I wonder if shoppers would be so relaxed if the price of groceries kept rising every day (as they are today) and anxious if everything they purchased on a regular basis kept falling in price? Some things are so obvious they are usually ignored - investors benefit from lower prices for shares in the companies they wish to invest in and are punished by higher prices.

If you buy shares in a company and keeps growing profitably, you are likely to get a growing stream of dividends and when you decide to reinvest the portion of those dividends you don’t need for current consumption, you can buy more shares if the price has fallen and fewer if it has risen. It is the stream of dividends that makes the investments worthwhile. If you hold shares that have risen in price and wish to realize a benefit, you have to sell some or all of them. That will trigger a tax consequence for most people, expose you to a trading fee, and burden you with the task of finding another investment for the proceeds that is as good as the one you sold. No mean feat. Eugene Fama won a Nobel Prize for the efficient market hypothesis (EMH) which, in a nutshell, means all stocks rise and fall in the same tides and are fairly priced for their relative risks, and picking “winners” is a mug’s game.

But despite EMH you can choose investments which do produce higher and more persistent returns. The Canadian Big Five banks are an example. These well-managed companies have steadily earned 12 to 15 percent after tax returns on equity for decades and in my opinion are likely to continue to do so for decades to come. If you buy shares in these companies when market are declining you may be able to buy some at or close to their “book value” and if you are, you will enjoy returns of 12 to 15% for long periods of time, those returns comprising current dividends and future dividends which are likely to rise with the growth in the economy and the respective growth in size and profitability of these banks. CIBC, TD, RBC, BNS and BMO are familiar names and it is hard to hold them for any extended period and not enjoy a profit.

We are likely heading into an economic downturn if not a recession. Share prices tend to fall in periods of poor economic growth or economic decline. If you have maintained a prudent cash balance, you will have the opportunity to open or increase an investment in a soundly managed company at a lower price. Periods of declining markets are called “bear markets”. I have often said that bear markets should be enjoyed like fine wines - in small sips. No matter how low a share price falls, it can always go lower.

In March of 2020 when the pandemic was declared, shares of many companies fell quite dramatically. There has not been a similarly good time to make investments since the global financial crisis. I did and built a strong portfolio of oversold energy companies like Birchcliff (I paid $0.88 a share), Peyto ($1.04 a share) and Whitecap ($1.10 a share). Each of these stocks is had increased in trading prices eight to ten fold since mid-2020 and I have no plans to sell. Birchcliff now pays an annual dividend of $0.80; Peyto of $1.32; and, Whitecap of $0.58 and now these three holdings alone provide me with over $100,000 annual dividend income.

To navigate the current softening economic environment, I suggest holding some cash and patiently waiting for opportunity. When you believe a shares of a company you wish to hold are “cheap” buy a few - a small sip. No one can pick the “bottom”, they are likely to fall even further and you can take another sip if they do. Be calm, be confident and be patient and do your homework on the fundamentals of your chosen investments. Seek out investmetns like Manulife (MFC) which today trades at less than 10 times net income, has a dividend in the 6% range, and benefits from rising interest rates and growing Asian economies where much of its business takes place.

Will it double to triple? Likely not but your view should be “who cares”. What you should expect is a growing dividend for years go come and little risk of corporate failure.

I avoid buying on margin, maintain a cash reserve, and buy quality stocks with demonstrated earnings records that are trading at sensible valuations. Stocks trading at higher multiples than the market averages are discounting growth and those at multiples of 25 to 35 times earnings are betting on 25% to 35% growth, and those numbers are fragile and carry high risk of disappointment. In my view, it is far better to have a foundation in established companies that grow more or less in line with the economy, pay out dividends of 30 to 40% of net income, and can withstand economic downturns, particularly when the macroeconomic environment points to a slowdown or recession. Growth stocks can produce spectacular results and don’t have to comprise the bulk of your portfolio to make a meaningful contribution and will not destroy you if the growth fails to materialize if you keep that more speculative part at sensible levels.

More baseball games are won with singles and doubles than with home runs.