The latest news on the swine flu virus is that perhaps – according to an unpublished study – getting an ordinary flu shot makes it 30% more likely you will contract swine flu. Canadians are damned if they do and damned if they don’t. If they take the normal flu shot, they are more likely to get swine flu. If they don’t, they are more likely to get regular flu. What should we do?
Well, we’re Canadians, so we'll wait for some government official to tell us what to do.
But this dilemma illustrates an often forgotten aspect of our humanity: life contains risk. Getting the flu is an important risk. There are no 100% guarantees that we will escape the virus whether we get the shot or do not get the shot. It’s all about the odds.
As a financial philosopher and partner in an investment firm, I am often asked about financial risk. The stock market might go up or it might go down. If all my money is in stock market mutual funds, and the market goes up, I win! This is what happened during the 1990s. But if the stock market goes down, I lose! This is what happened in 2001 to 2003 and again in 2008. What should I do?
The pat answer from the investment industry is: invest in some stocks, but also hold a diverse portfolio of non-stock investments, like bonds, real estate or precious metals. But that’s not a real answer, is it? If you own $100,000 in stocks, it will go up or down with the stock market: if you happen to own real estate or bonds or gold, your stock mutual funds will still go up or down with the market. The investment industry’s pat answer does not address the basic truth that there is risk in investing in the stock market and we need to know how to handle that risk. What should we do when the market goes down?
Canadian investors are exposed to wealth risk in the same way that we are all exposed to health risk?
Health conscious Canadians are smarter than wealth conscious Canadians. They expect to take precaution and to do something to protect their health from a flu epidemic. Most Canadian investors are doing nothing to protect their wealth from the ravages of an economic pandemic. During the 2008 market melt-down, most financial advisors encouraged their clients to do nothing: to hang in there and not worry… The stock market would recover.
How would you feel if you got this kind of advice regarding the up coming flu season? “Don’t worry about the flu: if you get it you will recover. Just keep washing your hands and hoping you don’t catch it.”
In my investment book, Beyond the Bull, I point out that an important part of our human experience involves luck. When the experts believe there is a good chance we’ll have a swine flu outbreak, we see that as an increase in risk to our health. When they experts believe there is a good chance we’ll have a banking crisis or an economic melt down, we should see that as an increase in risk to our wealth. In both cases, a normal intelligent person would take precautions to protect themselves. Strangely, however, the investment industry doesn’t see it that way. The slogan “buy and hold for the long term” implies that there is no real risk in the stock market. It always goes up eventually. I suppose this is the same a saying that every flu pandemic will eventually end.
It’s about survival, isn’t it? Will we survive a flu pandemic? Will our investments survive an economic melt down? And, if it’s about survival, then it’s about protecting ourselves against reasonable risk. We hope to protect ourselves from the flu by using vaccinations. And a variety of government health experts are advising us on the vaccination process. But not a single government health agency is telling us “Don’t worry, be happy.”
What is it about the investment industry that makes professionals continually advise individual investors to do nothing – to hold onto our investments through thick and thin?
When I first entered the investment business in 1975, mutual funds guru John Templeton got it right. He used to say: “We shop the world for undervalued stocks. We hold them for three or four years and sell them when that value is recognized.” He wanted us to buy and hold Templeton Growth Fund in full knowledge that he would buy and sell stocks for us within the fund. Modern mutual funds do not talk about selling at all. They want us to buy and hold their mutual funds, and they want to buy and hold stocks within that fund. And they really do hold: how many mutual funds off loaded their stocks before the 2008 melt down? Mutual funds management has changed dramatically since 1975.
In my investment book, Beyond the Bull, I discuss the five keys to correct investing. One of those keys is to have a method of deciding when to buy and when to sell. Sir John Templeton used his value models to help him make this decision. Modern mutual funds managers seem to have methods for when to buy; but they seem weak in the area of when to sell. It seems like their business plans call for the market to go up all the time. And if the market goes down, their mutual funds go down too.
Modern wealth management is a bit like modern health management. Will we take that shot to protect ourselves from the flu? Will we sell our risky investments to protect ourselves from economic weakness? It’s up to us to decide when to protect ourselves.
Ken Norquay, CMT
905-847-8511
CastleMoore Inc
Links to Beyond the Bull
Canada
http://www.amazon.ca/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246016&sr=8-1
US
http://www.amazon.com/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246055&sr=8-1
Tuesday, September 29, 2009
Monday, September 14, 2009
The Second Shoe: a fresh look at the world of banking
THE BAIL OUTS
2008 was a close call for the world’s banks. The system almost collapsed. The stock market did collapse. The only thing that saved the banks was government intervention: sovereign states all over the world poured billions into the banks to prevent the collapse. Let’s review the rules: what really went wrong?
THE MECHANICS
Imagine that you and I decided to start up a bank. Our investors put up $1 billion of capital. A year later we have $500 million in deposits for a total of $1.5 billion. In Canada our bank would be entitled to loan out 17 times $1.5 billion. In other words, our bank could create $1.5 billion X 17 = $25.5 billion in loans. We make our profit by charging interest on the $25.5 billion in loans. And where does the $25.5 billion come from? It was “created.” Canada’s central bank created $25.5 billion and loaned it to us at the Bank of Canada’s overnight bank rate.
In Canada, our rule is we can “create” loans of 17X capital + deposits.
In the USA, it’s 22X.
In some countries in Europe, it’s 27X.
THE SET UP
Years ago the world’s bankers decided to hold most of their capital reserves in US dollars [US$] assets. Mostly they would own US treasury bills or bonds. They wanted something safe. Their reserves were mostly in US$, but their loans were mostly local currency. So our bank would have held its $1 billion in reserve capital mostly in US$ and we would have loaned out the $25.5 billion mostly in Canadian dollars [CD$]. If the Canadian dollar went UP against the US$, we could get in trouble because our reserves were shrinking compared to our loans. If the CD$ became stronger and stronger, our 17X ratio might go to 18X or 19X. If this happened, we would have to call $1 or 2 billion in loans. When the banks are forced to call in loans, it’s called a credit squeeze and it is very bad for the economy. Business’s who rely on bank loans to operate need the money – they don’t have the cash to pay off those loans that have been called.
The world banking system needs a strong stable US$ to operate efficiently – and the world’s economies need a strong and stable banking system in order to operate effectively. And that’s where the 2008 banking crisis began.
In winter 2002, 62 cents US would buy one Canadian dollar. In autumn 2007 it took $1.11 US to buy that same Canadian dollar. The CD$ had gone up 79%! Another way of saying that is the US$ went down by 44%. The little bank we created for this article was under tremendous pressure. Our reserve capital had shrunk over those 5 years. The strong CD$ [weak US$] seriously impaired out ability to do business.
It wasn’t just the Canadian-dollar based banks that felt the pressure because of the long decline of the US$. The same story applied to Euro-based banks, pound-based, yen-based, etc. The US$ had been devalued against them all.
THE LAST STRAW
American brokerage firms had somehow persuaded the world’s bankers to hold pooled mortgage funds as part of their US$ capital reserves instead of treasury bills or bonds. Yes, they were not quite as safe as US treasury issues, but they paid a lot more interest. And with a booming US real estate market, how much risk could there be in mortgage investments?
The sub-prime mortgage fiasco became widely recognized in 2007. All the banks saw the defaults and they all wanted to reduce their exposure to this now shaky investment. Soon there were no buyers: only sellers. These vast pools of US$ paper that were now part of the banks’ capital reserve had no value. The world’s banks had lost their shirts. Our little bank would have been in serious trouble. No only did the currency of these junk mortgages go down, but the actual price of the mortgaged pools collapsed too. Our little bank would have had to call in loans to the tune of 17X the loss. European banks might have had to call 27X their losses. The US banks had not experienced the currency loss – but even so, bank after bank had to be bailed out because of their mortgage losses. The world’s banks were under pressure to call in loans on such a scale as to ruin the world’s economies. This all came to a climax as the US’s new president was being inaugurated. The nations of the world cooperated as never before and saved the banks.
PANIC TO CONTROL
It worked. The governments and central bankers actually did restore order. Here’s how:
1. Governments provided capital reserves to the banks so they would not have to call loans.
2. Banks began to raise their own capital. Canadian banks raised billions in spring of 2009 by selling preferred shares.
3. The US$ went sharply higher, stabilizing the value of the banks’ US dollar denominated capital reserves.
The stock markets recovered and now the economies appear to be recovering. The bail outs worked.
CAVIAT EMPTOR: THE ROCK
Americans do not want a stronger US$ right now. The US economy is in trouble. Their manufacturing sector is in tatters. A strong US$ makes it harder for them to sell US manufactured good abroad. Americans need a lower dollar right now.
THE HARD PLACE
But if a weak US dollar causes the worlds’ banks to fail, the US economy will go down too. What will they do?
THE SECOND SHOE
In the last six months, the US dollar has dropped 14% against an average of the Yen, the Euro, the Pound, etc. If the decline of US$ continues at this pace, by New Years Day the US dollar will be back down to where it was in the height of the banking crisis. The pressure will be on the world’s banking system again.
BUT THIS TIME IT’S DIFFERENT!
During the last six months the worlds’ bankers have taken steps to shore up their weak capital reserve positions. They are stronger now than they were last winter. And they have already written off those disastrous sub-prime mortgage assets. So, if the US$ gets even weaker and their reserves come under even more pressure, they are better able to stand the punishment than they were last winter.
NOT NEWS
Every central banker in the world understands these dynamics. Every pension manager, every mutual funds manager, every portfolio manager understands these dynamics. As the US$ eases down, it helps the US economy and it hurts non-American banks. As long as things happen gradually, the parties involved can adjust.
THEIR ADJUSTMENTS
What kind of adjustments do the parties involved need to make? Well, foreign banks and foreign governments need to continue to cooperate as they did last winter. Most observers believe this will work out just fine. But, what about those big investment managers? Their clients were hard hit when the stock market dropped so sharply last fall and winter. Many pension plans dropped so sharply that they were unable to meet their payment obligations. Bank stocks were particularly hard hit: after all, in a banking crisis, that’s where the maximum risk is. Will the big pension managers ride through the sharp decline as they did last year? Or will they try to sell off some of their stock portfolios? For the multibillion dollar stock portfolios, this is a theoretical question: they are so big that their selling is what forces the stock market lower. They are too big to sell. Even the adjustments they make to their portfolios must be done by stealth selling. Each day they feed a few big blocks of stock out into the market in an orderly and controlled way so as not to overly disturb the market.
OUR ADJUSTMENTS
What kind of adjustments do we need to make if the US dollar is devalued further? Should we sell our bank stocks? Should we sell all our stocks? We are not in the same position as the mega-money managers of billions – we can sell our portfolios in a heart beat. What do we wish we’d done last year when the US dollar was at this same level?
IRONY
Those mega-money investment managers who understand these financial dynamics can’t sell out of the stock market when the going gets rough. And those investors who can sell don’t. The small investor has an edge over the large when it comes to selling out – but often doesn’t use that advantage. Why not?
FINANCIAL REALITY DOESN’T MATTER
In my book, Beyond the Bull, I try to persuade ordinary investors to develop investment techniques. An investment technique involves objectively observing the world of finance, looking for certain events. When the sought-after events occur, we act: we buy or sell based on pre-planned logic. In this example, we notice a decline in the US dollar and suggest this spells trouble for the banking industry. If the US dollar continued to go down and then the prices of bank shares start to go down, this would be a reason to sell your bank stocks. But that’s not how most ordinary investors behave. Instead of selling, they worry. And, instead of buying their stocks back after a stock market sell-off, they hope the stocks they held through the crash will bounce back up: worrying and hoping instead of buying and selling.
Ken Norquay, CMT
Chief Market Strategist,
CastleMoore Inc.
Links to Beyond the Bull
Canada
http://www.amazon.ca/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246016&sr=8-1
US
http://www.amazon.com/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246055&sr=8-1
UK
http://www.amazon.co.uk/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228245979&sr=8-1
2008 was a close call for the world’s banks. The system almost collapsed. The stock market did collapse. The only thing that saved the banks was government intervention: sovereign states all over the world poured billions into the banks to prevent the collapse. Let’s review the rules: what really went wrong?
THE MECHANICS
Imagine that you and I decided to start up a bank. Our investors put up $1 billion of capital. A year later we have $500 million in deposits for a total of $1.5 billion. In Canada our bank would be entitled to loan out 17 times $1.5 billion. In other words, our bank could create $1.5 billion X 17 = $25.5 billion in loans. We make our profit by charging interest on the $25.5 billion in loans. And where does the $25.5 billion come from? It was “created.” Canada’s central bank created $25.5 billion and loaned it to us at the Bank of Canada’s overnight bank rate.
In Canada, our rule is we can “create” loans of 17X capital + deposits.
In the USA, it’s 22X.
In some countries in Europe, it’s 27X.
THE SET UP
Years ago the world’s bankers decided to hold most of their capital reserves in US dollars [US$] assets. Mostly they would own US treasury bills or bonds. They wanted something safe. Their reserves were mostly in US$, but their loans were mostly local currency. So our bank would have held its $1 billion in reserve capital mostly in US$ and we would have loaned out the $25.5 billion mostly in Canadian dollars [CD$]. If the Canadian dollar went UP against the US$, we could get in trouble because our reserves were shrinking compared to our loans. If the CD$ became stronger and stronger, our 17X ratio might go to 18X or 19X. If this happened, we would have to call $1 or 2 billion in loans. When the banks are forced to call in loans, it’s called a credit squeeze and it is very bad for the economy. Business’s who rely on bank loans to operate need the money – they don’t have the cash to pay off those loans that have been called.
The world banking system needs a strong stable US$ to operate efficiently – and the world’s economies need a strong and stable banking system in order to operate effectively. And that’s where the 2008 banking crisis began.
In winter 2002, 62 cents US would buy one Canadian dollar. In autumn 2007 it took $1.11 US to buy that same Canadian dollar. The CD$ had gone up 79%! Another way of saying that is the US$ went down by 44%. The little bank we created for this article was under tremendous pressure. Our reserve capital had shrunk over those 5 years. The strong CD$ [weak US$] seriously impaired out ability to do business.
It wasn’t just the Canadian-dollar based banks that felt the pressure because of the long decline of the US$. The same story applied to Euro-based banks, pound-based, yen-based, etc. The US$ had been devalued against them all.
THE LAST STRAW
American brokerage firms had somehow persuaded the world’s bankers to hold pooled mortgage funds as part of their US$ capital reserves instead of treasury bills or bonds. Yes, they were not quite as safe as US treasury issues, but they paid a lot more interest. And with a booming US real estate market, how much risk could there be in mortgage investments?
The sub-prime mortgage fiasco became widely recognized in 2007. All the banks saw the defaults and they all wanted to reduce their exposure to this now shaky investment. Soon there were no buyers: only sellers. These vast pools of US$ paper that were now part of the banks’ capital reserve had no value. The world’s banks had lost their shirts. Our little bank would have been in serious trouble. No only did the currency of these junk mortgages go down, but the actual price of the mortgaged pools collapsed too. Our little bank would have had to call in loans to the tune of 17X the loss. European banks might have had to call 27X their losses. The US banks had not experienced the currency loss – but even so, bank after bank had to be bailed out because of their mortgage losses. The world’s banks were under pressure to call in loans on such a scale as to ruin the world’s economies. This all came to a climax as the US’s new president was being inaugurated. The nations of the world cooperated as never before and saved the banks.
PANIC TO CONTROL
It worked. The governments and central bankers actually did restore order. Here’s how:
1. Governments provided capital reserves to the banks so they would not have to call loans.
2. Banks began to raise their own capital. Canadian banks raised billions in spring of 2009 by selling preferred shares.
3. The US$ went sharply higher, stabilizing the value of the banks’ US dollar denominated capital reserves.
The stock markets recovered and now the economies appear to be recovering. The bail outs worked.
CAVIAT EMPTOR: THE ROCK
Americans do not want a stronger US$ right now. The US economy is in trouble. Their manufacturing sector is in tatters. A strong US$ makes it harder for them to sell US manufactured good abroad. Americans need a lower dollar right now.
THE HARD PLACE
But if a weak US dollar causes the worlds’ banks to fail, the US economy will go down too. What will they do?
THE SECOND SHOE
In the last six months, the US dollar has dropped 14% against an average of the Yen, the Euro, the Pound, etc. If the decline of US$ continues at this pace, by New Years Day the US dollar will be back down to where it was in the height of the banking crisis. The pressure will be on the world’s banking system again.
BUT THIS TIME IT’S DIFFERENT!
During the last six months the worlds’ bankers have taken steps to shore up their weak capital reserve positions. They are stronger now than they were last winter. And they have already written off those disastrous sub-prime mortgage assets. So, if the US$ gets even weaker and their reserves come under even more pressure, they are better able to stand the punishment than they were last winter.
NOT NEWS
Every central banker in the world understands these dynamics. Every pension manager, every mutual funds manager, every portfolio manager understands these dynamics. As the US$ eases down, it helps the US economy and it hurts non-American banks. As long as things happen gradually, the parties involved can adjust.
THEIR ADJUSTMENTS
What kind of adjustments do the parties involved need to make? Well, foreign banks and foreign governments need to continue to cooperate as they did last winter. Most observers believe this will work out just fine. But, what about those big investment managers? Their clients were hard hit when the stock market dropped so sharply last fall and winter. Many pension plans dropped so sharply that they were unable to meet their payment obligations. Bank stocks were particularly hard hit: after all, in a banking crisis, that’s where the maximum risk is. Will the big pension managers ride through the sharp decline as they did last year? Or will they try to sell off some of their stock portfolios? For the multibillion dollar stock portfolios, this is a theoretical question: they are so big that their selling is what forces the stock market lower. They are too big to sell. Even the adjustments they make to their portfolios must be done by stealth selling. Each day they feed a few big blocks of stock out into the market in an orderly and controlled way so as not to overly disturb the market.
OUR ADJUSTMENTS
What kind of adjustments do we need to make if the US dollar is devalued further? Should we sell our bank stocks? Should we sell all our stocks? We are not in the same position as the mega-money managers of billions – we can sell our portfolios in a heart beat. What do we wish we’d done last year when the US dollar was at this same level?
IRONY
Those mega-money investment managers who understand these financial dynamics can’t sell out of the stock market when the going gets rough. And those investors who can sell don’t. The small investor has an edge over the large when it comes to selling out – but often doesn’t use that advantage. Why not?
FINANCIAL REALITY DOESN’T MATTER
In my book, Beyond the Bull, I try to persuade ordinary investors to develop investment techniques. An investment technique involves objectively observing the world of finance, looking for certain events. When the sought-after events occur, we act: we buy or sell based on pre-planned logic. In this example, we notice a decline in the US dollar and suggest this spells trouble for the banking industry. If the US dollar continued to go down and then the prices of bank shares start to go down, this would be a reason to sell your bank stocks. But that’s not how most ordinary investors behave. Instead of selling, they worry. And, instead of buying their stocks back after a stock market sell-off, they hope the stocks they held through the crash will bounce back up: worrying and hoping instead of buying and selling.
Ken Norquay, CMT
Chief Market Strategist,
CastleMoore Inc.
Links to Beyond the Bull
Canada
http://www.amazon.ca/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246016&sr=8-1
US
http://www.amazon.com/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246055&sr=8-1
UK
http://www.amazon.co.uk/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228245979&sr=8-1
Monday, August 31, 2009
Today’s heroes – Yesterday’s villains.
Last week Royal Bank reported record high earnings. In the twilight of Canada’s recession, Canada’s biggest, bluest bank surprised us all. Other banks experienced healthy profits too. Bank analysts and the financial press reported that the Canadian economy and the real estate/mortgage sector had not been as bad as they had been predicting – and this was why the banks reported such strong quarterly earnings. This, plus one other factor: trading revenues from investment banking and capital markets divisions.
Apparently 21% of Royal Bank’s record high earnings came from traders. And we all know that traders are paid salary + bonus. And, because those trading profits were so high, we can guess that those employees’ bonuses will be really high too.
Wasn’t it just seven short months ago that new president Barrack Obama expressed outrage at the bonuses being paid by the US banks he was bailing out? Even though the traders and managers had made money for the failing banks and had done their jobs, they didn’t deserve their bonuses. For those American banks late last year, the economy was weak and the real estate/mortgage sector was collapsing. Times were so bad that US banks were failing despite the traders’ having done their jobs. The traders’ bonuses were reduced because the mortgage department lost so much money.
We wonder how that problem was eventually resolved. Did the American banks’ traders get paid less? Or did they simply have those bonuses postponed until the banks became profitable again? Or did they quit their jobs in New York and join the Canadian banks in Toronto?
How the rules change in the investment business. What works one year may not work the next. It appears that rule-changing can also apply to people’s paycheques. Traders who had earned their bonuses in US banks in 2008 were financial villains who did not deserve to get paid. But Canadian traders in 2009 are financial heroes, helping propel Canadian banks back to blue chip status. Either way, their fate seems to have been determined by the mortgage department, not the trading department. Because Canadian banks’ mortgage departments were profitable, Canadian traders will have no trouble collecting their 2009 bonuses. Because American banks’ mortgage departments were a disaster in 2008, their traders were criticised for their ‘undeserved’ bonuses. This time around, American investment bankers and capital markets traders were somehow dependent on the bank’s mortgage portfolio for their bonuses.
How about your personal investment bank – or your personal capital market: do your advisors deserve a bonus? Most mutual funds investors pay management expenses of over 2% of the value of their investments. When your investments go down in value, you pay them 2% of that lower value. If your investments are down 30%, your mutual funds manager receives 30% less management fee. In a strange way, it almost seems fair; but it doesn’t feel fair. In fact, it feels outright unfair.
In the world of finance, feelings count. When the banks were being bailed out by the government, it didn’t feel right that bank employees would receive big bonuses, no matter how good a job they did. Now that the Royal Bank has proven to the world that Canadian banks are high quality blue chip banks, there is no problem paying those big bonuses.
In my book, Beyond the Bull: Taking Stock Market Wisdom to the Next Level, I discuss how our feelings affect our investments. In seven short months, banks have gone from presidential rebuff to examples of blue chip stability. And in those same seven months, Royal Bank stock went from under $30 per share to over $55. Your feelings count.
Ken Norquay, CMT
Chief Market Strategist,
CastleMoore Inc.
Links to Beyond the Bull:
Canada
http://www.amazon.ca/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246016&sr=8-1
US
http://www.amazon.com/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246055&sr=8-1
UK
http://www.amazon.co.uk/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228245979&sr=8-1
Apparently 21% of Royal Bank’s record high earnings came from traders. And we all know that traders are paid salary + bonus. And, because those trading profits were so high, we can guess that those employees’ bonuses will be really high too.
Wasn’t it just seven short months ago that new president Barrack Obama expressed outrage at the bonuses being paid by the US banks he was bailing out? Even though the traders and managers had made money for the failing banks and had done their jobs, they didn’t deserve their bonuses. For those American banks late last year, the economy was weak and the real estate/mortgage sector was collapsing. Times were so bad that US banks were failing despite the traders’ having done their jobs. The traders’ bonuses were reduced because the mortgage department lost so much money.
We wonder how that problem was eventually resolved. Did the American banks’ traders get paid less? Or did they simply have those bonuses postponed until the banks became profitable again? Or did they quit their jobs in New York and join the Canadian banks in Toronto?
How the rules change in the investment business. What works one year may not work the next. It appears that rule-changing can also apply to people’s paycheques. Traders who had earned their bonuses in US banks in 2008 were financial villains who did not deserve to get paid. But Canadian traders in 2009 are financial heroes, helping propel Canadian banks back to blue chip status. Either way, their fate seems to have been determined by the mortgage department, not the trading department. Because Canadian banks’ mortgage departments were profitable, Canadian traders will have no trouble collecting their 2009 bonuses. Because American banks’ mortgage departments were a disaster in 2008, their traders were criticised for their ‘undeserved’ bonuses. This time around, American investment bankers and capital markets traders were somehow dependent on the bank’s mortgage portfolio for their bonuses.
How about your personal investment bank – or your personal capital market: do your advisors deserve a bonus? Most mutual funds investors pay management expenses of over 2% of the value of their investments. When your investments go down in value, you pay them 2% of that lower value. If your investments are down 30%, your mutual funds manager receives 30% less management fee. In a strange way, it almost seems fair; but it doesn’t feel fair. In fact, it feels outright unfair.
In the world of finance, feelings count. When the banks were being bailed out by the government, it didn’t feel right that bank employees would receive big bonuses, no matter how good a job they did. Now that the Royal Bank has proven to the world that Canadian banks are high quality blue chip banks, there is no problem paying those big bonuses.
In my book, Beyond the Bull: Taking Stock Market Wisdom to the Next Level, I discuss how our feelings affect our investments. In seven short months, banks have gone from presidential rebuff to examples of blue chip stability. And in those same seven months, Royal Bank stock went from under $30 per share to over $55. Your feelings count.
Ken Norquay, CMT
Chief Market Strategist,
CastleMoore Inc.
Links to Beyond the Bull:
Canada
http://www.amazon.ca/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246016&sr=8-1
US
http://www.amazon.com/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246055&sr=8-1
UK
http://www.amazon.co.uk/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228245979&sr=8-1
Monday, August 17, 2009
Casino Bus Riders
The Blue Chip Bus
I was driving to work today with Sheldon Liberman, portfolio manager for the investment firm CastleMoore Inc. We were on the highway being passed by a bus heading for Casino Niagara. Chinese letters and two-foot poker chips were painted on the side of the bus. We were quipping about the phenomenon of gambling in our culture and wondering about the minds and hearts of the enthusiastic passengers on that bus. And this was all happening before nine a.m!
Based on the fact that there were so many blue poker chips painted on the bus, I joked that the passengers were probably all financial planners and mutual funds salesmen.
Shel shot back with the following conundrum: has the expression “blue chip” lost its meaning? Blue chip used to refer to higher quality safer investments. But in 2008 the biggest insurance company in the world [AIG], the biggest bank [Citibank], the biggest stock broker [Merrill Lynch] and the biggest mortgage company [“Fanny Mae”] all needed to be bailed out. And in 2009 General Motors, formerly the world’s biggest auto company went into bankruptcy. It seems that blue chip stocks have become the area of highest risk in the stock market.
Maybe my guess that the casino bus was full of financial planners was closer to the mark than I first thought. Mutual funds salesmen are trained to sell the products of the biggest mutual funds in the industry. Somehow they have been trained to believe that huge mutual funds companies are safer than the smaller companies. Somehow big blue chip is touted as being better for their clients than small, efficient, entrepreneurial. Maybe that’s the problem with Canadian investors’ RRSPs: we are too heavily exposed to the blue chip sectors of the stock market and the mutual funds industry. Canada’s financial planners just keep betting on the favourites and losing.
In my book, Beyond the Bull, I observe that stock market rules change from time to time. And if we plan to accumulate a lot of capital for our retirement, we’d better take these rule changes into account. Right now it is clear that Sheldon is right: the meaning of the phrase blue chip has changed. Somehow “blue chip” has come to mean “dysfunctional” and “high risk.” Yet somehow the financial planning/ mutual funds community has not yet picked up on it.
Ken Norquay, CMT
Chief Market Strategist,
CastleMoore Inc
905-847-8511
The Amazon links for Beyond the Bull are:
Canada
http://www.amazon.ca/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246016&sr=8-1
US
http://www.amazon.com/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246055&sr=8-1
I was driving to work today with Sheldon Liberman, portfolio manager for the investment firm CastleMoore Inc. We were on the highway being passed by a bus heading for Casino Niagara. Chinese letters and two-foot poker chips were painted on the side of the bus. We were quipping about the phenomenon of gambling in our culture and wondering about the minds and hearts of the enthusiastic passengers on that bus. And this was all happening before nine a.m!
Based on the fact that there were so many blue poker chips painted on the bus, I joked that the passengers were probably all financial planners and mutual funds salesmen.
Shel shot back with the following conundrum: has the expression “blue chip” lost its meaning? Blue chip used to refer to higher quality safer investments. But in 2008 the biggest insurance company in the world [AIG], the biggest bank [Citibank], the biggest stock broker [Merrill Lynch] and the biggest mortgage company [“Fanny Mae”] all needed to be bailed out. And in 2009 General Motors, formerly the world’s biggest auto company went into bankruptcy. It seems that blue chip stocks have become the area of highest risk in the stock market.
Maybe my guess that the casino bus was full of financial planners was closer to the mark than I first thought. Mutual funds salesmen are trained to sell the products of the biggest mutual funds in the industry. Somehow they have been trained to believe that huge mutual funds companies are safer than the smaller companies. Somehow big blue chip is touted as being better for their clients than small, efficient, entrepreneurial. Maybe that’s the problem with Canadian investors’ RRSPs: we are too heavily exposed to the blue chip sectors of the stock market and the mutual funds industry. Canada’s financial planners just keep betting on the favourites and losing.
In my book, Beyond the Bull, I observe that stock market rules change from time to time. And if we plan to accumulate a lot of capital for our retirement, we’d better take these rule changes into account. Right now it is clear that Sheldon is right: the meaning of the phrase blue chip has changed. Somehow “blue chip” has come to mean “dysfunctional” and “high risk.” Yet somehow the financial planning/ mutual funds community has not yet picked up on it.
Ken Norquay, CMT
Chief Market Strategist,
CastleMoore Inc
905-847-8511
The Amazon links for Beyond the Bull are:
Canada
http://www.amazon.ca/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246016&sr=8-1
US
http://www.amazon.com/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246055&sr=8-1
Thursday, August 13, 2009
Mutual funds - is the honeymoon over?
Too much of a good thing: The AIC buy-out.
Consider the recent marriage of Manulife Financial and AIC.
AIC’s founder, Mike Lee-Chin, is an inspiration to ambitious young finance students everywhere. The rags-to-riches story of the Jamaican immigrant who became a billionaire inspired me too. I knew Mr. Lee-Chin when he was merely a millionaire; he was the manager of Regal Capital Planners Hamilton office and I was the manager of Merrill Lynch Canada’s Hamilton office. He had a passing interest in my specialty which was technical analysis of the stock market. I had more than a passing interest in Canada’s top mutual funds salesman, rumoured to be earning a million dollars a year in commission!
In 1983 I moved to Toronto to search for opportunity in the financial capital of Canada. Mike stayed in Hamilton and proved that there was plenty of opportunity there too.
Apart from the human interest angle, will the Manulife-AIC wedding have any impact on the Canadian investment scene?
In my recently released investment book, Beyond the Bull, I talk about the three great drivers of the stock market: investor brains, investor heart and investor position. Brains is the easiest to understand: investors are motivated to buy and sell because of rational logical facts and figures about stocks and companies. Heart is easy to understand too: when investors are fearful or worried, they often sell stocks at too low prices – when they are full of confidence they sometimes pay too much for stocks. It’s the last one, investor position, that poses a potential problem to the Manulife-AIC newly weds.
AIC mutual funds’ core holdings include TD Canada Trust, AGF Management, CI Financial and IGM Financial. A quick check of Manulife’s website showed me that they too love the financial sector: about one third of their largest mutual funds are invested in this one sector alone. But, can a mutual fund own too much of a good thing? At one time it was rumoured that AIC had 10% of their total assets in one stock: TD Canada Trust. Portfolio managers refer to this as ‘concentration.’ Critics would say ‘over concentration.’ That’s an investor position problem.
If this mutual funds company wedding results in Manulife having too many of their collective eggs in one basket, they will be selling some of AIC’s TD, AGF, CI Financial and IGM stock. And the reason for the selling has nothing to do with the growth and value of these four companies. Nor does it have anything to do with Manulife’s portfolio manager’s emotional liking or disliking these four companies. The problem is their position: they own too much of a good thing.
Part 1 of the problem
Manulife may have to sell significant amounts of financial stocks because of this merger. This selling could dampen the performance of that sector over the next few months.
Part 2 of the problem
Use your imagination: if you were managing a big mutual fund or pension fund and you saw this AIC-Manulife wedding, what would you do? What if you had been planning to sell of some of your financial stocks over the next few months? Would you wait until the Manulife selling starts, or would you sell now? Of course, you would sell now. This selling could also dampen the performance of the financial stocks for a while.
Using position analysis, we might expect the financial sector, specifically TD Canada Trust, AGF Financial, CI Financial and IGM Financial to under perform the market until Manulife’s possibly over weigh position is liquidated.
Part Three.
What about the brains and the heart? Are there logical or emotional reasons why bank stocks and mutual funds management stocks might under perform? Wasn’t it only last year that the biggest banks in the USA and Europe were being bailed out? And isn’t the mutual funds industry in consolidation? AIC shrunk from $14 billion to $3.8 billion: it seems unlikely that AGF, CI or IGM would be thriving in times like these.
Part Four: it gets worse
Speculation has it that Mr. Lee-Chin received a dowry of around $150 million in Manulife Financial stock in exchange for his beloved AIC. Talk about an over concentration! Is it reasonable to assume that he might like to sell some shares of Manulife? Could his selling contribute to the under performance of Manulife stock?
Manulife management knows all about their position problems and will act prudently, so as to protect their shareholders and unit holders. They will have made plans for this wedding months ago. My company, CastleMoore Inc, manages investors’ portfolios too. We have no plans to buy financial stocks until the honeymoon ends.
Ken Norquay, CMT
Chief Market Strategist,
CastleMoore Inc
ken@castleMoore.com
Links to Beyond the Bull:
Canada
http://www.amazon.ca/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246016&sr=8-1
US
http://www.amazon.com/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246055&sr=8-1
Consider the recent marriage of Manulife Financial and AIC.
AIC’s founder, Mike Lee-Chin, is an inspiration to ambitious young finance students everywhere. The rags-to-riches story of the Jamaican immigrant who became a billionaire inspired me too. I knew Mr. Lee-Chin when he was merely a millionaire; he was the manager of Regal Capital Planners Hamilton office and I was the manager of Merrill Lynch Canada’s Hamilton office. He had a passing interest in my specialty which was technical analysis of the stock market. I had more than a passing interest in Canada’s top mutual funds salesman, rumoured to be earning a million dollars a year in commission!
In 1983 I moved to Toronto to search for opportunity in the financial capital of Canada. Mike stayed in Hamilton and proved that there was plenty of opportunity there too.
Apart from the human interest angle, will the Manulife-AIC wedding have any impact on the Canadian investment scene?
In my recently released investment book, Beyond the Bull, I talk about the three great drivers of the stock market: investor brains, investor heart and investor position. Brains is the easiest to understand: investors are motivated to buy and sell because of rational logical facts and figures about stocks and companies. Heart is easy to understand too: when investors are fearful or worried, they often sell stocks at too low prices – when they are full of confidence they sometimes pay too much for stocks. It’s the last one, investor position, that poses a potential problem to the Manulife-AIC newly weds.
AIC mutual funds’ core holdings include TD Canada Trust, AGF Management, CI Financial and IGM Financial. A quick check of Manulife’s website showed me that they too love the financial sector: about one third of their largest mutual funds are invested in this one sector alone. But, can a mutual fund own too much of a good thing? At one time it was rumoured that AIC had 10% of their total assets in one stock: TD Canada Trust. Portfolio managers refer to this as ‘concentration.’ Critics would say ‘over concentration.’ That’s an investor position problem.
If this mutual funds company wedding results in Manulife having too many of their collective eggs in one basket, they will be selling some of AIC’s TD, AGF, CI Financial and IGM stock. And the reason for the selling has nothing to do with the growth and value of these four companies. Nor does it have anything to do with Manulife’s portfolio manager’s emotional liking or disliking these four companies. The problem is their position: they own too much of a good thing.
Part 1 of the problem
Manulife may have to sell significant amounts of financial stocks because of this merger. This selling could dampen the performance of that sector over the next few months.
Part 2 of the problem
Use your imagination: if you were managing a big mutual fund or pension fund and you saw this AIC-Manulife wedding, what would you do? What if you had been planning to sell of some of your financial stocks over the next few months? Would you wait until the Manulife selling starts, or would you sell now? Of course, you would sell now. This selling could also dampen the performance of the financial stocks for a while.
Using position analysis, we might expect the financial sector, specifically TD Canada Trust, AGF Financial, CI Financial and IGM Financial to under perform the market until Manulife’s possibly over weigh position is liquidated.
Part Three.
What about the brains and the heart? Are there logical or emotional reasons why bank stocks and mutual funds management stocks might under perform? Wasn’t it only last year that the biggest banks in the USA and Europe were being bailed out? And isn’t the mutual funds industry in consolidation? AIC shrunk from $14 billion to $3.8 billion: it seems unlikely that AGF, CI or IGM would be thriving in times like these.
Part Four: it gets worse
Speculation has it that Mr. Lee-Chin received a dowry of around $150 million in Manulife Financial stock in exchange for his beloved AIC. Talk about an over concentration! Is it reasonable to assume that he might like to sell some shares of Manulife? Could his selling contribute to the under performance of Manulife stock?
Manulife management knows all about their position problems and will act prudently, so as to protect their shareholders and unit holders. They will have made plans for this wedding months ago. My company, CastleMoore Inc, manages investors’ portfolios too. We have no plans to buy financial stocks until the honeymoon ends.
Ken Norquay, CMT
Chief Market Strategist,
CastleMoore Inc
ken@castleMoore.com
Links to Beyond the Bull:
Canada
http://www.amazon.ca/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246016&sr=8-1
US
http://www.amazon.com/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246055&sr=8-1
Friday, July 31, 2009
"...the Slope of Hope."
The Slippery Slope of Hope
Have you noticed how strongly the Canadian dollar and US stock market are correlated lately? Every day that the stock market ticks up, the Canadian dollar ticks up too. In fact, if we check the long-term trends, this correlation dates back to 2002. From 2002 to 2007, the US stock market went up and the Canadian dollar went up.
For Canadians, another way to describe a strong Canadian dollar is “a weak US dollar.”
But the US dollar’s weakness went hand in hand with world stock market strength from around 2002. Not only that, but the weakening US dollar accompanied stronger prices for agricultural commodities, basic materials and energy. It seems we can tell the story of world economics by following the story of the US dollar.
How can we use this information for managing our investments?
In a previous article, we wrote that the 6-year US dollar down trend that started in 2002 and ended in 2008: “… the US dollar bottomed at a price of 71 currency basket units. Then, in the last half of 2008 it rallied to 88 units, dropped to 78, surged back up to 89 and dropped back down to 79: all this in one year.” [See “How to Break the Banks,” July 17, 2009]
Does the end of the decline of the US dollar proclaim the beginning of a down trend for world stock markets, commodities, materials and energy prices too?
That is exactly what it means.
In “How to Break the Banks,” we illustrated how the long-term weakness of the US dollar undermined the world’s banking system because the US dollar is the banks’ reserve currency. If the dollar gets weaker, it will put pressure on the world’s banks at a time when they are already shaky. But, if the correlation between the US dollar and the market continues to hold, a strong US dollar will put pressure on the world’s stock markets and commodities markets. The US dollar and the world’s banking system have a direct correlation: both are strong or weak at the same time. But the US dollar and the world stock market have had an inverse correlation for the past ten years: when one was weak, the other was strong,
Which will it be: a weaker banking system or weaker stock and commodities prices? Or, to ask the question from the other side of this correlation: a weaker US dollar or a stronger US dollar?
The only way the world can have strong banks and strong stock and commodities prices is for the US dollar and the markets to become uncorrelated. A new bull market in the US dollar would then help world banks, but not hurt the financial markets. Can they do it?
My book, Beyond the Bull, discusses two 10-year correlations between interest rates and the S&P500. For the first ten years, the stock market went up every time interest rates went down. For the second ten years, the stock market went up every time interest rates went up: the exact opposite. So, we know these correlations come and go. And we can always hope the US dollar vs. stock and commodities price correlation will go away too.
But managing your investments by hoping doesn’t work very well, as we learned in 2008 when the stock market dropped 40%+ in only a few months. Professional stock traders have a saying: “the slippery slope of hope.” When unsophisticated investors hold onto their stocks in a huge bear market, the traders mock them, saying: “They are sliding down the slippery slope of hope.”
Our advice? DON’T LOSE YOUR MONEY! If the slippery slope of hope develops because the world’s banking system needs a stronger US dollar, do what you wish you’d done in 2008. Cash in your chips and sit on the sidelines.
Ken Norquay, CMT
Chief Strategist, CastleMoore Inc
Links to my book, Beyond the Bull:
Canada
http://www.amazon.ca/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246016&sr=8-1
US
http://www.amazon.com/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246055&sr=8-1
k
Have you noticed how strongly the Canadian dollar and US stock market are correlated lately? Every day that the stock market ticks up, the Canadian dollar ticks up too. In fact, if we check the long-term trends, this correlation dates back to 2002. From 2002 to 2007, the US stock market went up and the Canadian dollar went up.
For Canadians, another way to describe a strong Canadian dollar is “a weak US dollar.”
But the US dollar’s weakness went hand in hand with world stock market strength from around 2002. Not only that, but the weakening US dollar accompanied stronger prices for agricultural commodities, basic materials and energy. It seems we can tell the story of world economics by following the story of the US dollar.
How can we use this information for managing our investments?
In a previous article, we wrote that the 6-year US dollar down trend that started in 2002 and ended in 2008: “… the US dollar bottomed at a price of 71 currency basket units. Then, in the last half of 2008 it rallied to 88 units, dropped to 78, surged back up to 89 and dropped back down to 79: all this in one year.” [See “How to Break the Banks,” July 17, 2009]
Does the end of the decline of the US dollar proclaim the beginning of a down trend for world stock markets, commodities, materials and energy prices too?
That is exactly what it means.
In “How to Break the Banks,” we illustrated how the long-term weakness of the US dollar undermined the world’s banking system because the US dollar is the banks’ reserve currency. If the dollar gets weaker, it will put pressure on the world’s banks at a time when they are already shaky. But, if the correlation between the US dollar and the market continues to hold, a strong US dollar will put pressure on the world’s stock markets and commodities markets. The US dollar and the world’s banking system have a direct correlation: both are strong or weak at the same time. But the US dollar and the world stock market have had an inverse correlation for the past ten years: when one was weak, the other was strong,
Which will it be: a weaker banking system or weaker stock and commodities prices? Or, to ask the question from the other side of this correlation: a weaker US dollar or a stronger US dollar?
The only way the world can have strong banks and strong stock and commodities prices is for the US dollar and the markets to become uncorrelated. A new bull market in the US dollar would then help world banks, but not hurt the financial markets. Can they do it?
My book, Beyond the Bull, discusses two 10-year correlations between interest rates and the S&P500. For the first ten years, the stock market went up every time interest rates went down. For the second ten years, the stock market went up every time interest rates went up: the exact opposite. So, we know these correlations come and go. And we can always hope the US dollar vs. stock and commodities price correlation will go away too.
But managing your investments by hoping doesn’t work very well, as we learned in 2008 when the stock market dropped 40%+ in only a few months. Professional stock traders have a saying: “the slippery slope of hope.” When unsophisticated investors hold onto their stocks in a huge bear market, the traders mock them, saying: “They are sliding down the slippery slope of hope.”
Our advice? DON’T LOSE YOUR MONEY! If the slippery slope of hope develops because the world’s banking system needs a stronger US dollar, do what you wish you’d done in 2008. Cash in your chips and sit on the sidelines.
Ken Norquay, CMT
Chief Strategist, CastleMoore Inc
Links to my book, Beyond the Bull:
Canada
http://www.amazon.ca/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246016&sr=8-1
US
http://www.amazon.com/Beyond-Bull-Taking-Market-Wisdom/dp/0980923182/ref=sr_1_1?ie=UTF8&s=books&qid=1228246055&sr=8-1
k
Tuesday, July 21, 2009
57 Banks go Bust
57 banks go broke
Fifty- seven American banks have failed so far in 2009. [Source: David Rosenberg of Gluskin Sheff]
When a bank fails in Canada, the Canada Deposit Insurance Corp makes good: CDIC insures that depositors get their money back, up to a certain limit. The Americans have a similar program. Because of this insurance, U.S. and Canadian depositors are not really at risk unless they deposit too much money in a single bank. With these bank failures happening in their own back yard, Americans are vigilant about making sure they don’t put too much money in any one bank. In 2009, there is clear danger in the US banking system; bank customers have to take the usual precautions seriously.
Why is it that a bank’s Guaranteed Deposit customer thinks so differently from a Mutual Fund customer? At the first sign of danger, Canadian bank customers review all their deposits to make sure they hold no more than the CDIC insurance maximum of $100,000 in any one bank. Amounts over $100,000 are not insured. If the bank fails, uninsured investors could lose their money.
Yet, in times of economic danger, those same customers won’t walk across the office to the bank’s mutual funds desk and redeem their stock market holdings. A stock market sell-off is way more likely than a bank failure, yet people do not protect themselves. What is it about the psyche of the average mutual funds investor that is so different from that of the average depositor, even when the investor and the depositor are the same person?
It’s the way these two different investments are sold.
A banker who persuades you to invest at today’s low interest rates will emphasize how safe Guaranteed Investment Certificates are. True, you don’t get much interest, but you are “guaranteed” not to lose. The banker’s pitch attracts investors who are afraid to put their capital at risk.
A bank’s mutual funds salesman or financial planner who sells you a stock market mutual fund will emphasize growth and higher long-term returns. The sales pitch includes a warning that mutual funds prices will fluctuate over time and that we should not sell because the stock market will be a good long-term investment even if it goes down for a while.
In other words, the mutual funds salesman prepares clients to take risk, but the GIC salesman prepares clients to avoid risk. So, at a time when 57 US banks have failed in six months, the GIC client checks his guarantee. But at a time when America’s biggest bank, stock broker, insurance company, mortgage company and car company had to be bailed out, the hapless mutual funds investor is told to hang in there and not worry.
It is clear that there are times of high economic risk, as well as times of less risk. But is there ever a time to ignore risk? Responsible investing is all about monitoring risk and making changes when financial risk changes. That change might be adjusting your GICs so that you don’t have over the insurable maximum of $100 thousand with any one bank; or it might be selling your stock market mutual funds and switching to some low-risk money market fund. But is it ever reasonable to expose yourself to big financial losses?
If those 57 American banks had been more risk averse, they might not have failed.
Fifty- seven American banks have failed so far in 2009. [Source: David Rosenberg of Gluskin Sheff]
When a bank fails in Canada, the Canada Deposit Insurance Corp makes good: CDIC insures that depositors get their money back, up to a certain limit. The Americans have a similar program. Because of this insurance, U.S. and Canadian depositors are not really at risk unless they deposit too much money in a single bank. With these bank failures happening in their own back yard, Americans are vigilant about making sure they don’t put too much money in any one bank. In 2009, there is clear danger in the US banking system; bank customers have to take the usual precautions seriously.
Why is it that a bank’s Guaranteed Deposit customer thinks so differently from a Mutual Fund customer? At the first sign of danger, Canadian bank customers review all their deposits to make sure they hold no more than the CDIC insurance maximum of $100,000 in any one bank. Amounts over $100,000 are not insured. If the bank fails, uninsured investors could lose their money.
Yet, in times of economic danger, those same customers won’t walk across the office to the bank’s mutual funds desk and redeem their stock market holdings. A stock market sell-off is way more likely than a bank failure, yet people do not protect themselves. What is it about the psyche of the average mutual funds investor that is so different from that of the average depositor, even when the investor and the depositor are the same person?
It’s the way these two different investments are sold.
A banker who persuades you to invest at today’s low interest rates will emphasize how safe Guaranteed Investment Certificates are. True, you don’t get much interest, but you are “guaranteed” not to lose. The banker’s pitch attracts investors who are afraid to put their capital at risk.
A bank’s mutual funds salesman or financial planner who sells you a stock market mutual fund will emphasize growth and higher long-term returns. The sales pitch includes a warning that mutual funds prices will fluctuate over time and that we should not sell because the stock market will be a good long-term investment even if it goes down for a while.
In other words, the mutual funds salesman prepares clients to take risk, but the GIC salesman prepares clients to avoid risk. So, at a time when 57 US banks have failed in six months, the GIC client checks his guarantee. But at a time when America’s biggest bank, stock broker, insurance company, mortgage company and car company had to be bailed out, the hapless mutual funds investor is told to hang in there and not worry.
It is clear that there are times of high economic risk, as well as times of less risk. But is there ever a time to ignore risk? Responsible investing is all about monitoring risk and making changes when financial risk changes. That change might be adjusting your GICs so that you don’t have over the insurable maximum of $100 thousand with any one bank; or it might be selling your stock market mutual funds and switching to some low-risk money market fund. But is it ever reasonable to expose yourself to big financial losses?
If those 57 American banks had been more risk averse, they might not have failed.
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