November 2, 2007--Stock market commentary

Greetings.

Without a doubt, the story of 2007 for Canadian investors is the unexpected rise of the Canadian loonie versus the US dollar. Imagine, year-to-date in 2007, the loonie is up 24% versus the US dollar. The other story is the high price of oil. I wanted to share my perspective so please read on.

Is this good news that the $CDN is up?

It depends. If you want to buy books at Wal-Mart, you can pay the $US price now instead of the higher $CDN price. If you're going on a holiday south, you may have savings passed onto you. But the news is not all good. Here's a simple example. One of my favourite fund managers, Brandes Investments, made some very good stock selections, buying Intel, Dell Computers and Microsoft Corp before January 1, 2007. Year-to-date, the Intel investment is up 32%, Dell up 22%, Microsoft up 23%. Did Canadian investors in Brandes reap the benefit? No, because the gain on the stock was all but eliminated due to the rise in the $CDN [and therefore the corresponding drop in the $US]. And the same applies to virtually all global investments that Canadian investors have made. A total of 1176 global stock funds, available to Canadian investors, did not make money so far in 2007 [obviously I'm talking about the funds priced in $CDN].

So why own global funds if you're Canadian?

[1] While it's true that our holdings in global funds have been recently punished, the merit of investing a portion of your portfolio globally has and will continue to exist. I won't list all of the reasons here, but consider that most of world's attractive, profitable companies are not based in Canada. And you can only buy stock in these companies by first buying the local currency.

[2] The Toronto Stock Exchange Index [TSX], which is a broad measure of the Toronto stock market, started going up five years ago due to rising stock values in oil/gas companies, minerals and banks. The result is a five year average annual return for the TSX of 20.5%! This result should make us cautious.

Why be cautious now about the TSX index?

Here are some interesting facts--The TSX had an excellent 5 year period ending in September 1987 [it averaged 23.6% per year]. During the next five years, ending September 1992, the TSX had grown by 0%. Five more years, to September 1997, the TSX had an excellent return [again averaging 20%+ per year]. During the next five years to September 2002, the TSX lost money. As you can see, the cycle is remarkably consistent. True,past performance does not guarantee future performance, but here are my thoughts.

1. The TSX is cyclical because it is primarily a market of resource stocks, and resource companies are classically cyclical. Calgary is a boom and bust town for a good reason! Think Alberta housing prices can only go up? Think that the resource or bank stocks you might own can only go up? Think that the price of oil can only go up? Be cautious.

2. Not happy about the recent performance of your global funds? Wait a few years and then see how you feel. Now may be a particularly good time to own global funds, which all of my clients do.

3. Don't look to sell your Canadian mutual funds--unless they are firmly focused on resource companies--but own Canadian funds with abroad mandate, meaning the managers can buy companies in any sector. And buy funds where the managers have a record of doing well when the TSX is not. These manager focus on value. They will not own overpriced companies no matter how well they've done recently.

* These are my thoughts that drive how I have been, and will be, managing your investments. I welcome any questions you have. Remember, it's important that I see you at least once per year to review your portfolio and to have you update me on your financial situation. The reviews allow us to ensure that your portfolio is still appropriate for your needs and to consider any changes.

Last thing--some clients have asked me to predict where the $CDN goes from here. To be sure, economists have a lousy record of making such predictions and I'm wise enough to not even try. Consider, though, that the $CDN has spent the last thirty-odd years at a lower price than it's at now. That won't tell you when, but it may tell you what direction from here. I'll finish with a quote from one of the managers I respect, Bill Miller of Legg Mason Capital Management, from September 2007--

We actually try to buy low and sell high, and you don’t buy low when everything is great and the headlines reflect it. Usually (but not always), when you read about some industry or company having the worst time since some period of years, or even decades, ago, you will find that buying that industry or company when it was going through those difficulties proved quite profitable if your time horizon wasn’t measured in days or months.

Cheers!

Tom

Notes--*For those of you who like statistics, here's another one that suggests caution about the TSX. In the nearly eight calendar years of this decade, the TSX has outperformed both the US and EAFE [Europe and Far East] markets in six years. This is unprecedented historically: in the previous thirty years, the TSX outperformed only 30% of the time. These facts imply that it's time for the US and EAFE to have a turn. Some may say that it's different this time because oil is only going to go up in price. I don't believe that. And since Calgary is an oil town, I'll provide a somewhat lengthy assessment of energy prices, again from Bill Miller.

Miller, a US stock manager, is considered one of the very best managers based on his long-term record [see http://money.cnn.com/2006/11/14/magazines/fortune/Bill_miller.fortune/index.htm].

Energy and energy related stocks continue to be among the market’s best performers and we don’t own them. That sector was the strongest performer in the month of June, in the second calendar quarter of 2007, in the 6 months ending June 30, and in the three and five year periods ending June 30. Only in the 12 months ending June 30 did other sectors perform better. It is said the only thing worse than being wrong is staying wrong. The question for us now is have we experienced a long cycle in energy, or is this a secular change where energy prices will not decline in real terms, as has been the historic norm, but will be stable or maybe even increase after adjusting for inflation.
That question should be answerable shortly. We are at or near the high prices for oil that were reached last summer. Most other commodities prices have peaked and have now declined from the highs achieved either last year or earlier this year, including nickel, once thought to be in a secular shortage situation, and corn, whose price has been boosted by government mandated ethanol programs. If oil retreats from these or modestly higher levels over the next 6 months, it is likely that we are nearing the end of a long cycle. If it breaks out to new highs and stays there, then the secular story may carry the day. Interestingly, prices for natural gas, which is both environmentally friendly and long term substitutable for oil, are not only less than half the levels reached post Katrina, they are also below the average price of the past year or so. Finally, speculative interest in oil futures on the commodities exchanges is at record levels, while oil companies and others in the industry are net short the commodity, believing the price will decline. Stay tuned. --Bill Miller, Sep. 2007

Tom Buck, M. Ed. CFP
Certified Financial Planner
Assante Financial Management Ltd
email: tom.buck@ethicalfootprint.ca