But by the time autumn comes, I believe that sanity will return to the markets

The upside down market
Gordon Pape
Monday, March 31, 2008

TORONTO (GlobeinvestorGOLD) - Most investors hate volatility. It makes them nervous. They don’t like to see their stocks soar in value one day and then plunge like a stone the next. All they want is predictable, steady growth, with no hiccups. I call it the “10 per cent with no risk” syndrome.

It’s easy to understand this mindset. The majority of people don’t have a clear grasp of the complexities of the stock market and don’t want to devote the time required to learn about it. There are other more important priorities in life. Instead, they long for the good old days of double-digit GIC returns when all they had to do was hand over their cash to the local bank and collect interest. Of course, they forget that double-digit interest rates were accompanied by double-digit inflation, which cancelled out the buying power of their profits. It’s the stability and the absence of risk that they recall so fondly.

This helps to explain the continued popularity of principal-protected notes (PPNs), which guarantee that you won’t lose your capital no matter what happens to the markets. Most independent financial commentators (including me) hate them because of their high cost, lack of transparency, and hidden risks. But investors don’t seem to care. They continue to pour billions of dollars into these structured products, much to the delight of promoters and advisors who are getting rich from the fees they produce.

In the past, it was easy for PPN critics to point out less expensive and more profitable alternatives. Certain types of stocks were relatively immune to the general volatility that has gripped the markets in recent years. Financials, utilities, telecoms, and real estate issues offered the kind of steady, low-risk growth that the average investor craves. Dividend funds captured that desirable combination in a neat package. By selecting carefully, an investor could have it all: good cash flow, reasonable growth, and limited downside.

But now that option has swirled down the drain like bathwater. The old reliables have become even more volatile than the broad market. The financial world has been turned upside-down, leaving investors more confused and anxious than ever.

Consider what happened in the first quarter of this turbulent year. As of the market close on Friday, the S&P/TSX Capped Financials Index was down 12.1 per cent year-to-date. The Utilities Index, which would normally be expected to rise in a falling interest rate environment, was off 8.4 per cent. The telecom sector was down 11.9 per cent. (Do investors really think people are going to stop watching TV or talking on their cell phones?) The real estate sub-index matched that dismal performance, also losing 11.9 per cent year-to-date.

During that same period, the S&P/TSX Composite Index fell 4.3 per cent. That’s not a major decline in the great scheme of things, however there is a widespread perception that the market is in dreadful shape. I attribute that to the fact that the so-called “safe” stocks bear most of the responsibility for dragging down the broad index. Looking for stability? You’ll find it these days in energy stocks (up 1.3 per cent year-to-date) and mining issues (up 5.5 per cent).
So what should the low-risk investor do?

Have we entered a new era, where commodities offer safe havens and utilities are fraught with peril? I don’t think so. I believe that the current situation is an aberration and that six months from now the markets will have regained a semblance of normalcy.

From that, it follows that I advise low-risk investors to stay on plan. Maintain a balanced portfolio, which means a bond/cash position of at least 30 per cent (more for older people). Hold quality blue-chip stocks and don’t abandon your dividend funds.

I know it’s tough to stick with them when the average dividend fund shows a six-month loss of 5.7 per cent (to Feb. 29) but remember that you’re investing for the mid to long term. Despite the recent losses, over the past five years the average dividend fund has generated an annual gain of 12.5 per cent. That’s a handsome return for what was once, and will be again, a low-risk place for your money.

I expect we will have to ride out at least one more tough quarter before conditions start to return to normal. But by the time autumn comes, I believe that sanity will return to the markets and we will be able to move on with our lives. Stick it out until then.

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