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My Thoughts on Toronto Financial Advisors

It was the most expensive lesson I’d ever learned – the equivalent of a University education. This lesson was much different from the material taught at school. There were no classes or lectures to attend, no books to buy, and no exams to write. Despite this lack of commitment, each day got increasingly more difficult. I felt helpless as my dreams were disappearing before my very eyes. Losing money sucks.

In 1997 I began investing proceeds from my online business ventures into the stock market. Technology was what I knew, and I felt comfortable investing my money in these companies. My portfolio grew at an amazing pace as “investors” bid up the share prices of these companies to nose-bleed levels. For three years I thought I was the smartest man alive and that I’d never have to work a day in my life.

I was brought back to reality in 2001 when I finally sold my remaining holdings for only a fraction of what they were once worth. My portfolio suffered a loss greater than eighty percent. I was the perfect “average investor” – buying at the top and selling at the bottom. Individual investors will do this because they don’t trade with logic; they trade using their emotions. I (along with millions of others) made irrational decisions while trading. I bought because stocks were going up, not for fundamental reasons. I sold because stocks were going down, not for fundamental reasons.
Academics teach us that we can’t time the market. Price movements are random, all known information is priced into a stock, blah, blah, blah. The problem with the theories they teach in school is that they all assume that investors are rational. Ha! I don’t buy that for a second. I’ve been trading for eight years and been a very astute student of the market for the last few, and I still make irrational decisions. There is a whole area of finance devoted to this subject called, behavioural finance. It’s a fact; humans have emotions. When we let our emotions dictate our actions we often act irrationally. For example I’m sure everyone knows someone (or has personal experience) that has done something crazy because they are in love. Love is a strong emotion, along with fear and greed. The latter two emotions are most responsible for driving the action of the stock market.

The majority of the investment community will disagree with me, but in order to make educated decisions, the decision maker should hear both sides of the story. In investing there are two sides – the bulls and the bears. Which am I you ask? Well, it all depends on the asset class. The “perma-bulls” showcased in the media through the likes of CNBC and The Wall Street Journal will only give you one side of the story. Over the next few pages, I will attempt to provide insight as to where the financial markets may be headed over the short, intermediate and long-term using fundamentals as my basis, and not Wall Street / Bay Street hype.hype.

I will begin by making a case for why the stock markets will not provide the returns which investors have grown accustomed to. I will support my case by examining the state of the U.S. economy, the effect that fiscal and monetary stimuli has on asset prices and fiat currencies. Now, I’m not all doom and gloom. In fact, I am extremely bullish on one particular asset class – the Rodney Dangerfield or asset classes – commodities! I know what you’re thinking, you think I’m crazy. Well guess what – we’re both right, but at least I’ll be crazy and rich.

After reading this essay I hope that you have a greater understanding of what will unfold in the next few years and maybe even have the courage to implement some of my suggestions. I understand that most investors are in for the long haul, buy and hold type investors – and not speculators. Therefore, I will tailor my suggestions such that they can be implemented by your average investor using a financial advisor. Before I begin, just remember that free advice is worth what you pay for it.

Past Performance is Not Indicative of the Future

Most western investors only care about returns; “What was the one year return, the 5 year return, etc.” What they tend to not focus on is risk. Risk can be examined by looking at the fundamentals. Fundamentals are the reasons why equities SHOULD go up or down. What are the fundamentals saying now? They are saying that equities should not perform well. The stock market has a history of alternating between secular bull markets and secular bear markets. By secular, I mean long periods that generally last about 15 years. In the year 2000, the longest secular bull market in history ran out of steam after an impressive 18 year run. We are now in the 5^th year of the current secular bear market. Yes, the stock market has performed well the last two years, but this is only a “cyclical” bull market operating inside of a larger secular bear market. Equities will experience downside pressure over the next few years after this cyclical bull market tops out.

What causes market cycles? Investor psychology. In 1982, stocks were very cheap and nobody wanted to own them. Nobody realized that the biggest bull market in history was about to begin. By the 1990’s, your average investor had mustered enough courage to enter the market. Extreme optimism marked the end of this bull market in 2000, and the Nasdaq proceeded to lose 85% of its market value. Over the next decade, investors will slowly lose confidence in the stock market until most have sworn off the market for good. It is investor confidence that drives markets. Tops are seen when we have extreme levels of confidence, bottoms are seen when we have extreme levels of pessimism. Currently, investors are still optimistic after achieving returns in the area of 15% per year throughout the 1990’s. They make the mistake of extrapolating past returns into the future. Ask these investors how much money they’ve made in the past 5 years since this secular bear market began. Most will say zero, although if they took inflation into account, they’re looking at a loss.

Since you really just can’t take my word for it, I guess I’ll have to provide some proof. Given the space constraints, I will focus on the most popular measure of value – the Price Earnings Ratio (P/E Ratio):

”From 1982 to 2000, earnings increased by 120% and stock prices rose six-fold in inflation-adjusted terms. Valuations were pushed up to a level not seen in more than 100 years. In the chart above, we see that valuations have come down significantly over the past several years but still sit at the high end of their historic range. It is doubtful that the rally from October of 2002 marks the beginning of the next secular bull market. It would be an unprecedented development if it were indeed the case.” (Zyblock)

Anyone can see that stock valuations today are higher than in 1929 when the Dow suffered its infamous decline! How can any reasonable person expect the market to continue going up? Well, company earnings could double, but as I will show you later, this situation is extremely unlikely. According to John Mauldin, the 10 year real return (return after inflation) has historically been zero with P/E’s at the levels we have today.

“Here's a study done by Jeremy Grantham, where he breaks up the years from 1925-2001 by looking at the average price to earnings level for the year. He then groups the years based on this valuation into 5 different buckets. The highest price to earnings years was labeled the "most expensive 20% of history"; the lowest price to earnings years was labeled the "cheapest 20% of history." What he found is that over the next 10 years the cheapest or second cheapest quintiles had an average compound return of 11%.“ (Mauldin)