Divestor

The best finance writer on the internet today, in my opinion, is David Merkel. Everything he writes is absolute wisdom that he has accumulated over his experiences and career as an insurance firm asset manager.

His last post on the typical “What should I do?” question that a lot of people (who don’t devote nearly as much time to the marketplace) give is something that I’ve had to deal with quite often.

The true issue is that whenever you start to mix together money and social relationships together, you end up with the potential for lots of trouble. This is why I never wade into the issue of finances in conversations unless if the other side explicitly brings it up and is clearly seeking my opinion on a matter. A few of my friends and colleagues know I write prolifically over the internet, but most do not.

My usual line of conversation, after being asked “the question” (What do I do with my lump sum of accumulated savings that I haven’t earmarked for my mortgage that is collecting dust in the bank account) is me asking a question back, “When do you need the money, and can you suffer, say a 20% loss and still be ‘okay’ about it?”

The typical answer I receive is, “I don’t know. Maybe two years? But I would still like to see the money there, while it would not kill me to lose 20% of it, I still would not like that to happen!”

Whenever I hear this, if this was my money with a similar risk profile, I’d probably spread it around some relatively safe convertible debentures that are due to mature in a couple years. Doing a cursory scan of the Canadian market you have about a 5% yield to maturity on decent 2-year term corporate issues out there, and going up to about 7% depending on what your definition of “relatively safe” is.

On Merkel’s post, he states:

I say to my friends asking advice, “Remember, I am your friend. I will take no money, but I won’t hold your hand and guide you either. I will give you very basic advice, and it is up to you to learn and implement it.” I don’t want to be a financial planner, but I don’t want to leave friends in a lurch.

Recommending debentures to others requires them to do quite a bit of homework (at a very minimum, fishing for prospectuses on SEDAR). It also requires them to deal with financial instruments that are quite unlike what they have previously been exposed to (at most, buying and selling common shares). There is little chance of this (them researching prospectuses, getting a ballpark valuation and doing the transaction) happening. Not helping either is that with most brokerage firms in Canada, they charge an arm and a leg to trade debentures.

So as a result, instead what I end up saying is, “Get a 2-year GIC. I believe [a CDIC-insured financial entity] has a 2-year GIC going on at a rate of 2.4%, which is a good market rate compared to other institutions. Even if you go to [big known Canadian bank], you can get about 2% which is not bad either.”

The usual response back, “But Sacha, 2.0-2.4% is NOTHING! Can’t I get a higher return on my money?”.

Then I just say, “Yes, you can probably get more, but this means taking more risk, and means taking a lot more time to follow and know the market you are talking about getting into. At least with the GIC, your money will be there for another day, and if you get more comfortable with investing, you can use that money. It is better earning zero return on your money than a negative return. If you really, really want to gamble, take 10% of your money and put it in a brokerage account where you can trade around and likely lose it – you can consider this as a form of tuition.”

By this point their eyes glaze over, they say thank you, and then the conversation goes to something else. After a few months, you usually end up discovering they invested the money in some sort of “balanced” mutual fund that charges a 2.5% management expense ratio and posted good 2-year past performance numbers strictly due to the fact that everything has gone up between then and now, especially in the fixed income world. You know that they will lose money in the future, but there is nothing you could or should do other than just smile and move on to a different topic.

As I was speculating, the Bank of Canada has raised interest rates by 0.25%, which is a change from 0.75% to 1.00%.

The key guiding paragraph to determine future rate hikes is in the last paragraph. From the July 20 statement:

Given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments.

From the September 8 statement:

Any further reduction in monetary policy stimulus would need to be carefully considered in light of the unusual uncertainty surrounding the outlook.

The phraseology of changing “would have to be weighed” with “would need to be carefully considered” suggests that the Bank of Canada is not necessarily totally done raising rates, but it is not out of the question if data warrants so.

The next Bank of Canada scheduled announcement is October 19, 2010 and the last one for the year is December 7, 2010.

3-month Bankers’ Acceptance Futures are at 1.24% for September and 1.3% for December. Both are trading about 0.15% up from yesterday as a reaction of today’s news. The futures imply there is roughly a 20% chance of a rate increase between now and years’ end.

Being an investor requires you to be part rational analyst, part number cruncher, and part armchair psychologist (and a lot of other parts as well). On the armchair psychologist side, you have to determine what other investors are thinking and determine whether this sentiment has reached a local maximum or minimum with respect to the expectations that are implied in market pricing.

So when I see a headline like “Equities are dead, long live bonds” it gets my attention. Not because there is any information in the headline, but rather that it is an indicator of sentiment. Although a single news article is never enough to give a definitive indication of sentiment, multiple articles over a short period of time spread across all sorts of non-specialized ‘conventional’ media tend to send signals.

While mining for this information is difficult without realizing that retrospective analysis is 20/20, recent memories such as the tech/internet mania in the late 90’s and early 00’s come to mind. Also, in the early 80’s when gold was bidded up to the moon, and the US currency was widely known as future toilet paper (along with those 15% 30-year government bond yields) made a sell gold / buy bonds trade to be the trade of that particular decade.

Trying to mine this information for future use, rather than historical use, might be impossible task. Who knows. Sometimes the masses are right.