“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” – Mark Twain
As investors, we need to be wary of what we’re absolutely, positively sure about. We may be flat out wrong. Economies, markets and companies are complex organisms, which makes them unpredictable.
“Sure things” nearly always represent the consensus view. This doesn’t necessarily make them wrong, but it does make it harder to make money from them. If something is clear cut and widely accepted, it’s already factored into prices.
A couple of years ago, the sure things were gold (rising), the United States (toxic) and a commodity and energy super cycle (driven by China’s growth). The outcomes of these predictions have been decidedly mixed.
What are investors most sure of today and why might they be wrong?
There’s general agreement that interest rates are unsustainably low, but there’s an equally strong consensus that they won’t go up any time soon. The reason: Western governments and their economies can’t afford higher rates. This argument doesn’t take into account another interested party – bond buyers. They may have something to say about future yields. Spain and Italy desperately need to finance their debt at low rates, but haven’t found the bond market to be overly sympathetic.
When the current rush to find safety in North American debt reverses direction, because of improvement in Europe or fresh concerns about the U.S. financial situation, North American rates could surge two to three percentage points higher.
Europe’s endless problems
It’s hard to argue with those who say Europe will stay in the tank, but cycles naturally correct themselves with time. The continent’s debt burden is enormous, but there’s more reform and adjustment going on in Europe than North America. To quote the late Peter Cundill: “The world has an amazing ability to muddle through.” If muddling through represents an improvement on what the market is expecting, Europe could prove to be more of an opportunity than a risk.
It’s widely accepted that China’s GDP growth has slowed to 7 to 8 per cent a year, but few if any economists are calling for a serious decline.
Yet China is exhibiting all the telltale signs of a country that’s hitting the wall. Inventories are building and many industries have too much production capacity. Each new labour contract is making the country less competitive. China’s economy relies heavily on real estate development, loose credit and government-funded capital spending. As with all the great meltdowns (Enron, Nortel and Greece, to name three), we really don’t know the true numbers.
For many investors, the notion of buying stable, dividend-paying stocks is a slam dunk. Dividend-paying stocks provide income and capital gains, and allow investors to sleep at night.
But let’s take a closer look. Banks, utilities and REITs have done well, but will they continue to outperform more broadly diversified portfolios? Two things in particular will make it tougher.
First, interest rates are likely to trend higher, which means these rate-sensitive stocks will face a head wind for the first time in 31 years.
Second, the valuations of these sectors reflect their popularity. Looking around the world, it’s hard to find many stocks that have less economic slowdown factored into them than the ones favoured by dividend lovers.
“We’re in a low-return environment.” These words roll off the tongues of investment professionals everywhere.
But the future may turn out to be brighter than many people think. While current yields seem to ensure that bond returns will remain low over the next five years, poor stock returns are far less certain. Indeed, the prevailing view of a low-return future is a bet against profitable, well-financed companies and reasonable valuations. Some sure things will no doubt come to pass, but it’s also a sure thing that one or more of the bedrock beliefs I’ve mentioned above just ain’t so. The key for investors is to be well diversified so that no one surprise can damage your portfolio.
Tom Bradley is president of Steadyhand Investment Funds. He can be reached at firstname.lastname@example.org.