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Why investors need to think slow, Bombardier is suddenly a hot stock, and what makes Robert Shiller nervous

FILE - In this Oct. 14, 2013 file photo, Nobel prize-winning Yale University economist Robert Shiller smiles at a news conference in New Haven, Conn. In his new book with George Akerlof, another Nobel-prize winning economist, Shiller examines the many ways credit-card companies, financial firms and other businesses lure people into buying things that might harm them. (AP Photo/Jessica Hill, File)

Psychologist Daniel Kahneman won a Nobel Prize for research popularized in his book, Thinking Fast and Slow. In simple terms, the work separates human thought processes into two categories where 'thinking fast' represents a series of psychological short cuts Mr. Kahneman calls heuristics, or rules of thumb. These heuristics are remarkably successful and efficient in terms of energy use, but many of them make us terrible investors.

Thinking fast processes are often emotional. Examples include herding – doing the popular thing because it feels safer in a crowd – and the 'fight or flight' response to physical, emotional or market risk. For investors, these two common tendencies can lead to chasing extended market rallies or selling investments when they've bottomed in price, and missing the recovery.

Thinking slow involves the analytical, logical parts of our brains that we'd rather not have to engage if we don't have to. Problems in mathematics are the most obvious example of a situation that requires thinking slow, and assessing corporate financial results is another.

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Logic and emotionless analysis are key traits of successful investors, so thinking slow has a best chance of leading to better portfolio performance. But just using the thinking slow process does not ensure success. There are almost as many pitfalls using the logical portions of our brains as there are in emotional heuristics, and these pitfalls are generally known as logical fallacies.

The Obsidian Field website  published a remarkable Venn diagram of logical fallacies (along with definitions) and it's remarkable how many of them are evident in the investing world every day.  Appeal to Authority, "an argument that something must be true because someone who is generally respected says so" features prominently. This has obvious investment implications in the form of "famous hedge fund manager owns this stock so it's a lock to go significantly higher."

Appeal to Probability, "an argument that because something could happen, that means it will happen" is a logical fallacy favoured by newsletter-writing, market doomsayers. There are many, many other examples of bad logic in the graphic – 'framing effect' is also notable – that could lead to bad investment decisions, even if we're thinking slow.

There are, of course, important limits to the use of formal logic in investing. The rules of argument are designed to arrive at objective truth whereas, in investing, the outcomes are in the future and are thus unknowable. Nonetheless, there is a wealth of important guidance here to help investors avoid conclusions that will limit portfolio performance.

-- Scott Barlow, Globe and Mail market strategist

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Stocks to ponder

Dollarama Inc. This stock that may soon appear on the positive breakouts list. It has just passed the eight year mark as a publicly listed company with a stellar performance track record – operationally as well as return wise. The company has a history of reporting better-than-expected quarterly financial results and the second half of the fiscal year is typically stronger than the first half. Consequently, the third and fourth quarter earnings announcements could result in continued earnings beats and share price appreciation. Jennifer Dowty explains.

Bombardier Inc. Bombardier's share price rallied Wednesday, the risks associated with the struggling Montreal-based company are subsiding and investors should be holding on to this stock for some time. On Monday evening, Bombardier announced that it had struck an agreement with Airbus Group SE, handing a controlling interest of Bombardier's C Series airliner program to the European-based aerospace giant. Quibble if you want about the terms of the deal, what it means for taxpayers, Quebec jobs and Canadian ownership of the 100-150 seat planes. But for investors, this is good news. Very good news, writes David Berman.


The Rundown
 

'I'm nervous because it could fall a lot': Robert Shiller's take on an uncomfortably pricey market

The historical precedents that fit best with today's stock market could hardly be scarier, by Robert Shiller's reckoning. The Yale economist's valuation analysis suggests that only twice before have U.S. equities been as expensive as today: In 1929 and 2000. But the numbers don't tell the whole story. High valuations alone didn't bring about two of the worst bear markets on record. At least as important are the popular narratives that tend to characterize investors' attitudes toward the market, Mr. Shiller said. For years, he's been studying investor psychology, which is primarily guided by what investors think other investors are likely to do. They tend to panic when they believe the masses are inclined to panic, he said. Read Tim Shufelt's interview with Mr. Shiller here.

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Canadian stocks catching up to rising profits

Canadian stocks and their underlying earnings are getting reacquainted after spending most of the year drifting apart. Even while the earnings backdrop has been consistently supportive, it was shaping up to be a lost year for domestic shareholders until a recent rebound. Now with the calendar year's final earnings season about to get under way, the uptrend in profits finally finds equities in a comparable pattern. Tim Shufelt explains.
 

Bank stocks are no longer cheap, but they're still worth owning

The great Canadian bank stock sale is over. But don't worry: There are more gains ahead. After a five-week rally, bank stocks have jumped more than 8 per cent on average. They have now emerged as clear leaders within the S&P/TSX composite index, after briefly lagging the index earlier this year. But valuations that were cheap by historical measures near the start of September, before the current rally kicked in, are now in line with the long-term average. While that doesn't mean that bank stocks are overpriced, it does suggest that they're no longer a steal. David Berman explains.

Some enticing stock ideas for investors searching the globe for growth

Capitalists everywhere will be watching this week's meeting of the Chinese Communist Party for clues about where they should be putting their money next. While most of the action at the once-every-five-years congress of senior party officials will take place behind firmly locked doors, previous conclaves have offered intriguing hints about what lies ahead for the world's second-largest economy. Ian McGugan explains how investors may be able to profit.

If NAFTA dies, it could be painful days ahead for the TSX and loonie

You wouldn't know from the upbeat look of the Canadian financial market that the North American free-trade agreement is dangerously close to being scrapped. Canadian stocks have rallied more than 5 per cent over the past month, closing in on record highs. The loonie is hovering around 80 cents against the U.S. dollar, which is not far off its multiyear high. And bond yields are rising in anticipation of good domestic economic growth and higher interest rates from the Bank of Canada. But if NAFTA dies after four rounds of unsuccessful negotiations and dismissive comments from U.S. President Donald Trump ("We'll see what happens," he said Wednesday), some observers expect the market's all's-good veneer will be replaced by something far more nerve-wracking: a diving Canadian dollar, falling stocks and loads of uncertainty about the economic impact. David Berman explains.

Don't wait for the fall into a bear market. It's time to act now

This year's winner of the Nobel Prize for Economics admits he is nervous about the stock market. Richard H. Thaler, who won the award in part because of his contributions to the understanding of behavioural economics, told Bloomberg: "We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping." Suffice to say he doesn't like what he is seeing in Wall Street, Washington, or London, where the British are still figuring out how to cope with Brexit. He's not the only one that has expressed concern about high share prices. Yet investors don't want to listen. The Dow, Nasdaq, and S&P 500 set more new records and the TSX is edging closer to a new all-time high. This train doesn't want to slow down. Gordon Pape explains.

This strategy could have you thinking twice about the benefits of annuities

With interest rates rising, it's time for a fresh look at the cash-for-life comfort and convenience of annuities. A lot of investors and their advisers have avoided annuities in recent years because low interest rates have depressed payouts. But there are signs the rate increases that began this summer have had a positive impact on annuities. To capitalize, consider the same kind of laddering strategy that works well for people buying guaranteed investment certificates. Rob Carrick explains.

Seeking portfolio diversification? Try exempt market securities

Beyond the public capital markets lurk investment opportunities you may have never encountered – securities sold privately. Businesses in need of capital raise money privately if they do not meet the criteria to list on a public exchange, or wish to avoid the time and cost of raising money in public markets. Private capital investments, commonly known as exempt market securities, encompass a range of debt and equity instruments as varied as bonds, mortgages, real-estate partnerships, income funds, oil and gas flow-through shares and hedge funds. Gail Bebee explains.

How dividend growth can push your stocks higher in price

As a company's dividends grows, so grows its share price. Growth in dividend payouts and share price don't move in lockstep, but there's a close relationship over the long term. That's one of the lessons to be learned from a 24-stock dividend growth portfolio followed by Tom Connolly of DividendGrowth.ca and his son-in-law, Gary Emanuel. Rob Carrick examines.

Are conditions right for selling U.S. property? Canadians say no

In the past year, economic conditions have likely left Canadians thinking about whether to cash out of their real-estate holdings in the United States. Property in the United States has appreciated well beyond the post-2008 levels at which many Canadians purchased, and the Canadian dollar seems to have risen out of its doldrums against the U.S. dollar. More recently, Florida and Texas have experienced the kind of extreme weather that makes real-estate investors wary. And don't forget about the Donald Trump factor. The U.S. president's politics haven't found much favour north of the border. But by and large, no such selloff has happened. Matthew Halliday explores.

Others

Tuesday's Insider Report: Companies insiders are buying and selling

Monday's Insider Report: Companies insiders are buying and selling

The Globe's stars and dogs for last week

Bullish on WestJet Airlines

Insiders are buying at Continental Gold

TSX investors should shift to defence as near-term market pullback looms

Research Report: Why Bank of Nova Scotia is the 'most attractive' Big 6 investment

Number Crunchers

Fifteen stocks that fit a less volatile U.S. momentum strategy

Ask Globe Investor

Question: My portfolio is now about 45 per cent cash after taking some profits. I am 75; my spouse is 65. I would like to have 25 per cent or so in fixed income. Would you see any problem with having the entire fixed income allocation in XBB, or would you suggest diversifying among a number of bond ETFs?

Answer: XBB is the trading symbol for the iShares Core Canadian Universe Bond ETF. It covers the entire domestic bond market, including corporate and government issues and bonds of varying maturities. If you only want exposure to Canada, it's a good fund to hold (I own it myself).

But Canada only represents a fraction of the world bond market. You may want to diversify by adding ETFs that give you some exposure to fixed income securities from the U.S. and overseas. Here are three you might consider.

iShares Core Total USD Bond Market ETF (IUSB). This invests in a portfolio of U.S. dollar-denominated bonds that can be both investment grade and high yield. It has done quite well in 2017 with a year-to-date gain of 3.56 per cent to Oct. 6. The expense ratio is only 0.06 per cent.

iShares Core International Aggregate Bond ETF (BATS: IAGG). The mandate here is to invest in a portfolio of investment-grade bonds that are not denominated in U.S. dollars. The main holdings are issues from Japan, France, Germany, Italy, and the U.K. The expense ratio is 0.09 per cent. Year-to-date return is 1.31 per cent.

iShares J.P. Morgan Emerging Markets Bond ETF (EEM). As the name suggests, it invests in debt from Emerging Markets countries but only in bonds denominated in U.S. dollars. It has been on a strong run this year with a gain to date of 8.8 per cent. The expense ratio is 0.40 per cent.

Any mix of these and XBB would provide a lot more diversity and profit potential for your portfolio.

--Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters.

Do you have a question for Globe Investor? Send it our way via this form. Questions and answers will be edited for length.


What's up in the days ahead

Scott Barlow probes deep into the oil market to see what the future holds for investors; meanwhile, our John Heinzl will share some good news about his refreshed dividend portfolio.

Click here to see the Globe Investor earnings and economic news calendar.

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Compiled by Gillian Livingston

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