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the buy side

It's a remarkable time to be an investor and investment professional. After decades of overspending, we're watching Europe melt down and the American empire decline faster than anyone expected. The debt burden has accelerated the power shift from West to East.

It's also remarkable because it feels like there are a lot of one-way streets out there. I'm referring to strategies, trades and trends where everyone is headed in the same direction. Being a natural contrarian, I feel uneasy when I see a seemingly unchallenged consensus. "This stock can't miss!" "You can never go wrong with real estate." "I can't see what could possibly take the market higher (lower)."

My points of uneasiness today are not the same as they were a year ago when the list included gold ("sky's the limit"), U.S. ("don't touch it") and China ("our salvation"). Gold is up 25 per cent over the last year, but the stampede has slowed and the commentary is more balanced today. There's still a hate-on for the U.S., but more Canadians are perking up to the real estate and stock bargains there. As for China, the steady stream of positive press has turned. The scale of capital misallocation and use of debt is being brought to light (it looks eerily similar to post-Bush/Greenspan America).

There are other extremes to keep an eye on now.

In my 28 years in the business, I've never seen a time when people's views are so universally negative. Certainly, it's understandable given the macro events of the day and the extreme market volatility, not to mention the fact that baby boomers are starting to retire with 2008 fresh in their memory. The fear/greed meter is firmly planted on the fear side.

I've written a lot about our artificially low interest rates because they're a remarkable feature of the landscape. It's a wonderful time to be a creditworthy borrower – everyone is competing for your business – while it's a lousy time to be a lender (bondholder). Savers are seriously subsidizing spenders.

Finally, large corporations are as well positioned and poorly appreciated as I can ever remember. With their strong balance sheets, steady cash flow, regular dividends and ability to finance cheaply, they're the antithesis of governments. They're able to use their scale to cash in on the trends toward globalization and industry consolidation. The strong are getting stronger, and yet their valuations are going lower.

So what should you do about fear, low rates and strong corporations? Well, first of all, you should remember that markets have a propensity to overreact to short-term news, so a strong consensus creates opportunities. Although the fear is understandable and very real, it's no less valuable for investors. Therefore, it's important to maintain a balanced perspective. I recommend reading, or rereading, a Warren Buffett book and seeking out all the information you can about what could go right in the next few years (the negative stuff will find you, the positive won't).

You need to stay in close touch with where valuations are. The big mistake made by investors who missed the 2009-10 rally was focusing exclusively on the bad economic news and losing sight of the compelling valuations on stocks and corporate bonds. You want to hold assets that look to be undervalued, or at least fairly valued, with respect to their long-term fundamentals. Conversely, you want limited exposure to assets that have become overvalued due to short-term factors.

I put equities in the former category. When people ask where they should invest, I tell them what they don't want to hear – "Stocks." In my view, equities will generate the best returns over the next three to five years.

On the overvalued side are assets that are dependent on low interest rates – bonds and real estate. Rates may stay near current levels for a few years yet, but it's not ordained that a weak economy means low rates (ask Europeans about that). The safety premium on U.S. Treasuries will go away one day and Canadians will be faced with lower bond prices and higher borrowing costs. Cheap financing is transitory, but paying too much for an asset stays with you forever.

So my recommendations for 2012 are: Warren Buffett, high quality stocks and corporate bonds, a modest cash reserve and two-way streets.

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