First Quarter 2011

  “My view tends to be that you look at long-term measures [of the market] (like the cyclically-adjusted [p/e] ratio or the dividend yield) and figure out that when valuations are high, future returns are likely to be low.” The Economist, Buttonwood's blog of January 28 2011. ♣ TC: I've used dividend yield to measure a stock's valuation for about 30 years now. More recently I started using C.A.P.E. too (cyclically adjusted [earnings over ten years] price to earning ratio). These two valuation measures put the Connolly Report list in much the same order: expensive common stocks on the bottom and the cheaper issues on top. The C.A.P.E. of my list is currently 19.3. The cheapest is MFC, of course, at a 11.3 C.A.P.E; the most expensive Fortis at 27.7. C.A.P.E. of the S&P 500 is 23.7. More inside…  Valuations are currently high. The market has been going up just about straight for two years. Buying now means lower future returns. “Have a risky bias.” Control your behaviour. Risk is more related to the price you pay for an asset, than the asset class itself. A stock can be a safe investment if you buy it at the right price. That time is not now.

  • The three sources of returns¹: 1. the initial yield, 2. dividend growth and 3. change in valuation. Don't believe it? What other source of return were you thinking of? Ah yes…appreciation. Price gains are driven by dividend growth² and changes in valuation. Don't believe it? To your folly, you'll learn over the next few years…especially about the third source. Falling P/Es will devastate portfolios. Want an example? Do a ten-year price chart of Walmart. WMT's price has gone nowhere in the last decade even though earning (and dividends) have risen by 11.8% a year (from $1.25 to $3.43). Why? P/E contracted from 45 to 14. It's as simple as that. We are in a secular (long-term) bear market (although the last two years were a cyclical (short-term) bull driven by low interest rates and quantitative easing by the Fed): expect p/e contraction and lower returns. ¹ Buttonwood blog, The Economist February 7 2011 ² Don't believe it? Do a five-year price chart for TransAlta (TA): no dividend increase, no price increase.
  • from JK, a subscriber in L6*: “For years I dealt with a broker who held my portfolio in well diversified mutual funds, Canadian and International, large and small cap, and we would change this from time to time. Very little gain was made. Dividends were very limited. When one sector was up the other was down. At the same time, I held Royal Bank stock purchased in 1994 in my Safe Deposit Box. I noticed that it had fairly stable growth and in addition I was receiving meaningful dividends. Overall the stock significantly outperformed the diversified mutual fund portfolio. When I found your report I closed the brokerage account, open a self-administered brokerage account and slowly converted the mutual funds to stocks on our list. I have never looked back. With your method there is less stress, maintenance and the results are better.” JK sent back a P.S. after I asked him if I could use his e-mailed thoughts: “The Royal Bank shares are now worth slightly less than 7 ½ times the original cost. I have no intention of selling them as the annual yield on cost is now 25% and the income tax is nominal.” * West of Toronto along the lake.
  • If your financial planner/advisor is pushing indexed annuities, get rid of him or her. “The complex contracts obscure high fees and long lock-up periods.” (Bloomberg Businessweek February 28 2011) The Bloomberg column gave examples of fees as high as 15 percent to cash out early and money locked-up until her 87th birthday.


first_quarter_2011.txt · Last modified: 2011/03/21 11:30 by tom
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