Ottawa Investment Advisor John Bruce

Profit From Stock Market Setbacks

September 2, 2011

In his book Winning The Loser’s Game, Charles Ellis writes “If you had your choice, which would you prefer?
Choice A: Stocks go up – by quite a lot – and stay up for several years. Choice B: Stocks go down – by quite a lot – and stay down for several years.”

It’s a trick question. Mr. Ellis writes, “If you selected choice A, you would be joining 90 per cent of the investors – individual and professional – who’ve taken this test. Comforted to know that most pros are with you? You shouldn’t be. Unless you are a long-term seller of stocks, you would’ve chosen against your own interests if you chose A.”

Mr. Ellis adds, “If you are a saver and buyer of shares – as most investors are and will continue to be for many years – your real long-term interest is, curiously, to have stock prices go down quite a lot and stay there so you can accumulate more shares at lower prices and therefore receive more dividends with the savings you invest. Thus, the right long-term choice is the counterintuitive choice B. You may even learn to see a benefit in bear (falling) markets. If you’re really rational, you will.”

So far in 2011, the S&P/TSX Composite Index is down by 10.23 per cent. The drop is even sharper from the Canadian stock market’s recent peak in April. Canadian stocks have dropped along with stocks worldwide. There are legitimate concerns that the United States and the European Union could fall back into recession.

North American companies are healthy

North American companies, however, are in much better financial shape than they were before the last financial crisis and recession. Many of them have significantly reduced their debts. And some are sitting on mountains of money. With company earnings continuing to rise, many generate more cash than they need. We expect companies to use part of this money to raise their dividends and buy back their own shares. Both reward shareholders. Like you.

The U.S. and most European governments can do little to combat slow economic growth. In the U.S., local and state governments are not allowed to run deficits. So as their revenue falls, so must their spending. The Republicans are pushing the U.S. federal government to trim its spending. Meanwhile, the debt crisis in Europe is forcing most governments to slash their spending. That is, the U.S. and Europe face what’s known as “fiscal drag”. As a result, governments are hoping that loose monetary policies will spur growth.

In the U.S., for instance, the Federal Reserve (central bank) has said that it intends to keep interest rates near zero for at least two years. In response, the yield on 10-year U.S. Treasury bonds dipped below two per cent for the first time ever. This should reduce the financing costs of companies, thereby further increasing their profits.

Dividends yield far more than bonds

Extremely low interest rates make stock dividends exceptionally attractive. Of our Key stocks, 35 yield three per cent or more. Even better, many regularly raise their dividends. We expect low interest rates to keep up stock prices.

Some investors worry that this loose monetary policy will lead to inflation. This is possible. Just keep in mind that companies can respond by raising their prices. Bonds, by contrast, offer no protection whatsoever against inflation. The only exception is “real-return bonds”.

Stocks may continue to fall in the near term. After all, September is, on average, the worst month for stocks. Even so, take advantage of any setback to buy stocks on the cheap.

In his book Stocks For The Long Run, Professor Jeremy Siegel writes, “Even the cataclysmic crash of 1929, which caused a generation of investors to shun stocks, appears as a mere blip in the stock return index. Bear markets, which so frighten investors, pale in the context of the upward thrust of total stock returns. One dollar invested and re-invested in stocks since 1802 would have accumulated to over $12.7 million by the end of 2006.”

So when the market falls – as it’s doing – invest in high-quality shares at bargain prices. That way you can profit from stock market setbacks.

John S. Bruce
Ottawa Investment Advisor
Also licensed in ON, BC, AB, QC, NS
Mackie Research Capital
Direct Line- 613-425-3732
Toll Free- 866-860-4190

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