KORNER REPORT / Investing & Market Kommentary - 1
Investing
Market Volatility Requires Careful Look At Investments
For those seeking refuge from the renewed market volatility that Brazil's economic crisis triggered this week, financial advisers are suggesting fixed income investments such as bonds and a disciplined approach to investing.
Wednesday's devaluation of Brazil's currency laid waste to the small upswing that the loonie and Canadian commodity markets had been enjoying in the first few trading days of 1999.
"We felt that some of the really strong, good news we were seeing in the first week of the year was a bit premature," said Peter Drake, deputy chief economist for TD Bank.
Drake said a market recovery from last year's fallout over the Asian econmic crisis should not be expected until the second half of the year.
"We're still cleaning up after last year's economic storms, so I think there is going to be some volatility."
And if the volatile ups and downs of this week's market are making you queezy, Drake suggests heading for safe harbour in fixed income investments.
"I think most people in terms of equity market volatility tend to be looking for something that's maybe a little calmer."
Norm Light, Royal Bank's vice-president for deposits, says his bank has really noticed a change in the GIC market.
"What we saw was that GICs started growing again where they had been shrinking. I think the story that hasn't been told is there has been a fundamental shift."
Light said there's more to it than the usual flight of capital from riskier markets to the relative safety of secured investments.
It has to do with a host of new GICs tailor-made for a wide spectrum of investors.
Prior to October, 1997, Royal bank had only two permanent GIC offerings. Today there are 11, including ones that have floating rates, rates fixed to the markets and those set in relation to the prime.
"You might be pleasantly surprised that they're now tailored much better to meet your needs than the staid old GIC of the past."
Pat Blandford has another plan.
The senior vice-president at Merrill Lynch Canada was patiently waiting in his Toronto office Thursday as the markets dropped.
He was placing orders for a client who concentrates his investments on just a few big name companies. And when the markets dip, he buys.
"This is the kind of disciplined approach that really can help an investor. Look at the company you want to own."
Blandford recommended paying attention to just a few good companies, and not getting worked up about the day to day movements of the marketplace.
"Then on a miserable day like this when some people are loosing their cool and saying 'Oh the market's going down, I'm selling,' the disciplined investor's there getting a bargain because he knows that these companies intrisically are sound."
Lloyd Atkinson, chief investment officer for Perigee Investment Counsel, recommends a longer-term view.
"My general sense is we'll live to see another day for commodities."
Atkinson said that this time last year, the world economy was forecast to grow nearly four per cent. By the time 1998 was over, growth was closer to 1.5 per cent. "And that's big-time bad news for commodities."
He said the most optimistic forecasts for this year predict global growth around two per cent, with some predicting growth will be even slower than last year.
"The interesting part of the story is that virtually everybody at this point is unanimous that there is potential for quite robust growth in the year 2000."
Why Analysts Are Almost Always Wrong - And Still Get Paid For It
According to Institutional Investor, the U.S. bible of the money management industry, analysts are ranked on many skills, including industry knowledge, quality of writing and stock selection. Way down the scale, in fact ranked as 7th (out of eight) most important for managers with assets of $5- to $10-billion (U.S.), is earnings forecasts. Which is a good thing, because most of the time those estimates are quite wrong.
Professional investors don't fault the analyst for error, nor the quality of his financial models. Institutional players grudgingly accept reality: Market conditions are in a constant state of flux. Any one of a multitude of variables can force large-scale forecast revisions. Canadian companies, with their export and commodity exposure, are especially vulnerable.
Nevertheless, the divergence of forecasts from ultimate reality is a major complication, particularly for individual investors. Macro targets, such as a one-year outlook for the Toronto Stock Exchange 300 index, are heavily influenced by the collective wisdom of analysts. If targets are low, because of soft earnings growth expectations, investors may opt to stand back, hoping for a market pullback to provide a better opportunity to invest. Their risk is being left behind in a rally. Alternatively, overly optimistic expectations could encourage investment when caution is a better strategy.
Specifically, earnings forecasts for the TSE 300 index of companies invariably undergo enormous revision, almost always downward. For instance, TSE 300 earnings for 1998 will likely come in at $294 or below. A year earlier, the consensus estimate for year-end 1998 was $436. (TSE 300 earnings are calculated by adding up the share earnings for each of the constituent companies, once they've been weighted to reflect the difference in market capitalization. So, BCE Inc.'s share earnings carry more weight than, say, Jannock Inc.)
This accuracy problem is not the exclusive domain of the TSE 300. A recent study reported in the Financial Analysts Journal showed that in the 12-year period ended Dec. 30, 1997, the average consensus 12-month share earnings growth forecast for the S&P 500 was 17.7 per cent, more than twice the actual growth rate during the period. Just as in Canada, earnings forecasts in the United States start high, and subsequently undergo continuous revision, generally downward.
On a company-specific basis, earnings may be dramatically affected by factors such as orders that failed to materialize, labour strife, a lawsuit that unexpectedly balloons into an absurdly high jury settlement, or even internal fraud suddenly revealed with catastrophic consequence. In cutting-edge industries, forecasting is always vastly complicated. In many cases, an analyst's ability to identify the technological trends and potential growth rates is more critical than precision in forecasting distant earnings prospects.
On a sector basis, a whole new range of possibilities gets added to the mix. A change in the price of a key commodity such as crude oil can have enormous impact on individual company results and on the overall performance of the index. Gold prices or supplies of key base metals such as nickel, copper and zinc are also enough to rattle the TSE 300 index performance. Indeed, collapsed commodity values was most of the reason that the TSE 300 earnings came in way below forecast in 1998.
In Canada and the United States, studies show that the most important variable is the economy. When Canada was in the throes of the recession of 1990-1992, TSE earnings virtually vanished. This was the result of poor operating results, combined with major writeoffs, especially of real estate as corporations pruned their balance sheets of assets that had no hope of recovering their value.
Investors are generally more incensed about faulty forecasting on a company-by-company basis than when an entire sector is clobbered. That's because the human element becomes paramount.
Several detailed studies have suggested compelling reasons why U.S. analysts tend to be overly positive in their forecasts. One study cited in the Financial Analysts Journal suggests that analysts, in a disarmingly human response, may instinctively "fall in love" with companies they cover, which could dull their critical faculties.
Another suggestion is that analysts reserve or moderate harsh judgment in order to preserve their relationship with management, and maintain the full flow of information. An alternative possibility is that analysts may sometimes succumb to a "herding" instinct, and find themselves carried along by a general enthusiasm.
The best analysts are aware of these human frailties, and are resolute in resisting them. But, it takes a very determined and hard-nosed number-cruncher to break away from the pack, particularly when the divergent path is to adopt a negative bias. Outright sells are frustratingly rare in this business.
In the tightly knit world of securities analysts and the institutional investors who consume their research, sloppy analysis is summarily disciplined. Whereas independent and prescient thought is rewarded with stratospheric compensation.
Institutional investors don't pay for herd mentality.
Surge Of Online Trading Tests Internet's Capacity
Once again, the rush to cyberspace has proven too much for the Internet to handle.
In much the same way that America Online's network was snarled by enthusiastic new customers two years ago, online brokers, including industry leaders Charles Schwab and E Trade Group, have been plagued by delays in filling customer orders amid a crush of trading.
On a day like Wednesday, when shares of Internet giant Yahoo! plunged $70 US in the opening minutes of trading, any delay can be costly.
There may be no quick fix, since even the latest network hardware is constantly being challenged by the unrelenting march toward faster and cheaper computers for consumers. Adding to that burden are the speedier connections and sweeter deals being offered by Internet access providers.
Online brokers have thus far averted the type of outcry directed at AOL in late 1996 and early 1997 when the online network was swamped by new members enticed by a new monthly plan featuring a flat rate and no time limits for use.
Perhaps online investors are savvy enough about computers to understand the current limitations of doing business on the Internet.
"I've pretty much assumed that if there's a bum rush going on in the market that there's going to be a (trading) bottleneck because the overall Internet will be bogged down," said Keith Christensen of Wappingers Falls, N.Y., a customer of the online brokerage DLJ Direct.
Christensen, 35, said periodic slowdowns while using his online account are nothing new. "I've noticed (system delays) from the beginning. A lot of the time I will ask for a page and it will tell me that it's unavailable."
Even before the recent spate of slowdowns and system outages, most online brokerages had been continually upgrading their networks to handle the growing traffic.
But just as the incredible Internet-stock rally is being fuelled by a spike in online activity that few ever imagined, it's only a guessing game to predict when the surge in online trading may plateau.
"The growth of trading on the Internet has been phenomenal and it's hard for (online brokerages) to shut off the faucet," said Junius Peake, a professor of finance at the University of Northern Colorado in Denver. "When someone wants to open an account, it's hard to say, 'No, we don't have capacity for a new account.'"
Judging from the increase in volume being reported by leading online brokers, it's easy to see why these troubles are popping up now.
Ameritrade Holding, a company that helped set off an industry price war with an $8-per-trade offer, estimates that it handled an average of 32,000 trades per day during the final three months of 1998, an increase of more than 30 per cent from the prior quarter.
National Discount Brokers is now handling between 10,000 and 12,000 online trades a day, up from 8,000 back in late November and early December.
"We did not have any outages this week, but we did experience slowdowns, which have typically occurred at the opening and the close," said Kris Lutz, a spokesperson for Ameritrade, which is based in Omaha, Neb.
One reason why online traders may not be lashing out is that, despite the assertions of full-service brokers, there's little difference between waiting to make a trade online and waiting to make a trade by telephone.
The big guns such as Merrill Lynch maintain that many investors are far better off with a professional adviser to guide investors, especially during euphoric or panicky times in the market.
"If you have a guy holding your hand and he has 200 customers and they all call to sell at same time, he only has one mouth and two ears," said Peake.
Market Kommentary
Brazilian Stock Market Recovery Helps Bay Street And Wall Street
Stock markets in Canada and the U.S. recovered with a vengeance Friday as Brazil's long-awaited decision to stop defending its battered currency lured investors back to Latin America. The situation helped buoy stock markets around the world.
Brazil started a worldwide market decline Wednesday after its central bank chief resigned and his successor devalued the Brazilian currency by 7.6 per cent. On Thursday the central bank's director of the banking industry resigned.
After falling five per cent Wednesday, Brazil's Sao Paulo stock exchange fell nearly 10 per cent Thursday.
Friday, Brazil's Central Bank decided it would no longer protect the peg between the U.S. dollar and its own currency, the real. The move, a way for Brazil to attract foreign investment and hold on to its dwindling currency reserves, saw the real's value plunge another eight per cent - its third straight day of free fall.
But the ensuing fire sale on Sao Paolo's main stock market brought investors back in droves as they pushed the Bovespa index to a 33 per cent gain, its second-largest one-day rally in history.
Market watchers were amazed at the quick developments.
"It's massive today. Quite frankly it's stunning," said Dave Picton, a portfolio manager at Synergy Asset Mutual Funds, in Toronto, concerning Brazil's developments. "The (Brazilian) economy is certainly not rescued all of a sudden but people viewed it as some kind of relief so up we go."
"Devaluation was the only option left for an economy unable to bear the punishing interest rates it would have taken to defend the real," CIBC Wood Gundy economist Avery Shenfeld wrote in a market report.
"Anyone who thinks that a cheaper currency is a panacea for Brazil has only to remind themselves of East Asia's fate in 1998." With a huge debtload and deficit alongside shaky consumer and investor confidence, the economy may not be able to withstand the impact of sharply higher imported goods, he added.
At ABN Amro Bank Canada, chief strategist Andrew Pyle warned that the devaluation in Brazil could either speed the country's recovery or force similar moves across Latin America. "If this newfound flexibility by the central bank also allows the economy to recover at a faster pace, all the better," Pyle said. "The risk is that other countries in the region are forced to devalue as well in order to compete with Brazilian exports -- the dreaded contagion."
"Brazil has accepted some difficult choices," said Rob Palombi, an analyst at Standard & Poor's MMS in Toronto. "They have started down the road to recovery by accepting a devaluation of their currency.
"Over the longer term, because the devaluation will help to bring interest rates down, the idea is eventually you're going to see a rebound in growth in the region."
But the stock market was taking the long-term view Friday, Palombi warned, and experts agreed that all is far from well with the Latin American economy.
Brazil's stance helped provide investors around the world with a badly needed respite from two straight days of heavy losses, the latest symptom of an international economic fever that after 18 months has shown few signs of breaking.
In New York, after four straight down days totally erased a five per cent New Year's rally, the Dow Jones industrial average roared to life, closing 219.62 points higher at 9,340.55.
Leading the gains on Wall Street were financial services stocks, which had taken big hits earlier this week on Brazil's devaluation. Basic materials stocks, like those of paper and chemical companies, were higher. Consumer stocks were mixed after taking big hits earlier this week on Brazil.
The technology-heavy Nasdaq composite index had an even steeper rise, climbing 71.38 points Friday, or by 3.1 per cent, to close at 2,348.20, according to preliminary figures.
The Toronto Stock Exchange's key 300 Composite Index was up 165.19 points, or 2.5 pct, at 6759.42. Volume was 86.8 million shares, worth $1.5 billion. Advancers outpaced decliners 526 to 361 with another 306 issues unchanged. The move in South America spurred the TSE 300 to close the week in positive territory after a number of sessions on the downside. It was still off last Friday's close of 6868.93.
The S&P/TSE 60, an index of blue chip companies, was also up 11.53 points, or 3.03 percent to 392.63
The TSE 100 rose 11.03 points to 413.36.
Of the TSE's 14 sub-groups, 12 finished the day higher, with industrial products posting a whopping 4.49 per cent gain. ATI Technologies Inc., which reported stronger than expected first quarter results Thursday, surged $4.50 to finish $23.90 on volume of nearly 10 million shares while JDS Fitel Inc. powered $5.40 higher to $56.
The heavily weighted financial services group rose 3 percent, and the consumer products group was up 2.9 percent. Royal Bank gained $0.80 to $77.30; Bank of Montreal gained $1.60 to $66. Bank of Nova Scotia, hurt in recent days because of its exposure to Brazil, jumped $1.45 to $32.60.
Consumer products fared well with a gain of 2.94 per cent; Seagram Co. gained $2.40 to $38.90, while Canadian Tire A shares climbed 65 cents to $38.90. BioChem Pharma gained $1.65 to $42.65.
Tempering the gains was the gold and precious minerals group which fell 0.3 percent. Franco-Nevada Mining fell 50 cents to $29 while Rio Algom gained 70 cents to $17.25.
The lightly weighted real estate sector which shed 0.2 percent.
Loewen Group Inc. shares fell to 52-week low of C$6.15 before closing down C$0.45 to C$7.35 with 998,000 shares trading. Florida Department of Banking and Finance on Thursday accused the company of negligent record keeping and suspended the licenses of 16 of its funeral parlors.
Among industrials, Bombardier Class B. gained $1.50 to $22.40; TransCanada PipeLines Ltd. lost $0.05 to $21.50.
Among oils, Poco Petroleums rose $0.35 to $11.95, Canadian Occidental Petroleum $0.85 to $16.90; Northstar Energy lost $1.00 to $44.90.
Among mines, Barrick Gold slipped $0.10 to $30.50, Lionore Minerals $0.08 to $0.60; Placer Dome Inc. climbed $0.15 to $18.55, Royal Oak Mines $0.05 to $0.45.
On the week, mining and minerals stocks posted the biggest gain, up 13.51 per cent, followed by financial services, up 9.9 per cent, and conglomerates, up 9.1 per cent.
Pipeline stocks were the worst performers, down 0.27 per cent, while real estate and construction gained 1.72 per cent and merchandising stocks gained 1.76 per cent.
In Vancouver, the VSE index stood at 418.32, up 0.2 per cent.
In Montreal the portfolio index finished at 3,501.13, down 2.7 per cent.
The following is a list of earnings reporting dates for some major companies listed on the Toronto Stock Exchange. Info is based on information supplied by the companies.
Jan 19 Canadian Natl Railway (CNR.TO), MAAX Inc. (MXA.TO) and Merrill Lynch & Co Inc (MER.N)
Jan 20 Corel Corp (COS.TO)
Jan 21 Aluminium Ltd (AL.TO), Imperial Oil Ltd (IMO.TO) and Le Groupe Videotron (VDO.TO)
Jan 22 BCE Mobile Comm Inc (BCX.TO)
Hot Stocks
Imasco Breakup Rumours Revived
Depending on who you listen to, the recent takeover of Rothmans International by British American Tobacco PLC is either going to mean the breakup of BAT unit Imasco Ltd., or it will guarantee the conglomerate can keep puffing along in relative peace.
Despite declarations that the Montreal-based company is worth more dead than alive, Imasco's component parts -- cigarette maker Imperial Tobacco, CT Financial Services Ltd. and drug chain Shoppers Drug Mart -- keep churning out profit gains that further propel its share price.
Imasco has been a stock market darling in the past year, rising 26%. That compares with a 6% gain made by the Toronto Stock Exchange 300 composite index. Imasco Ltd.
Imasco shares (IMS/TSE), which have a 52-week trading range of $33.95 to $22, closed yesterday up $1.25 at $32.40.
When Imasco's 42%-owner BAT shed its financial services business last year to become a pure tobacco play, investors speculated Imasco would soon follow. It never happened.
Now, with BAT threatening Philip Morris Cos.' title as the world's largest cigarette company, some hope once again Imasco would be broken up.
"I'm pegging [the probability of a breakup] at 40%," said Steven Holt, a consumer products analyst with Scotia Capital Markets of Toronto. He estimates Imasco is worth as much as $46 a share should that occur. If it does not, he has a 12-month target price of $38 on the shares.
BAT says its focus is now on the fast-growing markets outside North America and Europe. Places such as Asia, Africa, and Latin America, where the potential smoking population is huge and advertising restrictions are generally looser.
Analyst Michael Palmer, of First Associates Inc., describes Imasco as "an orphan in the BAT world" after the Britain-based company sold its banking assets last year to focus on its cigarette business. He has a negative outlook on Imasco stock generally and estimates it is worth only $35 a share on a breakup, close to its recent trading range.
"It may be a nice company without a lot of downside, but there is not a lot of upside either," he says.
Mr. Palmer says U.S. drugstore giant Walgreen Co. is "kicking the tires" of Shoppers Drug Mart, and could make a takeover play for Canada's biggest pharmacy chain.
CT Financial, which owns Canada Trust, remains an attractive takeover target for either a Canadian bank or a foreign competitor looking for a launching pad into the market.
Canada Trust has a 422-branch network spread across the country.
The failure of the bank mergers makes CT even more attractive, Mr Palmer says.
Other analysts say BAT's takeover of Rothmans would be so complicated and time consuming to complete -- the two are the leading cigarette sellers in 55 different countries -- that BAT would not have the energy or desire to dismantle Imasco. Also annual sales of 900 billion cigarettes give the new BAT a huge cash flow and less demand for funds.
"I do not think they have come up with a capital need that will really compel [BAT] to try to restructure the Canadian business by selling assets," says Richard Morrow, an analyst at CIBC Wood Gundy Securities Inc.
"The liquidation story is a potential one but I do not see anything in the current deal that pushes that timetable at all."
However, the two companies' dominance in Canada -- they control about 90% of the Canadian cigarette market -- could force regulatory reaction.
Imasco spokesman Peter McBride says it is unlikely the government would tolerate such a high concentration of industry ownership, and the company told analysts it expects the federal Competition Bureau would force some sort of divestiture.
According to figures from Scotia Capital, Imperial Tobacco has about 65% of the country's cigarette market with brands such as duMaurier and Players, Rothmans Inc. (ROC/TSE) has 22% and RJR-MacDonald has a 13% share.
Mr. Holt, of Scotia Capital Markets, says if BAT is forced to sell Rothmans International's 71% stake, that could begin the unravelling of Imasco.
BAT could buy up control of the biggest Canadian cigarette company "either by negotiating with Imasco for a direct interest in Imperial, or by buying the Imasco shares it does not currently own."
Imasco's terrific track record may be the best argument for keeping the company intact, despite the fact conglomerates are out of favour these days.
"I view it as being the core holding in Canadian consumer products, it's been outstanding," said Mr. Morrow, who has a "hold" rating on Imasco stock, mainly because it is trading near his $33 target price.
|
