Column

LESSONS FROM NATURE

Past market performance is not a good recipe for future behaviour

DONALD COXE November 10 2003
Column

LESSONS FROM NATURE

Past market performance is not a good recipe for future behaviour

DONALD COXE November 10 2003

LESSONS FROM NATURE

Column

Past market performance is not a good recipe for future behaviour

DONALD COXE

NATURE—AND MARKETS—go to extremes. Living outdoors or investing on the assumption that long-term averages are safe behaviour guides can lead to painful outcomes. That reflection came from recent visits to three drought-stricken communities—Victoria, Vancouver and now Denver. Only Denver’s still dry, although getting somewhat wetter. Coloradans vote on Nov. 4 on a referendum authorizing the state to construct big water resource projects. The proposition is hotly debated because it would involve shifting water from the low-population western side of the mountains to the heavily populated east side. From local media coverage, it seems as if the percentage of Democrats is higher on the aqueous side than on the arid side, where Republicans abound. Those on the western side are opposed to sharing their water, although they remain eager to share in the wealth generated by Denver and environs. There’s sharing—and there’s sharing.

Perhaps Colorado’s problem will be solved B.C. style, with record rainfalls and floods. In Victoria, I was told the drought was due to global warming. Local Wiccans held rain dances and prayer fests to appease their gods. Maybe the dancers are reviewing their rites. But droughts, floods and hurricanes are nature’s way of suddenly shifting water distribution. Always have been, and always will be, however much it may sicken Wiccans.

Extreme measures to control nature’s tendency to extreme ways can produce extreme results. When the U.S. government’s do-gooding arsonists set a “controlled fire” as a conservation measure near Los Alamos, N.M., they unleashed a conflagration that destroyed vast areas of vegetation during the season when mother birds were sitting on their nests. The firebugs claimed, in their defence, that it was a safe season for friendly fire, because it wasn’t the time, according to weather records, for worrisome winds. Yes, strong winds can, and did occur in the spring, but the burners relied on long-term averages.

Markets also go to extremes—always have and doubtless always will. In 1999, when U.S. stock prices soared to 10 times their 1982 levels, we were told by sophisticated snake oil peddlers—I labelled them “shills and mountebanks”-that the stock market had delivered average returns of 9.5 per cent since 1926, so investors could confidently sink their life savings into stocks, regardless of their lofty levels. They could count on those 9.5-per-cent average rewards.

Well, one kind of extreme begat another. Peter Bernstein, one of the most admired institutional investors, now cites the 2001 high-tech crash in support of his provocative claim that the long-established principle of “buy and hold” investing has become an imprudent strategy. Wall Street is shocked at this heresy from one of investing’s high priests.

WISE investors search out investment opportunities among beaten-up industries where few companies have managed to survive sustained earnings droughts

Buy and hold as a principle lacks the longevity or spiritual authority of “to have and to hold.” Yes, it’s certainly wiser than the wildly speculative day trading of stocks that became such a feverish fad in the late 1990s. Yes, great companies who manage their businesses brilliantly and increase their dividends annually are certainly buyand-hold investments, but there aren’t enough of them to make the principle universally applicable. Applying the rule to non-dividend-paying technology companies who were, in corporate demography, mere adolescents, was a stretch. It was like arguing that the durable appeal of the music of Bach, Beethoven and Verdi proved that the music of the Grateful Dead would be immortal. (To be fair, the same reasoning was used, in their day, to claim perpetual glory for Al Jolson and Kate Smith.)

Wise investors recognize such faddism and search out unrecognized investment opportunities among beaten-up industries where relatively few companies have managed to survive sustained earnings droughts. A perfect example is the commodities sector, where the long-term profit averages have begun to reassert themselves. In the two decades since 1981, companies producing basic materials experienced mostly tough times. Result: the world got cheap oil, gas and metals. Now, with Asia booming, demand for basic stuff is growing dramatically. Naturally, those years of low commodity prices and disappointing (or disappearing) earnings thinned the ranks of producing companies. Commodity companies have been, in investment terms, extremely unattractive compared with companies that produce optical fibre and gizmos any teenager can handle with delight.

If you knew when the rain would come to Squamish, you could have bought a boat, thereby emulating that sage who built an ark in the desert, much to the mirth of the sun-bleached locals. What you should know now is that it will take years of large-scale corporate investment in new oil and gas wells and mines to supply the world’s demand for stuff. Until oil and mining stocks become extremely faddish again (as they were in the 1970s), they will be sound investments. Opening a typical mine takes seven years or so from the time the ore body has been proved up, and it takes at least as long to get gas and oil from remote regions to markets. That means, in investment terms, a buy-andhold period that isn’t extreme, but probably extremely rewarding.

It’s only natural. fi1]

Donald Coxe is chairman of Harris Investment Management in Chicago and of Toronto-based Jones Heward Investments. dcoxe@macleans.ca