The Stock Market: A Look Back

I am a bit of a history buff. At least I have started to become one in recent years. This article, “The Stock Market: A Look Back,” takes a look at the last one hundred years in the global equity markets as told by a book, “Triumph Of The Optimists: 101 Years Of Global Investment Returns,” by Elroy Dimson, Paul Marsh, Mike Staunton. Particularly, they discuss the distribution of equity across the world’s markets, noting the “anomalous growth of the U.S. market during this time [1900-2000].” Furthermore,

“Many valuable lessons can be learned from history, but extrapolating historical returns into the future is difficult and complicated . . . despite the clear success of the U.S. markets since 1900, investors need to remember that this exceptional performance may be just that: the exception, rather than the rule for the twentieth century. “Triumph Of The Optimists” argues that economic and stock market performance in the U.S. has not been typical of other countries and, therefore, should not necessarily be extrapolated into the future.

There are some great graphs provided, showing the growth of the U.S. market, as well as some graphs showing the differences in sector allocation in world markets in 1900 vs. 2000. In 1900 railway stocks made up 63% of stock market equity vs. 0.2% today. Information technology and pharmaceuticals were 0% in 1900 and are now 23% and 11% respectively. Insurance was also (curiously) 0% in 1900 but is now 5%. The rise and fall of sectors also makes it difficult to extrapolate future market performance from past data.

Just as a country’s influence over global economics evolves, so do the sectors of an economy. As these two tables show, the economies of 1900 and 2000 had few similarities. Of particular note are the sectors that were small in 1900 and 2000. For instance, 84% of the sectors today (represented by market capitalization) were of immaterial size or were non-existent at the beginning of the last century. These sweeping changes also make extrapolating future market performance from past events difficult.

The Inefficient Market

I just read three articles from The Big Picture about market inefficiency that I found interesting:

  • The kinda-eventually-sorta-mostly-almost Efficient Market Theory” talks about how the father of efficient market hypothesis (EMH), Eugene Fama, has now admitted that “poorly informed investors could theoretically lead the market astray; Stock prices, he noted, could become “somewhat irrational.” This has shift in thinking “has big implications for real-life problems, ranging from the privatization of Social Security to the regulation of financial markets to the way corporate boards are run” according to a quoted Wall Street Journal article.
  • The Hardly Efficient Market” discusses the case of Apple’s (AAPL) stock in the past year. “That’s a perfect example of bad theory costing you money.”
  • The Astonishingly Inefficient Market” looks at Enron as a perfect example of how inefficient the market is. “Where, pray tell, is the efficiency there? The information that Enron was giant fraud was out, and yet the stock took over a year to collapse. Efficient? P’shaw . . . “

Google Dives

Of course everyone has heard by now that Google’s shares dropped about 9% today. I had heard earlier that their stock had dropped 19% in after-hours trading, but settled back to 12%, then 9% today:

Google shares fell 12 percent in after-hours trade to $379.00, slicing roughly $15.3 billion from a market capitalization that had stood around $126 billion. To put that in perspective, the decline represents the entire market value of Gannett Co. Inc. (NYSE:GCI – News), the largest U.S. newspaper chain.

Wow. Well not everyone is buy buy buy:

“It would be fair to say that the bloom is off the rose,” said Stifel Nicolaus analyst Scott Devitt, who issued a rare “sell” recommendation on Google stock this month. “Google remains a great company. But there is a disconnect between the business and the market capitalization.”

It looks like there are only 2 analysts labelling Google as a sell. It’s 29-8-2 (buy-hold-sell). Actually 29 out of 31, that pretty much IS everyone. Here’s what a friend wrote to me thing morning:

Watch Google crash…they missed fourth quarter earnings estimates by a mile. It’s the first sign of adversity since the IPO. The stock already lost 9.05% at the time of this email. People will probably forget about this in a couple of days when someone on Wall Street announces that “despite poor fourth quarter performance, Google remains ‘a great buy’.” Everyone will then start dumping money in again. The daily press releases from Wall Street seem to be what drive the “Bulls.” Google is a great present day example of the “psychology of investing.”

It’s also a typical example of irrational exuberance and of history repeating itself.

Ten Most Dangerous Things People Say About Stock Prices

There is an article about Peter Lynch, the famous manager of the Magellan Fund from 1977-1990, at, written by Kaushal B. Majmudar from The Ridgewood Group entitled, “The Wit and Wisdom of Peter Lynch.” I found the “Ten Most Dangerous Things People Say About Stock Prices” a great reminder about the uncertainty in the stock market:

In addition to the above points, Peter also shared his Ten Most Dangerous Things People Say About Stock Prices reproduced below. Even more than the points above, Peter’s good sense of humor came through when he discussed these old saws:

1.) “If it’s gone down this much already, how much lower can it go?” (answer: Zero)

2.) “If it’s gone this high already, how can it possibly go higher?” (some of the best companies grow for decades)

3.) “Eventually they always come back.” (no they don’t – there are lots of counterexamples)

4.) “It’s only $3 a share, what can I lose?” ($3 for every share you buy)

5.) “It’s always darkest before the dawn.” (Its also always darkest before it goes absolutely pitch black. Don’t buy a business just because price dropped and it is cheaper now)

6.) “When it rebounds to my cost, I’ll sell.” (The stock does not know you own it! Don’t take it so personally Note: this comment is explained by the well documented psychological tendencies called loss aversion and anchoring bias which are talked about in Behavioral Finance. If you liked it at ten, you should love it at 6 so either buy more or sell)

7.) “What me worry? Conservative stocks don’t fluctuate much.” (There is no such thing as a conservative stock – the average stock fluctuates between 50% to 70% from its high to its low price every year. There is a graveyard where all the “conservative” stocks get buried. Companies and businesses change!)

8.) “Look at all the money I lost – I didn’t buy it!” (Don’t beat yourself up about the missed opportunities because it is not productive – when he managed the Magellan Fund, he almost never owned one of the 10 best performing stocks in a given year, but he did fine anyway).

9.) “I missed that one. I’ll catch the next one.” (Doesn’t work that way)

10.) “The stock has gone up – so I must be right” or “The stock has done down – so I must be wrong.” (Technical analysis is not worth much. So many people like something at 20 and hate it at 12 – never made much sense to him).

Peter’s fundamentals, like those of many other super investors are grounded in common sense and an understanding of human misjudgments and failings.

What many of these points tell us is that buying cheap stocks alone won’t get you any success; you have to invest in cheap stocks of good companies. This is very hard to do and takes a lot of work. For me these points serve as a reminder that I (as well as many of you I imagine) should never try to pick stocks myself (unless it’s with a small portion (<5%) of my portfolio). Unless I can devote my entire day to investigating companies, I should let the professionals do it, or stick to investing in indexes.

Yield curve inverts

The yield curve on US Treasury yields inverted today, as reported in this Globe & Mail article an event which has frequently signalled the beginning of a recession:

“Here is the historical record — we have endured eight Fed tightening cycles in the past three decades: the Fed has inverted the curve on five of those occasions, and out of those five Fed-induced inversions, the economy slipped into recession a year later all five times,” said David Rosenberg, North American economist for Merrill Lynch & Co. Inc.

The Big Picture quotes Alan Greenspan, who says “it’s different this time”:

Fed Chairman Alan Greenspan has noted that “its [sic] different this time.” He has challenged the view that “inversion signals economic trouble, pointing out that the shape of the curve is less predictive than it once was.” [emphasis theirs]

Others agree:

“[The inverted yield] has been taken as a negative omen, but I think you have to be cautious in today’s circumstances,” said Andrew Busch, global foreign exchange strategist for BMO Nesbitt Burns Inc. The yield has inverted at relatively low levels of interest rates and not the normally high levels of rates when the Fed tightens to subdue inflation, he said.


During the past 20 years, 10-year yields have exceeded two-year yields by an average of almost one percentage point, according to Bloomberg.

“This clearly suggests we are very close to the end of the tightening cycle … and it is not an indication of a recession,” said Michael Rottman, a strategist at Germany’s Hypovereinsbank.

S&P TSX 60 Equal-Weighted Index

For those who don’t already know, I am not a fan of market-cap-weighted indexes like all the S&P Canadian indexes and the US S&P 500. In the US S&P has the S&P Equal-Weight Index and there is an ETF that tracks it, the Rydex S&P Equal Weight ETF. In Canada there is no such index provided by S&P and no ETF. I knew that there was no Canadian ETF in existence that was equal-weighted but I thought that there must be at some theory, data-mining, or an informal index out there.

Yesterday, I finally found something: an equal-weighted index for the S&P TSX 60. After what seemed like hours digging through Google search results and varying the keywords I gave to Google, I finally found a company called Shaunessy Investment Counsel in Alberta that has formed such an index which they invest in using their clients’ money. The performance as of September 30, 2005 is shown here, where they also mention that the index is “equal weighted, re-balanced quarterly.” An older Shaunessy news article I found on Google compared this index to the S&P TSX 60 Index and shows excellent results, which I will reproduce below:

Canadian Large Cap versus Index Comparison
Rates of Return Ended June 30 2004

Q2 04 Year to Date One Year Three Years Five Years
TSX 60 TRI -0.1% 4.1% 22.1% 4.1% 4.7%
SIC 60 EWI* 2.5% 4.3% 26.2% 8.9% 9.9%
Mercer Median 0.9% 5.4% 25.3% 6.9% 10.0%
Source: RBC Capital Markets, Mercer Investment Consulting, Shaunessy Investment Counsel (SIC)
* Price Index only constructed by Shaunessy Investment Counsel

The “Mercer Median” is the median performance of a whole bunch of mutual funds, from the “Mercer Institutional Pooled Funds report.” They also note that “the EWI is a price index and does not include dividends which would add at least another 1-1.5% to total returns.” The results are even more impressive if you take into account the dividends paid.

Don’t get your hopes up about buying a piece of the index from Shaunessey. They require a $2 million minimum to be a client. To just buy the index and not have a “fully-managed” portfolio with them, you will need to invest $6,666,666 million (0.15% as percent of assets, minimum fee is $10,000). More evidence that the more money one has, the more access one has to better investment advice and services.

It is possible to create your own S&P TSX 60 Equal-Weighted Index (EWI), however, paying $50 commission for each stock would become prohibitively expensive. To keep your commissions to 1% of your initial purchase you would need $300,000 total assets. And rebalancing every quarter would also become very expensive.

Another way to have an approximation to Shaunessey’s index would be to buy certain amounts of sector ETFs and rebalance the allocation of each ETF regularly; however, within each sector ETF the stocks would still be market-cap-weighted.

The best way I can think of to create your own S&P TSX 60 EWI is to use Shareowner . It looks like you could buy 60 stocks for $36 using Shareowner and have your dividends reinvested for free.

Teaching kids about investing

Interesting story here about someone who has set up a stock account for his 9-year old daughter. The account is actually in her name but controlled by the parent. The original post is here, “My 9 Year Old’s First Investing Lesson” and the update is here, “Update on Sharebuilder Account.” It’s too bad that so many parents don’t teach their kids about investing and many parents don’t even teach their children about personal finance, often controlling their chequing accounts well into their 20s (I can give first-hand accounts of this). I think it’s great that this kid has an account opened up where she can buy stock in her own name. I actually hope that her stocks do very, very badly! Losing money in the stock market is a very important lesson that ever person should learn as as young an age as possible! I didn’t learn this lesson until my early 20s; however, I wish I had learned even earlier.

She owns $28 in Apple stock and $21 in Chesapeake Oil stock (as of last weekend). The only thing I found surprising was that they purchased such low amounts. The commission was $4 per trade. So Apple’s stock has to go up 14% just to break even, and 19% for Chesapeake Oil. Apparently “if she does all the chores we have on the list she stands to make $30 a month.” I would have advised her to be patient, wait a few months until she has enough money to invest such that the commissions become a very insignificant percentage of the stock purchase.

This reminds me of when I first invested in mutual funds in around 1996-1997. I invested my own money that I made through my own jobs, but my dad matched my contributions, much like an employer might. This is another great way to encourage kids to save and teach them about investing. has some other tips for helping children learn about finances.

Another interesting aspect of these articles is this site. The explains:

The great thing about is you can purchase partial stocks or ETF (Electronic Transfer Fund) of any company they carry. This means that I can fund my account with $30 and buy $26 worth of Apple stock. ($30 minus $4 transaction fee per trade) even though I may not have the funds to buy a full share.

You also have the option of setting up monthly automatic investments. For example I can set up my account so that every 2nd Tuesday I purchase $30 worth of Apple, or I can set it up to purchase $10 worth of Apple, $10 worth of Home Depot, $15 worth of Sirius etc. Keep in mind there is a $4 fee for each stock you buy. That is the fee under the plan we have which is the Basic Account, some account have lower fees.

This is certainly an excellent way to invest in stocks using smaller amounts of money. It makes building a diversified group of stocks (20-30) much easier for the small investor. I haven’t yet looked into whether or not Canadians can open an account at I know that a long time ago when I set up an account at a US based discount online trader I had to send in some extra IRS forms, but other than that anyone could set up an account (in US dollars of course).

John B. Sanfilippo & Son, Inc.

The Canadian Capitalist had a link to this an article at by Irwin A. Michael called “The Nutty Investor”. The article starts of,

Most investors want stocks that are exciting, glamorous, novel. I tend to find that the best buys lie in the opposite direction, among the overlooked and ignored sectors of the market – which is why I am now happily investing in nuts.

This article was timely for me, as I just noticed John B. Sanfilippo being discussing on Mr. Michael’s “Value Favourites” page at his site a few weeks ago. It is his newest addition to the value favourites page (which is why I read it) and he talks about it here. There, he really fleshes out the reasoning why ABC Funds bought JBSS (they own 5% of JBSS):

. . . Today, with its shares trading at $13.75, JBSS appears to be a bargain. The stock is trading at a 27% discount to its book value of $18.42 and at approximately eight times next year’s estimated earnings of $1.65 per share. Book value is likely understated given that JBSS owns quite a bit of real estate, most of which was purchased in the 1980s and early 1990s. The company is planning to consolidate its operations by building a new larger central facility. Given the expected short payback of the project, the cost savings could be materially accretive to earnings in a couple of years. As far as tree costs are concerned, management expects prices to fall as newly planted crops are harvested in the coming years. Finally, given the company’s low stock price, the costs and time required complying with Sarbanes Oxley, and the favourable prospects for the company, the Sanfilippo family could take the company private. If it did, we feel it would be worth considerably more than what the stock is trading for in the market.

Like Graham, Irwin tries to find stocks that are trading for significantly less than their book value, or what a private owner of the business would be willing to pay. The Sarbanes Oxley Act is something you will hear about often these days. You can read more about it here.

New iUnits: Dividend Index and Real Return Index

Four new ETFs were announced by Barclays Canada a couple of weeks ago.

XMA and XTR provide sector exposure: Providing investors with exposure to the Canadian materials sector, XMA will replicate, to the extent possible, the performance of the S&P/TSX Capped Materials Index. XTR is designed to provide investors with exposure to the Canadian income trusts sector by replicating, to the extent possible, the performance of the S&P/TSX Income Trust Index. XMA and XTR will join Barclays Canada’s other sector iUnits funds, including energy (TSX:XEG), financials (TSX:XFN), gold (TSX:XGD), technology (TSX:XIT) and REITS (TSX:XRE) to provide investors with the ability to target investments in some of the largest and most popular Canadian equity sectors / segments.

XDV provides yield opportunities: Designed to provide investors with exposure to higher yielding, dividend paying Canadian stocks, XDV will replicate, to the extent possible, the performance of the Dow Jones Canada Select Dividend Index. XDV will focus on investing in stocks with higher yields, proven dividend growth and dividend sustainability and higher liquidity.

XRB provides inflation protection: To provide fixed income investors with an inflation-protected investment, XRB is designed to replicate, to the extent possible, the performance of the Scotia Capital Real Return Bond Index.

I am personally going to be staying away from the income trust fund (I don’t know enough about the quality of the trusts in the S&P/TSX Income Trust Index).

I Googled for “Dow Jones Canada Select Dividend Index” and apparently it was just launched on December 5, 2005. Here’s the description:

The Dow Jones Canada Select Dividend Index’s 30 components are selected from the Dow Jones Canada Total Market Index, which represents 95% of the country’s float-adjusted market capitalization. To be included in the index–which is calculated in both Canadian and U.S. dollars–stocks must have a nonnegative, historical, five-year dividend-per-share growth rate; a payout ratio of less than 80% for all companies; and daily average dollar volume of $1 million for three months prior to the annual review. Stocks that meet these criteria are then ranked in descending order by indicated annual dividend yield, and the top 30 components are selected for the index. The index is weighted by indicated annual dividend, and the weight of any
one component is capped at 10%.