The European Economy Explained

November 28, 2011

Thanks to Eric Lascelles, Eric Lascelles, the Chief Economist at RBC Global Asset Management has written an excellent article on the current and future challenges of the countries in the European Union.

Based on the research he did, his article suggests the following:
–    Despite the recent bail out, Greece remains unsustainable and likely to go through an orderly default
–    Italy should remain solvent despite its recent crisis
–    The plan to recapitalize the European banks is undersized but workable
–    European leaders are not acting fast enough and typically will require a crisis to make headway
–    Likely candidates for the next crisis are Portugal, Ireland and Spain.
–    European bad news will continue for awhile and over shadow good news.
–    Global contagion on the scale of the fall of 2008 is unlikely

More of the same for awhile


Is Buy and Hold Dead?

Any investor who invested a lump sum 10 years ago in a diversified portfolio has likely not seen any returns and may even be negative.   Investors who have continued to invest regularly through the highs and lows over the last 10 years likely have some returns to speak of – but not the returns expected.  So does this mean the strategy of buying a diversified portfolio holding for the long term – still worth using?  Questioning once recognized investment strategies is common during periods of volatility and this time is no different.

Even the shares of the renowned investor Warren Buffet who says the ideal holding period for a stock is forever, finds the shares of his company Berkshire Hathaway are only selling for just slightly above book value, the lowest valuation in decades.  Proof investors are not interested in buying the shares of investment managers advocating a “buy and hold strategy”.

Note that in this context, buy and hold means the stock is purchased at the right price – typically below its true value and reviewed regularly for its potential future return.  If at any time the stock is perceived as over valued, it is sold; or if its business or market changes and its future potential value is eliminated, it is sold.

After World War II, the average American investor held stocks for about four years.  Given a stock is not just a piece of paper but a shared ownership in a business, this seems appropriate.  By 2000 stocks were held for about eight months on average.  The 2008 numbers suggest the holding period was just two months.  The mood over the last year suggest the average holding period is down to days if not minutes.

Value vs Price

Most investors agree that the value of a stock is the present value of its future cash flows over the life of its business.  The value is not then in next years earnings but in the cumulative profit of the business over decades.

This tenant of investing – that stocks are long duration assets, has been forgotten.  Is it even remotely possible that all the great businesses like Walmart, IBM, Abbot Labs, Nestle and Johnson and Johnson with a history of increasing earnings and dividends suddenly reverse that trend?  If that’s not likely, why does their stock decline in so called periods of uncertainty?  The answer is, of course, that the current investor focus has moved to the short term outlook which impacts the short term price of the stock but not its true value.

This presents the long term investor with tremendous opportunity.  If stocks are at historic lows in price but represent good value, buying and holding is the logical strategy.

“A serious investor is not likely to believe that the day-to-day or even month-to-month fluctuations of the stock market make him richer or poorer.
-Benjamin Graham,  The Intelligent Investor

Why Sir John Templeton’s protégé feels tremendous opportunities now:

So why all the gnashing of teeth

The article below in the Financial Post provides a perspective on the last six months regarding the volatility we’ve experienced – the equity market is like living with a person who is nice much of the time but goes through periods of “unstablity”