Where to invest? Look at what makes you squirm.

By Dan Hallett on August 26, 2010

Yesterday’s Globe & Mail featured an article by U.S. equity manager Larry Sarbit making the case to invest in U.S. stocks now.  He cited his 70% invested position (compared to 10% – 20% a few years ago) to illustrate his bullishness.  I have never really been convinced of Mr. Sarbit’s stock picking skill despite his good track record.  Still, I found myself more or less agreeing with the article.

In particular, Sarbit recalls how, in 1999, mutual fund investors couldn’t get enough U.S. and global stocks while they were tripping over themselves to get out of Canadian stock funds.  It was a bull market so Canadian stocks were doing quite well, as shown in the table below.  But U.S. and global stocks (hedged and unhedged) were on an absolute tear over all time periods.

5yrs through Dec 1999 10yrs through Dec 1999
Unhedged Hedged Unhedged Hedged
Global Stocks 20.77% 21.19% 14.62% 11.64%
U.S. Stocks 29.53% 28.56% 20.45% 18.21%
Canadian Stocks 16.98% 16.98% 10.55% 10.55%
Gold (spot) -4.86% -5.41% -0.96% -3.12%

Since foreign stocks lost less than Canadian stocks in the summer 1998 bear market, fund flows for 1999 were strongly in favour of foreign stocks.  Calendar 1999 saw $12.7 billion flow into U.S. ($2.9B) and foreign ($9.8B) stock funds, according to IFIC data.  The ‘foreign’ group included all of the technology and other specialty funds which accounted for so much of the foreign inflows.  In the same year, investors pulled $2 billion out of Canadian stock ($1.4B) and dividend ($0.6B) funds.

As we now know, the subsequent ten years (2000-09) was miserable for U.S. and global stocks while being kinder to unpopular investments of the day – i.e. Canadian stocks and gold.

5yrs through Dec 2009 10yrs through Dec 2009
Unhedged Hedged Unhedged Hedged
Global Stocks 0.26% 2.50% -1.60% 0.56%
U.S. Stocks -2.22% 0.42% -3.86% -0.95%
Canadian Stocks 7.66% 7.66% 5.61% 5.61%
Gold (spot) 16.76% 20.08% 10.50% 14.12%

The lesson:  the most attractive investment opportunities are often those that make you squirm.  Just about everybody cringes at the thought of buying American companies.  Yet, there remain many bargains in the vast pool of multi-national businesses.  Bill Miller, in his recent commentary, illustrates the disdain for U.S. stocks using Exxon Mobile (held by his funds) and Kimberly Clark (not held at the time).

Miller noted that 10-year U.S. treasuries yielded just 2.93% (a yield that was not rising).  By comparison, he cited Exxon Mobile’s dividend yield (which exceeded 10-year treasuries) and its significant share buy-backs.  More importantly, he said that Exxon’s share price was near where it was five years ago when oil was at US$50/barrel.  Similarly, he highlights Kimberly Clark, which boasts a 4% dividend yield and a historical 8% dividend growth rate.

If you want to repeat the return-detracting behaviour that so many investors have exhibited in the past, just take your ‘buy ideas’ from the top performing asset classes of the most recent 5 and 10 years.  Going against the crowd, however, will require you to unglue your mind from simply projecting the recent past into perpetuity.  But as the saying goes, this is easier said than done.

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