When Fear and Greed Won the Day, Neither Won the Decade
The Financialist • Issue 94 • July 2007
BY BRETT A. SIMPSON BComm CLU CHFC CFP
Some of the events of the last 10 years will continue to shape our attitudes for decades to come. In 1997, BC real estate prices were below their 1991 last cycle peak; tax rates exceeded 50% at just $60,000 of income, and the Bre-X gold fraud and Asian currency crisis crippled markets. In 1998, BCE was Canada’s largest company at 6.6% of the index, Russia defaulted on their debt, and oil hit $11.28 US per barrel. 1999 had gold at $250 US per ounce and technology at a premium in the Y2K frenzy.
The century started with all time highs in most world markets, with Nortel ballooning to $124.50 per share and 34.2% of the Canadian index. Then, excess money supply, born of government’s response to Y2K fears, was retracted and "irrational exuberance" subsided in the wake of the dot-com meltdown; oil, however, surged to $34.40 US.
In 2001, the avalanche of selling continued across tech and telecom companies, but buyers returned to real estate. I remember feeling the world would never be the same while watching the 9/11 devastation. By year end, energy darling Enron had collapsed and oil had returned to $19.33 US per barrel.
2002 became the year of scandal and suspicion, as WorldCom declared bankruptcy and joined Enron in infamy as their accounting frauds surfaced. The investor exodus from large corporations, fuelled by mistrust, eventually spilled across the market and resulted in the worst stock market performance since 1974. When the "perfect storm" of financial markets had subsided, Canadian and US stock markets were half of their previous highs. The emotional swing from greed to fear had left the technology laden NASDAQ down 78%, at only 22% of its former luster. Nortel had reached bottom at 67 cents, but gold was up to $389 US per ounce. The low interest rates, designed to fend off recession, were already fuelling the next frenzy in the world’s real estate markets.
2003 brought war in Iraq and the SARS epidemic, but the real estate run continued, with interest rates cellared at 40-year lows. Canada’s dollar, at 61 cents US, made our assets and exports attractive, but residents feared it could go lower. By year end, federal balanced budgets, the swell of commodity prices (in particular, oil), and foreign buyers of cheap Canadian companies and real estate had boosted the Canadian dollar to over 77 cents US.
By 2004, the Iraq war seemed done, Bin Laden was on the run, and world stock market recoveries were well underway. The global real estate boom appeared fully mature, with Australia and the UK starting to roll over and the average MLS house price in Canada up 57% from the 1991 peak (3.6% compounded annually). At year end, oil broke $43 US per barrel after terrorist attacks in Saudi Arabia, gold hit $445 US per ounce, and the Canadian dollar had ridden currency flows up to 83 cents US.
The endless appetite for commodities to fuel Chinese industrialization, combined with continued fears of shortages, pushed oil through $60 US per barrel and our dollar to 86 cents US. Renters bid up the residential real estate market, fearful of losing an affordable opportunity, while speculators "flipped" properties in 20% of all the US sales. Gold ended 2005 at $520 US per ounce.
In 2006 the US real estate market turned down, and gold peaked at $730 US an ounce, sliding to $543 US before recovering to $640 US at year end. Oil peaked at $78.40 US and receded to $61 US per barrel, and our dollar broke 90 cents US before falling back to 85.
2007 is the seventh year of rising BC real estate prices. This trend is already four years longer than the historical norm and the pendulum of emotion will swing back. Does the pattern seem familiar? It should.
As I look back at each headline, I can see how investor attitudes have cycled from greed to fear and back again. Legendary investor Sir John Templeton said, "Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria." Our collective propensity to react emotionally to recent news will not change. Thus, the opportunity for out-performance will continue to be available for investors who employ a disciplined decision process – one based on fundamentals rather than feelings.
The last decade contained the greatest height of our collective optimism and the lowest depth of our pessimism in the last seventy-five years. The sentiments of greed and fear were potent distractions from strategic principles. Yet, through all the ups and downs, the world stock market index outperformed guaranteed investments by almost 50%. More significantly, in a simple sample of the largest 10 global mutual funds, only one professional stock picker underperformed this index, despite diversifying for risk. Ironically, the same manager has the longest history of out-performance against the same index (53 years). These actively managed funds definitely cost investors more than the passive index. However, their combination of lower downside risk, coupled with long cycle out-performance, and a paid advisor to coach through the swings of fear and greed, has delivered value beyond their cost. Principles - with advice - help manage risk.
Managed risks return more than emotional responses. We should plan accordingly.