Luck

Let’s face it, the Canadian equity market has been a terrific place to be over the past 12 months.  For instance the TSX300 from September 2004 to September 2005 has returned over 29.3%.  This return contrasts with the Dow Jones at +4.9%, the NASDAQ’s +13.4% and the Russell 2000 of +16.6%.  Not shabby at all.

The problem with this 29.3% TSX return is that it was not uniform amongst all TSX industry groups.  It was conspicuously skewed to one industry.  Oil and gas now comprising 27% of the TSX 300 Index probably accounted for about 2/3 of this 12-month return.  Interestingly, the TSX, devoid of the energy group would have returned less than 10%.  Clearly whether expected or not, a little luck hasn’t hurt investors as virtually all oil and gas securities did extremely well over the past 12 months.,  Furthermore, the income trust sector with yields ranging from 8% - 12% also provided investors with serendipitous returns.  IPOs of newly-created trusts surged from 50¢ to $5 or 5% to 50% from their initial $10 offering price.  With regard to these securities little or no research was needed.  The key was to “just get invested”.

To some investors with good memories this investment setting appears to be remarkably similar to what went on during the high technology boom in the 1999-2000 period.  During this span inexperienced investors flip-flopped from one high-tech initial public offering to another while racking up significant profits.  This fortuitous period went on for a number of months until the “music stopped playing”.  High-tech equities then plunged in value and huge investor losses were sustained as financial turmoil set in.  Many investors who depended upon luck rather than hard-core fundamental analysis were severely burned.

Now, this is not to imply that the Canadian equity market is ripe for financial implosion; on the contrary as we stated in our page 1 ABC Perspective editorial, it is our opinion that the general market has more room to improve.  We reiterate, however, that prudent fundamental analysis and shrewd stock selection have become particularly important today.  Our sense is that the market has entered a new stage and no longer can one purely depend upon luck.  This is not to take anything away from the many neophyte investors who through good luck and opportunism may have scored huge profits playing the energy stocks and income trust IPOs.  The fact is that luck, like the sands of an hourglass, can only last so long.  When luck eventually runs out, investors must ultimately rely upon sound equity fundamentals, keen investment focus, disciplined analysis and good judgement.

Irwin A. Michael, CFA