Originally published: July, 2002 (Phillips, Hager & North Investment Funds Quarterly Report)
Context of the article: In the summer of 2002, we were well into a bear market for equities. This article is build around the fact that when everyone is thinking the same thing, it's probably a good time to look the other way.
Ian Mottershead, one of our senior partners, coined the phrase, "What appears obvious is probably untrue". His simple statement refers to the fact that when equity investors all line up in a certain direction, they are probably facing the wrong way.
It's an interesting statement in the context of the current markets. Investors seem to be taking an extreme view of everything, and, as a result, there are a number of things that "appear to be obvious" today. Will they prove to be "untrue"? Let's look at three "obvious" and topical statements.
The stock market is built on trust. Financial statements and corporate executives are not to be trusted. Therefore, the market isn't going up any time soon.
We are currently watching the excesses of the last economic and stock market cycle being exposed. Accounting and corporate governance abuses are part of every cycle, but this time it is worse. Why? I think it's because the cycle was longer. These excesses build up in good times without being noticed, and we just finished the longest economic cycle, marked by one of the greatest bull markets, in history.
Nonetheless, with increased scrutiny from regulators and professional investors - the latter being the most important - I think this issue is yesterday's news. Yes, confidence has been shaken, but the reality is that going forward we will have the highest standard of corporate governance we've ever had. Yes, we need more investor confidence now, but history has shown us that confidence can come and go very quickly, often without notice.
The stock market won't go up until we have better visibility.
Investors today are very focused on visibility, which is the latest industry buzzword for certainty. If you read the business or investment press, you're constantly being barraged with phrases like: "As we look forward, we have no visibility as to next quarter's revenues and profits" or "We don't recommend investing in equities until there is better visibility." In these uncertain and volatile times, visibility is what everybody is looking for.
In this case, we think the obvious is untrue. To quote a recent Morgan Stanley report, there is "too much worship at the temple of visibility." I prefer to be more direct: Visibility is overrated.
Indeed, I would go so far as to say that whenever we attain visibility, we should be very careful. On the one hand, look back at when we last had it. The most recent time was probably when the Ottawa Senators were up three games to two over the Toronto Maple Leafs in this year's NHL playoffs. At that time, everyone knew Ottawa was going to the next round. Certainly the sportswriters in Toronto and Ottawa did. Whoops. It didn't quite turn out that way. Before that, the best example of visibility was during the technology boom in 1999 and early 2000. Investors knew that the world had changed and the new economic paradigm would be driven by technology. Whoops again.
On the other hand, think about how little visibility we had on September 21st last year, when the market started a dramatic three-month rise. We heard it loud and clear - "There is no visibility!" And how certain about the future were investors in the summer of 1982 when the last great bull market started? Not very. At the time, we were suffering from runaway inflation, high interest rates and poor corporate earnings.
Telecom is dead. It will be years before we see any life from the telecommunications companies - if ever.
On this issue, we think the market view will prove untrue for a number of reasons. First and foremost, telecommunications is still a growth industry. You just have to look around to see the increased usage of wireless, Internet and data transmission. Second, because the industry is growing, we think the overcapacity that is evident today will be short-lived. There's enough fiber-optic cable to carry long-distance calls between Calgary and Edmonton for many years to come, but there's not much extra capacity for wireless voice and data transmission or high-speed Internet access to your home. Third, we see signs that the competitive environment is improving. No doubt you've already seen some additional fees on your cellular bill. And last, but not least, stock valuations in this industry have become very attractive.
At this stage, when telecom shares have dropped substantially and investors have thrown in the towel, we think it is timely to increase our funds' exposure to this depressed but growing industry.
Most of the obvious things in "investment land" lean toward the negative right now. If you read the commentaries presented earlier in this report, you will see that we are positioning the funds away from the obvious. So far in 2002, these strategies have impacted our performance negatively, but given how extreme investors' views have become, we are convinced it is the right thing to do.
At the present time, our balanced and equity portfolios are positioned for better markets ahead. We think valuations are now very attractive and most of the bad news has been factored into stock prices.
We are focusing our analysis and share purchases on companies and industries that have had, or are having, a recession. Going forward, this is where the opportunities lie. Sectors such as telecommunications, technology, banking and brokerage hold particular appeal to us. We are investing for the long term in companies that we think will do well when their industry fundamentals recover over the next year or two.
As the events of the coming months play out, we'll see whether Ian's adage is confirmed once again and if what appears obvious is, indeed, untrue.
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