In this “Spring-Fresh” edition:

• Nortel? No way!
• An update on Manitoba Telecom
• Trading Notes: BFI Canada Income Fund, Transalta Power, Riocan
• Closing Bell: A Pilgrimage to Arby’s

Nortel? No Way!

Since the last column, I’ve heard from a number of readers asking:

a) If I were planning a new column.
b) If I were still alive.
c) If I were interested in Nortel at these levels.

Here are my answers: a) Yes; b) Most days, yes; c) You’ve got to be kidding? In fact, every time I get together with investors, I ask what’s on their radar screen and 9 times out of 10, I hear “Nortel.” What is this world coming to? Surely the apocalypse is upon us (my money is on a swarm of malevolent locusts devouring us all). The only acceptable reasons for succumbing to the Nortellian impulse are the following:

• you’re interested in a speculative trade
• you’re drunk
• you’re really, really drunk
• you’re stoned
• your money shredder is on the fritz
• you’re being threatened at gunpoint, and the only way out is to consider buying Nortel

I can’t imagine any other circumstances. In fact, let’s make each of these a rule. Allow me to continue: Investing in Nortel reminds me of David Cronenberg’s movie, Crash. The film follows the lives of people who get aroused by car accidents. So if you enjoy car accidents, you might also enjoy investing in Nortel. I think that about covers it.

An update on Manitoba Telecom

As you know, I’ve been following with great interest the saga surrounding Manitoba Telecom (MBT). I bought in on the expectation that MBT would do something wonderful with the $650 million owed to them by BCE. I was giddy about the possibilities of the company converting to the income trust structure; excited about the prospects for a large, one-time payout; I even laughed myself to sleep thinking of a massive share buyback. It was like being at Arby’s. Do you go for the hall-of-fame sandwich that is the Beef ‘n Cheddar or the smokey, beefy goodness of an Arby-Q? It’s one of those rare instances in life when you can’t go wrong. The market clearly had its preference and was pricing in a trust conversion. When the company announced they were putting a shareholder proposal regarding trust conversion on the agenda for the annual meeting, the shares took off. However, MBT was low-key and tight-lipped about the whole affair. Did they have other plans?

In March, we learned there was a method to their being mum. Manitoba Telecom announced a $1.7 billion takeover of Allstream, a provider of telecom services for business clients. You might recall that Allstream is what became of AT&T Canada, post-bankruptcy. Of particular interest was MBT’s take on Allstream’s $3 billion in unused tax losses. MBT noted these losses would be used to offset future income, generating considerable tax savings. But to be honest, I’m not thrilled about any company that had $3 billion in losses to begin with. I’d be just as impressed if the Ottawa Senators framed losing to the Leafs as an effort to save on travel expenses.

I can’t help but wonder what Olaf Kolzig would have done for the Sens. Maybe when the lockout is over and hockey returns in a few years, we’ll find out.

MBT had a nifty little monopoly within the friendly confines of Manitoba. With the takeover of Allstream, they’re going head to head with BCE and Telus, and every other provider of telecom services. Sure, MBT will continue to generate piles of cash. However, this is an ultra-competitive sector with an ever-changing technological landscape. Worst of all, the managers of these companies always seem to find a way to destroy investor capital with questionable takeovers (e.g., BCE buying Teleglobe). MBT may find a way of bucking this trend. But I have no interest in risking my capital to find out for sure.

Many investors are upset, feeling they were misled by MBT dangling the prospect of income trust conversion and then heading in a completely different direction. I’m not, because I don’t think the onus is on MBT to telegraph their every thought to the markets. If they had spent the past few months stressing the need to make an acquisition, it’s entirely possible that Telus would have felt some pressure and then swept in to acquire Allstream themselves. I would have been fine with that, but MBT’s management team had other ideas.

In any event, nobody saw this acquisition coming and the shares of MBT promptly collapsed. After the dust settled, I sold the entire position at just under $49. As mentioned in MG #18, I had sold 1/3 of the position earlier just in case trust conversion didn’t occur. This proved to be a good move and illustrates the wisdom of booking some profits on the way up. Simply, it’s prudent risk management. The initial position was acquired a few months ago at prices just under $40, so this was a worthwhile investment. Time to move on.

Trading Notes

• I sold the remaining position of BFI Canada Income Fund (BFC.UN) at $18.95 after selling 25% of the holding in March (see MG #18). With the advancing unit price, the yield had declined to such a level that the risks of holding seemed to outweigh the risks of selling. Every time I see a BFI garbage bin out back of a pizza parlour, every time I take out the trash, every time I see a garbage truck making its noble journey to a landfill, I’ll think fondly of the few months I spent with BFI. In the short term, the sell proved to be a good move, as the units have since given investors a rough ride. Speaking of that…
• I continued the trimming of interest-sensitive income trusts, selling my holdings in Transalta Power LP (TPW.UN). A couple of unexpectedly strong US jobs reports and the expectation that interest rates are headed up have sent income product into a tailspin. The prevailing wisdom is the raising process will begin later this year (some say the Fed will move as early as June). The Canadian economy is decidedly less robust and rate hikes are less likely in the near term. So why all the panic about Canadian rates? The last time I checked, the rate on a one-year GIC was 2.5%, with the five-year coming in at 4%. Risk-free Government of Canada 10-year bonds are yielding around 4.6%. Not very exciting, if you ask me. It would take much higher rates to get me interested, but the trend is certainly up. In any event, the inflated nature of the income trust sector probably contributed as much to the selling pressure as interest rates. Simply, many of the units were frothy, leaving them highly vulnerable for a pullback. 

• Speaking of tailspins, the REIT market has been especially hard hit. One of my longtime holdings is Riocan (REI.UN) and it wasn’t immune to the selling pressure. In MG#3, I mentioned feeling nervous about its valuation and subsequently pared the holding in September (MG#10). The strong start to Riocan’s year left me feeling even more nervous. Once the units started to shift down, it was easy to dump a few shares back into the market just south of $16. I haven’t eliminated the position, but I’m happy to have taken more profits. But I should have trimmed when the units had advanced to such an extent that the yield on any new purchase would have been only 7%. I remember telling myself it was the right thing to do, and yet I failed to act (heck, I did it with BFI, why not Riocan?). I suppose much of it has to do with the fact that I had committed one of the cardinal sins of investing: I’d fallen in love with a stock and its company. Of course, if you’re going to fall in love, why not pine for the real deal? As a company, Riocan is top-notch, as evidenced by their most recent quarter and 10th consecutive year of increasing distributions. Occupancy levels are stable and they have lots of cash to pursue acquisitions. My position is now relatively modest, but I’m content holding on. My average cost is well below $10, so the yield on my original purchase price is roughly 14%. Where am I going to get that on newly-invested capital?Roughly 25% of my portfolio is allocated to the income trust market. In speaking of the sector as a whole, I’d like some stability to return to unit prices so I can just sit back and enjoy the distributions. But if the downtrend continues, the crystal ball shows a buy or two in my future. As always, I’ll keep you posted on what I’m up to.
  

Market Guy’s Closing Bell: A Pilrimage to Arby’s

Now I’m thinking about Arby’s, so I might as well tell you an Arby’s story. I live in Ottawa, a town that has been Arby’s-free for about 15 years. For some reason, all the public servants and high-tech people don’t appreciate slow-roasted, lean beef marinated in barbecue sauce. I know, I know….I can’t believe it either. Anyway, one day I decided to take matters into my own hands. So I piled into the car with Bouch from Embrun and Ozner from Barrhaven. We decided to head for the nearest Arby’s. Only one thing: The nearest franchise was in the United States. No problem. This was pre-September 11th so you could tell the border guard that, yes, you were traveling from Canada for the sole purpose of getting beef sandwiches at the St. Lawrence Centre Arby’s in Massena, New York. True, border guy wanted clarification, but he was a good sport and I’d like to think that deep down, he understood. If memory serves, I had 4 Beef n’ Cheddar’s and an order of curly fries. Bouch had 5, but told his wife he ate only 3. I can’t recall how many Ozner had, but he got it done. And all that pleasure cost about the same amount as a couple of Nortel shares.

Don’t forget to ask for extra Arby’s sauce!

The Market Guy is an Instructor with the Department of Psychology at Carleton University. He’s not a professional advisor. He’s just a guy who loves investing and talking about the markets. He’d like to thank The Flyers for conquering the dark side of the force. As the Sens are out, it’s Go Flames Go over at mail@marketguy.ca

In this, “Been Away For a While” edition:

• An evaluation of TD Bank’s recent quarter
• Trading Notes: Northland Power, BFI Canada, Manitoba Telecom
• Closing Bell: “Free Martha!”

It was only a matter of time before I wrote about the big banks. That I hadn’t already owes much to the fact that financials, although performing quite well, have been decidedly less interesting to discuss than income trusts. Forgive me and my obsession. In fact, it’s ironic that I invest in financials at all, given that I spend so much time trying to keep the banks from making money off me. I’d rather eat leftovers on the set of Fear Factor than pay bank fees or incur high trading costs. I have yet to find religion, so this is my belief system. And yes, it makes me very happy.

The only financial stock in my portfolio is TD Bank (TD - TSX). Added within the last year, it is Canada’s third-largest bank by market cap, behind only Royal Bank (RY - TSX) and Bank of Nova Scotia (BNS - TSX). Beyond that, my only exposure to the sector is indirectly held through a number of mutual funds. With the latest earnings reports in hand, I’ve been reviewing my holding to see how it stacks up vs. the rest of the group. In fact, I anticipate the bank earnings with as much excitement as most people do a new season of The Sopranos. When looking at the banks, there are so few options in Canada and comparisons are fairly easy to make. The metrics that I use include return on equity, tier one capital ratio, loan loss provisions, dividends, stock performance, and a consideration of risks and opportunities.

You’ve spent 15 months waiting for Season 5. You only have to wait 3 months for the next round of bank earnings.Bada bing!

Return on equity
When evaluating stocks, one of the key measures of profitability is return on equity (ROE). This statistic allows us to compare the company’s use of its equity with other investments. In other words, are they allocating their resources in a profitable manner or is good money being flushed down the toilet? On this measure, the quarterly results just announced by the banks compare favourably with a year ago. A number of factors contributed, including strong capital markets and an improving credit environment. In the latest quarter, the bank group averaged a 19% return on equity, with CIBC(CM - TSX) and TD topping the list at more than 21%. Meanwhile, Bank of Montreal (BMO - TSX) at 18.3% and Royal at 17.8% offered the weakest results. Based on ROE, I’m satisfied that TD is making good decisions and generating positive value for shareholders.

Tier one capital ratio
Another key metric is tier one capital ratio. Also known as core capital, this provides a measure of the capital adequacy of the bank. Over the past year, the banks have done a good job increasing these ratios and the group average stands around 10%. CIBC (11.1%), TD (10.9%), and BNS (10.9%) scored top marks, with BMO (9.7%) and Royal (9.3%) once again at the rear. Again, I’m satisfied.

Loan loss provisions
In trying to assess bank performance, it’s important to note the quality of the loan book. Over the past quarter, the banks have benefited from an improving credit environment and significantly reduced their exposure to bad loans. This reminds me of another pearl of wisdom offered by Warren Buffett. When asked to account for his investing success, he suggested it had less to do with picking winners and more to do with avoiding losers. By this measure, the banks have been increasing their level of success. As a percentage of loans, the lowest provisions belong to BMO, Royal and TD. No alarm bells here.

Dividends
Of course no discussion of the banks would be complete without a consideration of dividend yield. In this regard, the group is closely packed around 3%. CIBC and Royal have the highest target payout ratios (40-50%), with the rest of the group, including TD, a tad behind (35-45%). Most of the banks have been increasing their dividends every 2 or 3 quarters and this trend is expected to continue. I’d like for TD to raise their payout ratio and it might just happen unless they want to be left behind. Clearly, the banks understand that investors are hungry for income and any bank that fails to deliver will eventually be punished. Using the extra cash for stock buyback programs is fine, but all things being equal, I’d rather have the cash in my pocket.

Risks and opportunities ahead
For TD and CIBC, so much depends on the performance of the equity markets. Both are vulnerable to the bears but free to run hard with the bulls. In part because of this exposure, most commentary that I’ve come across expects TD and CIBC to have the highest earnings growth among the banks in the near term. The latest quarter saw TD blow by analyst estimates, although the bank did caution investors not to expect many surprises for the rest of the year.

For the entire group, retail margins are razor thin, with a low rate environment and fierce competition for products such as mortgages. TD is behind many of its peers in terms of execution at the retail level, but the gap is narrowing. CEO Ed Clark has been drawing positive reviews for the bank’s recent execution and improving the retail operation is surely on the agenda. It’s like my Dallas Cowboys. We all know that Quincy Carter and Troy Hambrick aren’t going to lead the team to the Promised Land. In order for the Vince Lombardi Trophy to assume its rightful place in Texas, the team knows what needs to be done. Just do it. As you can see, I’m suffering from a severe case of NFL withdrawal.

Comparing TD’s retail operations to one of Quincy Carter’s horrific bounce passes really isn’t fair…to TD

Another factor that has merited considerable attention is the topic of bank mergers. I find it impossible to make investment decisions based on merger speculation, as the “who’s,” “what’s,” “where’s” and “when’s,” are in a constant state of flux. And don’t forget that mergers are still at the pleasure of the federal government, making for quite the wildcard. What’s the punch line? Because I can’t get a handle on the various merger scenarios, I’m going to continue making my investment decisions based on the fundamentals.

Finally, with interest rates likely to increase at some point (who knows when?), the banks could come under some pressure. But I’m not convinced that rates are going to spike anytime soon, so I think there is still money to be made in the financial sector. Plus, I don’t think financial stocks are the interest-rate sensitive animals they used to be.

Stock performance
I don’t care if I own the top gainer year-in-year out. I do however expect above average performance or else I might as well find a new hobby. In terms of stock performance, BNS has averaged 20% a year for the past 5 years to top the category. Over the same time period, TD has experienced considerable volatility and has returned much less to investors. Over the past year, TD’s stock price is up around 40%, trailing only CIBC’s stellar 55%. Royal is the clear laggard, returning less than 10% over the same time period. What does this say about valuation? Based on earnings estimates for 2004, National Bank (NA - TSX), CIBC, and TD have the lowest price to earnings ratios in the group. No warning signs here. I expect the shares to continue rising, albeit at a slower pace than seen over the past year.

The fact of the matter is, I’d be quite happy to hold any of the big Canadian banks. The cynic in me is saying that it doesn’t matter which bank you own. Just pick one and eventually it will be the toast of the town. It’s fun talking with older investors who speak of purchasing stocks like CIBC many years ago at a split adjusted price of something like $5. Some of these investors rarely even look at the stock ticker and they surely don’t care about which bank is currently in favour or which one is in the doghouse. They figure that it all works out in the wash. Right now, TD and CIBC have been drawing strong reviews, while RY has been sent to the penalty box for problems with its US operations. But as recently as last year, TD was the object of ridicule and scorn given lackluster capital markets, a low tier 1 ratio, and an inability to correctly estimate how nasty their loan book really was. How quickly things can change. As an investor, I’m a happy holder of TD and I hope they make lots of money from other people. But when it comes to fees and such, I practice a NIMBY philosophy…Not In My Back Yard.

Trading notes

• I recently eliminated my entire holding in Northland Power (NPI.UN - TSX). The current yield on the units dipped below that of my other power holdings, Calpine Power (CF.UN - TSX) and Transalta Power(TPW.UN - TSX). Calpine and Transalta are each backed by a large corporate sponsor (Northland is not) and their distributions are expected to be mainly tax deferred (Northland’s are largely taxable). Therefore, I didn’t think that I was being adequately compensated for the added risk. The power trusts are highly sensitive to interest rates and have benefited a great deal from the current cycle. When rates turn, the units prices will be left highly vulnerable (so if we’re going to have rates heading north, let’s hope the increases are modest and gradual). In any event, given the stellar performance of the power trusts and my overexposure to the sector, I’m quite comfortable taking some profits and storing the cash for a new day.
• I sold 25% of my holdings in BFI Canada Income Fund (BFC.UN - TSX). The company recently received Quebec government approval to significantly expand the Lachenaie landfill. The approval was largely expected, but when it comes to government, one never knows. The news spurred an already advancing unit price and compressed the current yield to less than 7%. Investors are anticipating growth in distributions. I’ve said it before and I’ll say it again: There’s nothing more beautiful than making money from trash. What a wonderful world in which we live. However, when I bought the units I was expecting the distributions and some modest capital appreciation. Instead, the units are up almost 40% since my purchase last August. This appreciation is equivalent to 4 years of distributions, but were earned in only 7 months (plus 7 months of actual distributions). If I didn’t take any profits, I’d explode.
• In the previous edition of Market Guy, I speculated that it might be a good time to pare the holding in Manitoba Telecom (MBT – TSX). Well, a couple of weeks ago I pulled the trigger and reduced the position by one-third. I’m locking in some profits and hedging my bets just in case the company decides not to convert into an income trust. I’m content to ride the remaining shares.

Market Guy’s Closing Bell
In between marking papers I had the chance to watch CNBC’s coverage of the Martha Stewart verdict. It made for fascinating TV and I couldn’t look away. They had legal experts in the studio, police setting up barricades, a verdict tally board outside the courthouse (complete with markers and a confused correspondent who initially reported that Martha had been acquitted on all counts), a ticker devoted exclusively to Martha stock quotes, crazy trading in that stock, and producers running down the courthouse steps, waving signs and scarves to alert reporters of each verdict. If that wasn’t enough, CNBC offered a very special “U.S. vs. Martha Stewart: GUILTY: One Hour Special.” And if you missed that, they were also promoting “U.S. vs. Martha Stewart: GUILTY: One Hour Special: Encore Presentation.” I’m still waiting for the “U.S. vs. Martha Stewart: GUILTY: One Hour Special: Encore Presentation: The Highlight Show with Maria Bartiromo live from the NYSE.”

Outside the courthouse: I’ll bet this guy loves telling the girls that, at least for one day, he was known as “Mr. 8.”

So what’s missing here? I really wanted a crowd shot and was desperately hoping to see some guy wearing a “FREE MARTHA!” t-shirt. If nobody has thought of this already, then capitalism is in a sorry state.

The Market Guy is an Instructor with the Department of Psychology at Carleton University. He’s not a professional advisor. He’s just a guy who loves investing and talking about the markets. He’s in the middle of marking 90 first-year oral presentations and then moving on to 1500 pag

The mail has been piling up, so let’s open up the Market Guy Mailbag:

The first letter deals with the growing speculation that Manitoba Telecom (MBT on the TSX) will eventually convert to an income trust (see Mum’s the word on Manitoba Telecom from December). More fuel was added to the fire on January 27th, when the company announced that a shareholder had requested the issue be placed on the proxy circular for the annual meeting to be held in the spring. The stock immediately shot up over 9% to close around $50. That’s one heck of a move for this type of stock.

Letter #1: Gary in Winnipeg
Does this likely mean that a BCE takeover is not in the cards, and likely never will be… Will the bottom ever fall out of this thing?

Keep in mind, of course, that I know nothing. Having said that, a takeover is certainly more expensive than it was a few days ago. I’ve read some speculation that BCE won’t fight conversion and may in fact cheer from the sidelines. Fair enough.

MBT has cautioned investors that a shareholder proposal doesn’t necessarily mean that conversion to the trust structure will occur. And it could be a few months until we find out for sure. In fact, the board of directors may not make their feelings known until the proxy circular comes out. Andrew Willis of the Globe and Mail wrote about all the money managers traveling to Winnipeg trying to persuade the board and executives that conversion is the way to go. But here’s the thing: If the company fails to convert, the stock is going to be absolutely pummeled. It’s now trading in the low $50’s, but Scotia Capital thinks it’s worth $41 if they don’t convert and $60-65 if they do. Meanwhile, CIBC counters with $44 as equity and $55 as a trust. So if there is no conversion, the stock is extremely vulnerable and yes, I think the bottom would fall out.

The pain would be almost akin to what I experienced the other day. I came home from work to find the Market Gal and a friend watching “Oprah’s Birthday Party” on television. The special included guest appearances by Celine Dion and Jay Leno. Apparently John Travolta came in, serenaded Oprah, and then referred to her as a “national treasure.” I ran as fast as I could and retreated to my psychological safe place. If a young child ever asks me about hell, I can say that I’ve been there. And I don’t need Manitoba Telecom to proactively give me similar pain. I’m not rational enough to discuss my dislike of Leno and Dion…but I’m left with the same question offered by my buddy Dick in Edmonton: “After Pulp Fiction, what the heck happened to Travolta?” I have no explanation for any of this.

Take a moment to get in touch with your feelings. Oprah would have wanted it that way

As I mentioned before, I would have been happy if Manitoba Telecom paid out the proceeds from the $650 million Bell put as a special dividend. Some analysts figured the dividend could have reached as much as $10 a share. I also would have no objection if they’d used the money to cancel shares. But the prospect of a trust conversion is just gravy. I think it’s going to be very difficult for the board to recommend another option without erasing hundreds of millions in market cap. And even if they are against conversion, they’ll be going against a significant number of their shareholders, which would make for an interesting fight. It’s almost a case of the cat being out of the bag.

As always, the essential question is, how can I make money here? I got in at just under $40 a share, although some stupid trading on my part shaved about a buck from the current gain. I’m seriously thinking of selling one-third of the position and letting the remaining shares ride. That way, I’d lock in some profits but still participate on any additional upside if conversion is announced. For now, this is a news-driven story that may take a few months to figure itself out.

Letter #2: Michael in Vancouver
I love the website, but I can’t believe you invest in tobacco stocks (seeSmoke ‘em if you got ‘em). Surely there are more worthy industries to invest in. What kind of ethical statement are you making?

I understand what you’re saying. But here’s the thing: If I want to invest in a worthy cause, I’ll make a charitable contribution or volunteer my time. For me, investing in the markets is about making money, not about making ethical statements. I can appreciate those who link their morality and investing dollar and I wish you the best. But I’d invest in the Springfield power plant if Mr. Burns could show me some decent cash flow, low debt and a nice payout. Besides, I don’t believe that investing in tobacco stocks is akin to supporting the product. 

On a side note, I have to say that I fell in love with your town about 3 seconds after I got off the plane. Here in Ottawa, we’ve been enjoying several weeks in a row of “exposed flesh will freeze in less than 5 minutes” warnings. I have a student from Vancouver who may have to go into therapy after a winter spent in the capital.

Letter #3: Bill in Mississauga
I really enjoyed your column on your worst investing experience. It actually helped. Let me tell you about my worst experience, although I’m sure it mirrors that of many of your readers. A few years ago, and on the advice of my financial advisor (we are no longer on speaking terms), I purchased 500 shares of Nortel at $98. I enjoyed the trip to $120 and thought about selling, but he kept telling me about bandwidth, optical something-or-others, and the merits of buy-and-hold investing. The stock peaked and then eventually went back below $100 and my advisor said it was a “temporary pullback.” $80 came and went. $70, $60, and so on, right down to the point when I had to insist he sell at $35. It was a horrible experience, but I stayed in the market and (thank goodness) now have a fairly diversified portfolio. I’m mainly in mutual funds because I can’t stand the volatility of individual stocks. Perhaps you could do a column on mutual funds?

Thanks for sharing your experience. Glad to hear you haven’t soured on the markets and that you’re aiming at diversification. I hate being upset with the markets, but in the end, we always make up and fall in love all over again. I’ve had many letters from people who are still in Nortel after buying much higher. They are finding it very difficult to get excited about the 2003-04 march to $10 and are quite nauseated with all the analysts jumping on the bandwagon.

The Nortel rise and fall reminds me of 1988 when Ben Johnson captured Olympic gold in the 100m. Remember how he accomplished what no expert thought possible: He shut Carl Lewis up and did so with a world record time of 9.79? Before that, my cornerstone sports moments had been the 1985 Blue Jays capturing their first division title and Gretzky to Lemieux with 1:26 remaining in game 3 of the 1987 Canada Cup. Anyway, the Johnson medal almost necessitated a national holiday. That’s all anyone talked about…especially two days later when the results of the drug test hit the airwaves. The medal was stripped away, handed to Lewis, and everything after that remains a blur. We’d just been subjected to a national colonoscopy and a bad case of emotional whiplash.

This sounds like the experience so many had with Nortel, JDS, and a host of other stocks. Pure ecstasy followed by serious pain. The other day a friend on mine was in line at the bank and overheard a couple talking about Nortel and perhaps “getting in!!” What’s old is new again and the analysts are tripping over themselves to recommend the stock (Gordon Pitts discusses the issue of Nortel hype in the Jan. 31 edition of the Globe and Mail). The turnaround at Nortel has been remarkable, but I just can’t get excited about a company that pays no dividend, operates in a very unpredictable market, and experiences violent swings in stock price. If I held a fund that owned Nortel, that’s fine. But I’m not interested in the stock itself.

Ben and Johnny (former Nortel CEO John Roth)…before kicking our collective groin

And sure, it’s only a matter of time before I write a column on mutual funds. Of course the “What I Learned about Investing by Watching Television in the 1980’s” column may have to come first. Stay tuned.

Letter #4: Shannon in Toronto
Thanks for mentioning the Canadian Tire Options Mastercard (MG # 7). By Christmas I had so many dollars on the card that I was able to get a number of presents for free. Keep the ideas coming. Your column is quirky, but in a good way.

Thanks Shannon! The debate I always have is this: Do I use my points for something big or do I grab lots of small stuff throughout the year? After grabbing a kick ass socket set in 2002, last year I went small and earned the following items free: 1 boot tray, 9 boxes of Kleenex, 1 bottle of glass cleaner, 2 jugs of windshield wash (Teflon), 3 Rubbermaid containers, 1 TV tray, 1 brake pad, 2 packs of spark plugs, 3 bags of charcoal briquets, 1 lawn sprinkler, 1 bottle of car wax, 1 jug of liquid fertilizer, 1 car headlight, 1 can of deluxe primer…OK, I’ll stop now.

Letter #5: Greg in Kanata
Where do you go for stock quotes?

If I want real-time information, I head to my broker sites. If 15-minute delayed will suffice, then it’s globeinvestor.com. The site has a useful stocklist function that will allow you to generate a substantial list of favourite quotes (see the very top of their page). This is the easiest way to do it.

This next part is for market diehards only: In order that my browser loads up with stock quotes, I’ve gone at this a little differently. I first went to the globeinvestor main page, typed in a quote (e.g., BCE-T; the T is the appropriate exchange code for the TSX). When the quote popped up, I went to the address window at the top of the screen and continued the string (e.g., I’ll add a few ticker symbols so that it looks something like “BCE-T+NT-T+TRP-T” and so on and so forth). You can add up to 30 stocks. Then I copy this string, head to the Tools menu (I use Internet Explorer), select Internet Options, the paste the string into the homepage address box. Of coure you don’t have to use this as a homepage, and can simply add it to your Favourites. I currently monitor 90 stocks over 3 pages.

Letter #6: Bouch in Embrun (a mailbag regular)
Perhaps as your readership grows, your trading notes section could generate it’s own “mini-rally”, similar to the ones enjoyed by companies mentioned in Canadian Business and like publications.

I think a more likely scenario would involve my subscriber base eventually deciding to vote me off the island. But speaking of media-inspired rallies, I have noticed that thinly-traded small cap stocks often enjoy a brief pop after being identified as top picks on ROB-TV’s Market Call. I have to devote a column to that show. The fact that I haven’t already is just plain wrong.

This concludes another edition of the Market Guy Mailbag. Thanks for writing in.

Trading Note
I participated in the recently announced $115 million bought deal in Calloway REIT (CWT.UN on the TSX). This fast-growing real estate investment trust focuses on retail properties and has been on a buying binge as part of their relationship with First Pro Shopping Centres. First Pro seems to be Wal Mart’s developer of choice in Canada and the recent transactions will expand the number of Wal Mart’s in the Calloway portfolio to 16.

Under the terms of the bought deal, the units were priced at $13.75 with a mid-February closing. Within minutes of placing my expression of interest, the deal was completely sold out. I managed to secure a decent position, but only because I jumped on it so fast. The units are currently trading in the mid-$14 range, and I’m hoping to still be in a position to flip the shares when the deal closes (that is, sell as soon as I receive the shares in order to capture the spread. Under the terms of these secondary offerings, you can’t trade the shares until the deal officially closes). The other option is to hold the shares and maintain the position. I already own Riocan in this space, but Calloway has some interesting growth possibilities. We’ll have to see. The units currently pay $1.15, for a yield just north of 8% on my purchase price.

The Market Guy is an Instructor with the Department of Psychology at Carleton University. He’s not a professional advisor. He’s just a guy who loves investing and talking about the markets. He didn’t get around to snowblowing this week, so a large snow hump resides at the end of his driveway. There’s always a hump over at mail@marketguy.ca

In being retrospective, it’s common for us to exaggerate the extent to which the events of the past were predictable. That is, we typically convince ourselves that an outcome was inevitable and that deep down, we knew it all along. Sports fans refer to this tendency as Monday morning quarterbacking, psychologists speak of the hindsight bias, and doctors probably call it malpractice litigation. Whatever it’s called, it sure is popular in the financial pages at this time of year. Financial commentators, analysts, and ordinary investors speak of the year as unfolding exactly as it should have. The Dow behaved logically and anyone paying attention saw it coming. The fact of the matter is, I had no idea 2003 would unfold as it did and I’m not sure what 2004 will bring. I trust you are same. Now that I’ve inspired your confidence and completely de-legitimized my own writing space, let’s proceed with a post-mortem on the year that was and the portfolio that could have been. What worked, what didn’t, and how can I apply what I’ve learned to the year ahead?

Performance
The year 2003 saw the portfolio increase by over 27%. This is in-line with with the 24% advance of the S&P/TSX composite and the 25% lift in the Dow Jones Industrials. It looks good compared to the portfolio’s 17% return last year and the 12% generated in 2001. After a good year, don’t you find the air fresher, the colours brighter, and even your food tastes better? Or is it just me? More importantly, I came in 11th place out of 30 in my NFL pool, only 8 games out of the money. Market Dad placed 20th, so I get bragging rights until the new season begins in September. It’s important to have priorities.

My Best Investment Decisions of 2003:

1. Sticking with income trusts and dividend-paying stocks.

Talking about my TransCanada shares (TRP on the TSX) and financial stocks just isn’t as exciting as talking about trusts. So let’s talk about trusts. Is there anything more satisfying than looking at your monthly statements and seeing the cash flowing in? In 2003, every sector of the trust market advanced nicely and there were some wonderful investing opportunities. There wasn’t nearly as much value to be had as last year, but investors didn’t seem to mind. New issues were eagerly snapped up and it actually would have been a challenge to lose money here. I was thrilled with the distributions and unit appreciation of BFI (BFC.UN), Riocan (REI.UN), Inter Pipeline (IPL.UN), Calpine (CF.UN), Arc Energy (AET.UN), among others.

However, the prevailing wisdom for 2004 is that investors should be content with their distributions, and not much else. Very little capital appreciation is expected and that could be difficult for some investors to swallow. I’m totally content with the cash, but that’s just me. In fact, many predict strong headwinds for the sector, with possible increases in interest rates, lower energy prices, and investor dollars moving into growth stocks. The bulls counter that the issue of unlimited liability is being addressed, which should lead to the inclusion of trusts in S&P/TSX Index. This would increase the level of institutional participation, which is a very good thing. Also boding well for the sector is that many of the trusts are actually GDP rather than interest-rate sensitive.

In reality, who knows where rates are headed? With the Canadian dollar appreciating, the Bank of Canada has some flexibility to either maintain or actually reduce rates. A tame inflation picture and the US election should render the Fed about as talkative as Lt. Castillo from Miami Vice. This leaves me even more at ease with trusts. Besides, it’s really the pipeline and power trusts that are the most sensitive to rates and these represent only a small percentage of the overall trust market.

Lt. Castillo rarely spoke …and neither will the Fed in 2004

Here’s the punchline: For now, I’m not so much a buyer of trusts, although I’m always on the lookout for value candidates (the sector is maturing to the point where it’s easier to determine the cheap from the pricey). However, I sure am an enthusiastic holder across each sector. As the year moves along, I’m eager to evaluate the new trust product that’s coming and will pare back on holdings that have become stretched.

2. Taking currency into account.

So the S&P 500 index was up 26% in 2003. Sounds like a great year, doesn’t it? A buddy of mine has a financial advisor who kept recommending US stocks all year long. Based on what happened to the S&P, it sounds like a good call, right? Well hold on there Pedro! If you’re a Canadian, you need to consider the effect of currency valuation. Because of the 22% appreciation of the Canadian dollar, Canadians owning the average stock in the S&P started 22% in the hole. So in order to match the 26% return offered by the S&P index, your American stocks had to appreciate by 48%. In any investing universe, that’s a tall order. Sobering, isn’t it? For some investors, this realization might provoke a scene like in Cast Away when Tom Hanks lost Wilson. Sheer agony. As a result, most of the US index products had underwhelming years to say the least. For example, the iUnits S&P 500 index fund basically broke even. My preoccupation, obsession, and love affair with Canadian income product kept me largely removed from the US market in ’03, and for that, I’m quite thankful.

Looking ahead, most commentators seem to be calling for continued weakness in the US$. What’s been pressuring the greenback? Among other things, the US budget deficit is at its highest point in 50 years and Bush seems content to run up the tab. I’m still trying to get my head around the fact that Republicans have become the spenders and the Democrats the fiscal conservatives. Also against the buck is the decision by the US to abandon a strong dollar policy and it’s unclear at what point (if any), they’d jump in to reverse the current trend. If my brain had been firing on all cylinders, I would have made money here. So let’s discuss…

My Worst Investment Decisions of 2003:

1. All that glitters is not gold…although gold sure did glitter

In order to capitalize on US$ depreciation, many investors flocked into gold stocks. Meanwhile I missed the entire rally. Is there an area of the market that inspires more devotion than the gold sector? The gold bugs have been out in full force the past few months, spreading the word. It’s almost as if they are part of a religion and anyone who doubts the bullish case for gold just doesn’t understand. I completely misplayed the sector a few years ago by selling about 5 minutes before the whole thing took off. It seems that a modest allocation to precious metals would be appropriate for a diversified portfolio. Perhaps the fact that everyone is all excited about it makes it somewhat less interesting.

If I were going to play the gold market, I’d probably go with the iGold units (XGD on the TSX). It’s an exchange traded fund that is currently invested in 14 of the larger Canadian gold companies, so if you’re into the juniors, keep moving. American Barrick (ABX) and Placer Dome (PDG) make up over 45% of the portfolio, which is kinda spooky. But the MER of 0.55% is hard to beat. I’ve been hearing about an investment vehicle by which you can move beyond the gold stocks and make trades specifically around the price of bullion. What an emotional ride that could be. Let’s just say I’m curious enough to pay attention.

2. Early profit-taking in the energy patch

For several years the portfolio had been dramatically overweighed to the energy sector. The results were very positive, but entering last year I wanted to book some gains and have a more balanced portfolio. What better selling opportunity than a war in the Middle East, a cold winter, and a natural gas shortage at home? It was the perfect storm. With the thermometer dipping, crude trading in the high $30 range and natural gas on a spike, I bailed on several holdings….and subsequently missed out on more significant gains. My selling focused on energy trusts, specifically those inter-listed in the US. The rationale was that American investors would create powerful selling pressure once energy prices dipped. Little did I think that Iraqi “insurgents” would keep blowing up their own pipelines, we’d start hearing about China’s emerging appetite for oil, and the US economy would perform much better than expected? As a result, American investors kept taking the inter-listed trusts higher and higher. I missed out. Looking back, I should have gradually sold into the rally, rather than eliminating these positions entirely. An added benefit of such a strategy is that I could have spread my tax burden around. In any event, I held ARC (AET.UN) throughout the year and it performed exceptionally well, thereby dulling some of the pain of a missed opportunity.

The trade I didn’t make…but should have
It was July and I was looking at convenience store operator, Alimentation Couche-Tard (ATD.B on the TSX) in advance of their quarterly release. This is the company that owns Mac’s, Becker’s and a host of other places. I’d been following the company for about a year and was ready to make an investment. I was logged into my discount broker, had filled out the order screen for a batch at $13.50. At that point the only thing between doing business and not doing business was the click of the mouse. This reminds me of that 1999-2000 discount brokerage commercial involving the investor in front of his computer, nervously looking at his order screen, then pacing around the room while he contemplated the trade? Finally he clicked on the order button, the trade was executed, and a mariachi band started playing? Well, for ATD there was no mariachi band because I never placed the trade. They subsequently released a fantastic quarter, made a huge, much lauded acquisition in the US and the stock is now trading over $24. I’m not sure what stopped me from making the trade, but every investor has been there. The mind tells you it’s a good deal, but the heart steps in and kyboshes the whole thing. Stupid heart.

It reminds me of the time Market Gal asked me to go see a Madonna concert in Montreal. I knew the baseball playoffs were coming. I knew the Jays were in first place. I knew I might miss a game. But she begged and pleaded and she looked really good while doing it, so the brain jumped out of the car and let the heart drive. I subsequently missed game 6 of the 1993 World Series. Yes, I missed Joe Carter’s 9-inning, series-winning shot. The most memorable sporting event of my lifetime and while it was happening, I was walking out of Olympic Stadium, packed in a crowd of people dressed like the Material Girl. I’ve often thought of how I might have reacted had I been sitting at home watching THE game. Would I have jumped up, sat there stunned, yelled? How many fist pumps? When would the tears of joy stopped flowing? I’ll never know. And to make matters worse, Dick in Edmonton has taken the incident as a permanent license to ridicule. If he writes my epitaph, it will surely read, “Here lays a man who missed game 6 to be at the Girlie Show Tour. Only now he rests in peace. What an idiot.”

Up until Game 6, the Market Guyhad seen every pitch of every playoff game the Jays had ever played. Learn from his mistake and just say “no.”

By way of an update, ESPN Classic just replayed the entire series andMarket Gal had a chance to at least soothe some of the pain. She could have sat down and watched game 6, maybe made some nachos, and lied to me about how exciting it all was. She could have watched Joe hitting that 2-2 slider to left, then touching all the bases as he headed for home. She could have heard Sean McDonough’s indelible call: “Well hit down the left field line…waaaay back aaaannnnnd GONE!” But instead, she went into the other room and watched sitcom reruns and reality TV. I’m not bitter. Not bitter at all. Let’s just move on. Can we just move on? I need medication.

Back to Couche Tard. I suppose it’s better to regret the buy you didn’t make, than to regret the buy you did. It was that kind of year. Stupid heart.

Who isn’t being sued?
If you’re having a good year, it leaves some time to stop and appreciate some of the little things that otherwise might have been regarded as noise. The Martha Stewart saga gained steam, an Italian dairy went sour, and just about everyone tried to avoid Elliot Spitzer (or is it Ness?). 

But was there anything more satisfying than watching video from Tyco’s Sardinian retreat? I mean haven’t you always wondered what a $2 million toga party would look like? I especially enjoyed hearing of Jimmy Buffett’s $250 000 performance fee (not my choice booking for toga party, by the way) and the ice sculpture of Michelangelo’s David urinating vodka. The only thing missing was Bluto Blutarsky of Animal House and Caligula playing on a big screen. I laughed out loud when they played clips of all this at former CEO Dennis Kozlowksi’s larceny trial. He must have squirmed more than a 10-year old on the last day of school. The best quote to come from the whole mess was offered by some legal commentator who said, “This could be devastating in front of the jury.” Just like a broken leg could affect the play of your quarterback.

Tyco and Togas and Tips…Oh My!

As long as we’re dabbling in the oozing hubris file, let’s not forget Lord Conrad Black, who after resigning in disgrace as the chief executive of Hollinger boasted, “I made 50 million bucks yesterday.” Let’s give thanks for the financial enema that he is about to receive.

Christmas tree ornament giver of the year award
To Market Gal (also the winner of this year’s award for going above and beyond the call for the portfolio when she insisted her boss rent a BFI garbage bin). The ornament combines a stock exchange facade with a stock chart and computer keyboard. What could be more festive?

There surely is a Santa Claus when the Market Guy gets an ornament like this

The Market Guy is an Instructor with the Department of Psychology at Carleton University. He’s not a professional advisor. He’s just a guy who loves investing and talking about the markets. Over the holidays he became addicted to the Food Network. There’s always a tasty morsel over atmail@marketguy.ca