Maybe it’s a “reset” but it’s not a depression

Today’s economic environment is difficult, but it’s not the start of a depression, according to two of Invesco Trimark’s senior portfolio managers, who say while there’s no way to sugarcoat the severity of this downturn, it’s nonetheless rife with opportunity for shrewd stock pickers.

Dana Love, vice-president at Invesco Trimark and the lead manager of the firm’s flagship Trimark Fund, says many managers are now referring to the 2008 downturn as a reset. Speaking to the Invesco Trimark’s Portfolio Manager Forum in Toronto, Love was adamant he has no idea what’s going to happen in the near term, and he strongly suggested that nobody at this point can accurately forecast what is going to happen with certainty.

“You can gather enough data in this market to make whatever argument you want,” he says. “There is no one single entity in the world right now that can solve the problems on their own.”

Instead, Love says a global restructuring of the financial system is taking place. Much of the run-up in the markets has been due to the leverage and debt that inflated asset prices. As the world de-leverages itself from this debt, it is, in a very real way, structurally resetting itself.

“The structure of the global financial system is changing as we speak,” he says. “Within the last 25 years, we’ve had this broad trend of a rising market, increasing productivity, relatively low inflation rates, stable monetary policy rates, increased risk taking and all these things have led to uniform increases in asset prices across all asset classes. If you look at the 25 years, you view this as a hiccup; you buy on the dips — because over the last 25 years buying on the dips was a strategy that worked.”

Love says there’s a growing view that the last 25 years was an aberration in stock market performance, fueled in part by the massive amount of leverage in the markets.

“If you look at a much longer period of time, such as 80, 100 or even 200 years of financial history, you can see that the last 25 years have been the outlier,” he says. “If what we are doing is resetting, as some people are suggesting — which are some very bright business leaders — then we all need to reset our expectations. If we are resetting to a lower level, and have to re-grow from that lower level, we may have to reset our expectations for the next quarter century.”

Love emphasizes that for long-term investors this is actually a positive development. The Trimark investment discipline is focused on bottom-up selection, buying individual businesses at discounted values. The present market is offering historical opportunities for this stock selection process, he argues.

“Different doesn’t mean worse. It just means we think a little bit differently and frame things a little bit differently,” Love says. “This isn’t something that is measured in months or quarters; it’s likely to be measured in years.”

He says the economy may have to start to improve for people to even gain a sense of confidence before they return to the market.

“Right now is the best time to buy some of the very best businesses ever created, as long as you’re not too picky about what happens in the short term,” he says. “We’ve been mostly focused on upgrading the quality of the companies in the portfolio. That means making some hard decisions, so portfolio turnover is probably higher than you’re used to seeing with the Trimark discipline. Usually we have to be very selective, because there are only a few companies at any given time that meet our portfolio selection criteria.”

He adds, “Nobody knows when things are going to improve. The good news is that if you’re a buyer of good businesses and you’re not doing any sort of tactical or strategic allocation between sectors, you can make money. Given the abundance of opportunities across all sectors, we’re actually able to cherry-pick the best businesses wherever we find them across different industries.”

A thesis being thrown out by the pessimistic is that another Great Depression is imminent; a doomsday scenario for stock investing that would make buying now a very bad idea.

Rob Mikalachki, vice-president and portfolio manager for Trimark’s small cap mandates, such as the Trimark Canadian Small Companies Fund, says that if an advisor can take the emotion out of what’s happening, most clients will realize circumstances are nowhere near where they were during the Great Depression.

Unemployment during the Depression was 25%; today it’s 7.2% and rising, but there are no indicators to suggest one in four adult Canadians is going to be officially unemployed. It should be noted that data for employment statistics gathering has changed in the last 70 years.

Other indicators do not suggest anything resembling the 1930s. For example, GDP fell 30% during the Depression, while the Bank of Canada is calling for a decline of a little more than 1% next year. Mikalachki also notes there were more than 9,000 bank failures globally in the Depression; in the current crisis, that tally stands at 23. Also, Depression-era depositors did not have deposit insurance we have today.

Mikalachki says, “2008 was the second-worst year on record in 183 years. When the market bottomed last November, on a ten-year basis, this was the worst market we have ever endured in almost 200 years of recorded years. The market was given a decent punch and we’ve absorbed it.”

Mikalachki places much of the culture of fear surrounding the markets squarely at the feet of financial pundits who have been trying to outdo each other with predictions of financial devastation.

“These economists, these prognosticators, are showmen, in a sense. That’s how they earn their income. They are not going to earn an income by being the guy that says what everyone else is saying. It’s very easy to take a single data point and look at it out of context to support some of the crazy arguments out there.”

(01/26/09)