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Should investors take action?
Status quo a viable strategy

Now that the world has had a chance to digest last week's horrific attack on New York and Washington, many have read opinions on the economic/financial impact of the attacks. While many have expressed concern over the impact of their portfolios, not everybody is taking action by making changes to their portfolios. Others are ready to take action to protect what they've got, but are unsure of how to set up their portfolio's defence strategy. I hope what follows provides a bit of insight.

Reasoning behind market volatility

Stock markets and uncertainty are like oil and water - they don't mix. Picture yourself driving down a road. All of a sudden, a dense fog appears preventing you from seeing beyond your own hood. What do you do? In all likelihood, you would probably slow down substantially or even come to a complete stop since you can't see what lies in the road ahead. That's exactly what's happening in stock markets all over the globe. Applying the breaks to your car is analogous to selling pressure on the stock market. Investors are opting to "pull over" until the future gets a little clearer.

The most significant factor right now is the lack of clarity on exactly who will be involved in the U.S. military strike. It seems fairly obvious that Afghanistan and Iraq may be included, but we just know what other nations will be involved. The markets must first know the parties involved in this "war on terrorism" before it can even guess at what the future holds.

As I write this, it's also evident that U.S. markets are extraordinarily volatile today, September 21, 2001. Aside from the uncertainty facing the market, many futures and option contracts are expiring today, putting even more "uncertain money" into this nutty market.

Defence tactics

For those already holding a portfolio of investments, there are a couple of moves that may bring some much-needed stability. The safest way to go is to simply hold more cash. For mutual fund investors, that means having a higher than normal weighting in money market funds. Money market funds, GICs, and other similar instruments will shelter investors from market volatility.

A class of assets known as "hard assets" has historically been a good hedge and diversifier against traditional equity and bond investments. Hard assets include things like real estate, gold, energy, and other natural resources and precious metals. However, gold appears to be the best spot among hard assets at this time. Real estate is getting beat up since some fear other skyscrapers may be targets of future terrorist attacks. Non-energy natural resources are suffering from delayed air travel time and clogged border crossings. Slower travel will hamper exports - something upon which the Canadian natural resource industry depends. Energy may be a decent move but its prospects are uncertain. While conflict with middle-east nations typically pushes up oil prices there are two forces working against that typical behaviour. First, a slow economy equates to a likely fall in demand for oil. Second, OPEC has vowed to do everything in its power to (raise production and) prevent an oil shortage. Those two factors likely point to relatively flat oil prices. That leaves gold and other precious metals.

Investors can buy actual gold bars, but you can't put that in your RRSP. In the world of mutual funds, there are many choices. My top picks, in no particular order, are Mackenzie Universal Precious Metals, Royal Precious Metals,and TD Precious Metals. For those thrifty investors who are comfortable buying stocks and prefer a more passive approach (i.e. indexing), Barclays offers an exchange-traded fund called iGold, which trades on the Toronto Stock Exchange under the symbol XGD and tracks the S&P/TSE Gold and Silver Index.

No matter what your method of defence, don't go overboard. I think moving some money into defensive assets is a reasonable move, but keep it within limits. For instance, in a memo to Sterling Mutuals Inc.'s financial advisors, I recommended that no more than 10 per cent or so of portfolios be put in money market funds. I also recommended that no more than 20 to 25 per cent of one's stock exposure be put into gold and other hard assets.

New money

As mentioned in last week's column, those investing new money may do themselves a favour by averaging in over a period of twelve to twenty-four months, and speeding up that pace as opportunities arise. For more aggressive investors, investing up to 20 per cent of the new money is a good starting point in an attempt to be opportunistic with a small chunk without taking huge risks.

Do nothing

What some may define as lazy, I say is a viable strategy. Investors who make absolutely no changes to their investment portfolios as a result of what I think will be a short-term crisis, should be just fine as time passes. Trying to time a market that can't decide what's going to happen is like "flooring it" in the middle of that dense fog. Think about it. One day, energy is up, and then the next it's down. One day insurance companies are down sharply, and then they rebound the next day. Decisive action should only be taken when information is more certain. Currently, there simply is no certain information, so sitting tight is a good move.

Putting my money where my mouth is

I don't have clients. Well, that's not entirely true. I manage accounts for my family and a few friends. I have not made any changes to any of my own accounts or those of any family members since the attacks occurred last Tuesday. Part of my personal portfolio was invested in a gold fund, but that was prior to the terrorist attacks. So, I'm definitely taking my own medicine.

Crisis equals opportunity

While North America has never quite experienced anything quite like the 9-11 terrorist attack, it's quite evident that we have been through very long and difficult crises in the past. In the end, we emerge stronger - both on a personal and business level. Uncertainty tends to make people overreact to situations and the stock market is no exception. Once the U.S. military strike begins, we'll know who is involved and have better clarity on the situation. While all indications are that this battle won't be quick, greater clarity should have somewhat of a calming effect on financial markets.

Money managers and economists who have commented during this past week agree. Since this attack has sped up the recession many thought was inevitable, it's also expected that the recovery will be more robust than original estimates. Staying calm and patient should eventually bring with it rewards that typically follow world crises.

Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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