THE BURMAH FABLE TRADE

There is a very old fable about a parrot and the bird trapper in the jungles of Burmah where the trapper sets a trap, sprinkles some seeds and waits for the hapless parrots to walk right into the trap, while chanting verses taught by a kind sage; “trapper will come, set a trap, sprinkle some seeds, don’t even go near it.” Currently the stock market feels like that trap. For months we have known about high valuation in many markets like India, China and even Canadian real estate. All central bankers have spoiled us with their generosity by keeping rates near zero forcing us to buy the seeds of destruction, either chasing higher than nothing as yield or in hopes for capital gains. Oh yes, we know the verses as well as our own sage of Omaha has taught us well. Do you think we will escape the trap? Not a chance.

Curiously most investors are still smarting form the debacle of 2008-2009. Only a very small fraction of the portfolios is anywhere near the level it saw in the fall of 2007. This is true of most equity investors, be they in North America, Europe or Asia. Back then also, there were ample signs of doom ahead.

How close are we to the precipice? What kind of evidence suits your fancy? Technicals have deteriorated in the last month to a point that you have to do some serious wishful thinking to find a pointer that says markets are still trending higher in the short term. Fundamentally, Chinese tightening is being ignored, Indian Reserve Bank seems to be a non-entity and of course Greece and Spain have joined the basket of failed economies along with Ireland and even UK. Of course we hope that there will always be lenders to the trillions demanded by US government operations to feed the already obese.

Australia has been tightening for months and it is only matter of time before we too get on the rates too-lose-to-win band wagon. Sages have long taught us that rising rates are no good for you.

How have we reacted? Like always with complete lack of concern. Investor still keep looking for reports that support a bullish view recommending the current 10% lower prices as a bargain. The question is should you bite or stay clear of the trap.

Unfortunately the answer is far more complicated than either, or. If you bite, there is certainly a better than fair chance of getting hit with another wave of selling and a further 10 or even 20% drop in value. Staying clear could be a repeat of what has been happening since March of last year as the other parrots keep piling in making the seeds even more expensive, they call it buying the dip.

I have and continue to follow the now very ancient and often ignored strategy of spreading your assets into a diversified portfolio. The term asset allocation is hackneyed and in all fairness it works much less now than it did twenty years ago. The streaming parrots have fouled it up. Nonetheless it is the least of all evils if you pay close attention.

The strategy is pretty simple; you never put all your investment in the same asset class like equity or bonds, or the same sector like oil or banks, or even in the same region like Americas or China. Implementing is much more difficult though. Not because there aren’t products available for you to do this well. Au contraire, too many products like ETF’s, closed end funds, country funds and mutual funds are spread wide and thin all over the country side by the trapper.

The problem is that most of these are the same and behave the same, so how can they achieve your primary objective of diversification? Check out the response to the market corrections or crashes by each of the asset classes including gold, going right back to 1987. No, all parrots seem to behave the same way except for a few odd ones. And it is the odd ones that you need to keep an eye on. Professor Taleb calls them Black Swans. I call them cash or cash equivalent. True, having an out of money call or put (a right to buy or sell something if it drops or rises dramatically at a really cheap price) is good insurance. But like most insurance products, they expire worthless. You really need to die (or crash) before you can collect.

So, cash is the best asset class when you don’t know how wide is the trap and how long is the trapper willing to wait for you to make the mistake and buy or sell at the wrong time. Unfortunately as we know, the central bankers have made it very difficult to make any return if you want to take no risk. They too are part of the game.

So reluctantly, I take some risk. First asset class that is still likely to stay close to even if this correction deepens, is short maturity corporate bonds. These are debts issued by the likes of banks, insurance companies and even industrial corporations like General Electric. My rationale for making this a choice sector is that if a company did not collapse over the last two years like a Lehman Brothers or Bear Sterns, chances are good that they will survive a second rout of trouble. Depending upon your need and greed, you can buy shorter term bonds (under five years) for safety and longer term (going to infinity in case of perpetual preferred shares) for decent return. In either case, I feel comfortable that as long as I follow the rule of thumb of not having ANYTHING that is more than 3% of my portfolio, I will get back my capital and some.

Of course my greed (perhaps like yours) knows no limit, so like the parrot I look for better returns at higher risk. And now, the dividend paying stocks like Canadian Banks and Utilities look mighty appetizing now that they have come down form their lofty valuations just a few weeks ago. Here I like Trans Canada, Bank of Montreal and National Bank. But whatever you do, keep an ear open for the sound of the trap snapping shut.