Regression to the mean is one of those terms that doesn’t get bandied about often enough at this time of year. The tendency of investors is to take a look at the hot funds and sectors and jump on the bandwagon, convinced that what has worked will continue to work. Perhaps, just perhaps, a lesson might have been learned as the technology sector, featuring spicy Internet plays that were so torrid heading into 2000, was pounced upon by a vast cross-section of the populace, before their funds disappeared into vapour. Not surprisingly, this arena regressed to the mean as super returns became soberingly substandard.
On the other hand, investors who hopped aboard dismal sectors like health care and tobacco hit two of the best spots to be in 2000, as these areas “progressed to the mean.”
A cynic might suggest that there is a major interrelationship here: Those who invested in techs saw their hard-earned savings wiped out, causing them to smoke more, thereby creating more demand for health care. Uhmm, sure.
So where are the stone-cold sectors today? Well, except for a brief upturn in 1999, Japan has been in the doldrums for a decade. That is a very long time. Certainly there is a distance to go before the vast, interlaced cobwebs that have enveloped their industrial base are removed, but this country is indeed getting its house in order. Combined with South Korea, a country that took it on the chin last year and is not quite so far along in its turnaround, this part of the world is starting to look enticing again.
Many questioned us when we sold off our Asian holdings in 1997 while things were booming but ultimately it proved prophetic. We still have not reinvested in this part of the globe, but our interest is piqued.
Steel is a sector that should have prospered during the boom but it was crushed by competitive pressures. With a slowdown signalled in the automotive industry, it is probably a little early to invest in this area, but we stuck with our three losers at their downtrodden prices. Currently steel comprises about 6 percent of our portfolio.
Our favourite is Stelco Inc., a firm that almost died in the early nineties when times were a lot tougher, and is once again facing a difficult road. After years of improving results, the company recorded a loss of $8 million or 7 cents a share in the most recent quarter. Management complains that shipments were down by 10 percent and prices by 4 percent largely because of dumping by manufacturers in foreign countries. The Canada Customs and Revenue Agency is currently checking this out, acting on a claim from Dofasco Inc. that Stelco is supporting.
We believe that Stelco will wallow through the bad times and recover during the next upturn. At its current moribund level of about $3.50 a share, it is cheaper than our buy-in price of $5.88, and far less than the double-digit prices where it was last year and we expect to see again.
And what has been hot that should be avoided? The US dollar, though experiencing a bit of a setback toward the end of the year, is way above previous levels. When investing in 2001, be wary of stashing too much money in US-denominated assets. In fact, those loaded with US stocks should consider diversifying out of the United States and converting some of their dollars to other locales with currencies that have been battered in recent years.
Investors with time might want to plan the trip of a lifetime. Australia and New Zealand are two countries among others that have experienced currency devaluations and are now at bargain prices. Not your typical money management advice perhaps, but we do promise a refreshing experience.
On a more straightforward note, consider avoiding investments that have been hot and therefore are likely to regress to the mean. You’ll find friends in most of the out-of-favours as they recover, and progress to the mean.