IceCap Asset Management’s view on global investment markets.

Brass Monkeys

GREEN BAY, Wisconsin (1967) “I just took a bite out of my coffee” chattered TV Commentator Frank Gifford. Yes, it was that cold. With temperatures hovering at -44 Celsius, everyone agreed that the biggest risk wasn’t football strategy – it was staying alive strategy.

With the clock seemingly frozen with 13 seconds remaining, no time outs left and a mere 1 yard from the end zone, the Green Bay Packers had time for one last passing play to win the game. There was little risk with this play – they catch the ball and they win. If they don’t catch the ball, they simply kick a field goal to tie the game and take their chances in overtime.

– Passing the ball was the low risk play.

The only other option was to run the ball, but if they didn’t score the clock would wind down to zero and Green Bay would lose.

– Running the ball was the high risk play.

Green Bay ran the ball, scored their touch down and their coach Vince Lombardi would go on to become the most famous coach in American football history.

Green Bay fans proclaim it was ingenious to run the ball. Everyone else counters that it was dumber than dirt. So dumb and high risk that even Tom Landry, the normally reserved coach of the Dallas Cowboys said it was “a dumb call” to run the ball.

Of course, hindsight is perfect but also irrelevant – the most important point of the famous last play from the Ice Bowl is that the risk involved with running the ball, was very obvious but since it didn’t happen, it wasn’t perceived to be risky at all.

Today’s investment climate is rather chilling and the major risk is so very clear. So clear in fact – it is crystal clear. Yet, most investors, advisors and managers continue to ignore this obvious risk because since it hasn’t happened – then the risk simply doesn’t exist.

What risk? Well, let’s just say Green Bay Packers fans everywhere are holding dearly onto government bonds, high yield bonds, their local currency and their beloved bank stocks. Dallas Cowboys fans meanwhile, are investing in non-bank stocks, US Dollars and avoiding everything else – especially anything from Europe.

So, the question to ask – are you a fan of Green Bay or Dallas? Be careful, as the wrong choice carries significant risk.

Unlike the sporting world, in the investment world, it’s perfectly acceptable to change your opinion and investment strategy. In other words, don’t be afraid to switch teams and cheer for the other side. After all, on the investment field – it isn’t always about winning, sometimes it’s about not losing.

And today, not losing means passing on the investment strategies that have become socially accepted as the low risk plays in the investment world.

Very nice indeed

Hold on to your hat

Since our last writing, global markets have been anything but boring. While US stocks are currently at the same trading levels as they were in early December, the intraday, the gap-day, the daily, and the weekly volatility has been enormous. In other words, 5% market swings have suddenly become the norm.

Yet, these up and down days were not solely relegated to stock markets. Chart 1, shows a few rather unexpected market moves that caught not just a few investors off guard. The interesting point to understand is that prior to these very dramatic market moves, each of the underlying investments were perceived to have very little risk. Yet, as anyone who has met us, will confirm that we consistently tell investors that many people incorrectly perceive something as being risky only if the risk actually happens.

Think about that for a moment.

This is a key point to understand, and as we venture further into 2015 we believe many so-called low risk investments will in fact become high-risk investments. Unfortunately, this will only become obvious with hindsight.

In Canada meanwhile, the great hunt for yield has finally come crashing down. For our non-Canadian readers, understand that the worst investment idea in the Canadian stock market was to buy energy & energy related stocks to capture the 5%-8% dividend yield.

The reason for the “worst ever” label was due to the comparative-return with the risk-free rate of return. In Canada, the central bank set the risk-free rate of return at 1%.
In other words, if an investor wanted (or needed) a return greater than 1%, they had no choice but to take on investment risk.

If you wanted a 2% return, in reality you wanted a return that was 2 times bigger than the risk-free rate of return of 1%. With energy stocks offering 8% dividend yields, investors were taking on a return that was 8 times bigger than the risk-free rate of return. Clearly, there is some risk with these investments.

Now, there’s nothing wrong with this – risk is risk, and this is what makes markets. But, to say (as many investment advisors did) that these energy stocks and their 8% dividends were very low risk was clearly not true.

Prior to the crash in oil prices, investors were told that these companies were managed by smart folks, with huge cash flows and a strong economic recovery to support their really nice dividends.

In fact, investing in high dividend paying energy stocks was considered so easy, that we were recently schooled by an investor about how ignorant we were of these energy stocks, that we didn’t understand markets and all of our talk about risk was just plain wrong.

Global markets Greece

If risk happened in the forest…

Well, considering these nice dividend paying stocks recently dropped 30-50% with some cutting their dividends, most of these investors have suddenly discovered that risk does exist.

Now, prior to the epic collapse in energy markets, the investor was 100% correct, and we were 100% wrong. Yet, the only reason for being wrong was that the risk had yet to happen.

What we mean by this is that the risk was always there – it didn’t go anywhere, it just hadn’t happened – yet. And this is the case today with what we see as the biggest risk in investment markets.

As we’ve stated, written and presented numerous times in the past, Europe remains a slow-motion train wreck and recent events only confirm our perspective and sends even more icy-chills down our spines.

The risk we talk about of course, is the risk of sovereign debt defaults emanating from Europe. And based upon recent market events the world has moved ever so closer to the European debt bubble finally bursting and putting an end to this disastrous financial experiment.

Up until recently, no one thought energy prices or energy stocks could drop by 50% – yet they did. Back in 2007, practically every investment firm, every bank, every economist, every realtor and every homeowner all claimed that housing prices could never decline significantly – yet they did.

Back in 1990, no one believed the sun would ever again set in Japan – yet it did.

The point we make is that today very few people believe the Euro-zone will break-up. And even fewer people believe

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