INTERVIEW

Where did you grow up in Canada?

Toronto.

How did you first get interested in the markets?

I first got interested in the markets when I was 13 years old. I’m Jewish and I had a bar mitzvah. Two uncles of mine gave me shares for my bar mitzvah present.

What were those shares?

One of them was a company called Columbia Cellulose, which was in B.C. It eventually got bought, many years later after many ups and downs, by a company with the acronym of BCRIC. Eventually I made money. The other company was called Wellington Financial, which was owned and run by a guy named Sinclair Stevens. Sinclair was a self-made financial whiz kid on Bay Street at the time, having built an investment empire allegedly worth $130 million. Anyway, the company had tons of controversy; it went bust.

You hung on to both?

I tendered the one to BCRIC, and the other one I hung on to until it went bust.

What early lessons did you learn from that bust experience?

Well, they’re not the first stocks I ever bought for myself. The first stock I ever bought for myself was in high school — Crush International. Crush, as I’m sure you know, is a soft drink. Orange Crush. I sold it at the all-time high it ever had [laughs].

This was the seventies?

I’m an old guy, so I was in high school. I graduated in ’70 so it was probably in the late sixties.

Why did you invest in Crush International?

I was a consumer [laughs], and I liked the product. It caught my attention.

Since then they’ve been gobbled up by Dr Pepper.

Well, Jimmy Pattison bought it, and then he sold it to Procter and Gamble. P&G sold it to Cadbury Schweppes, and then I think they spun it off within the Dr Pepper Snapple Group.

Would you buy into a soda pop company today?

[Laughs] I no longer drink soft drinks, but we own PepsiCo. However, we own it more for the snack food business than the beverage business.

There’s some talk that PepsiCo will spin off parts of its business.

It’s possible. There’s arguments on both sides.

You obtained your BA from York University. Were you investing on the side?

I did. In Yorkdale Mall there used to be a brokerage firm, Dougherty Roadhouse, that had an office on the outside of the mall, facing the 401 highway. I dealt there for a while. And then I switched to Richardson Securities on Adelaide, and dealt with a broker there by the name of Peter Oliver. Peter Oliver is the Oliver and Bonacini Oliver. He was a retail broker then. He partnered with a guy named Morris Keston and they set up their commodities brokerage firm. You see, Morris was a meteorologist. They figured that they would be able to trade agricultural commodities based on weather forecasts.

Did that work out for Oliver?

He’s in the restaurant business now [laughs].

[Laughs] Good story. Did you trade commodities?

I never traded commodities, but I became a licenced commodity broker.

There was a commodities boom in that period.

Yeah. Because there was inflation. Commodities do well in an inflationary environment.

Where did you land after York University?

After York I got my first job and that was as a retail broker.

Merrill Lynch?

Yes. My father happened to be talking to a cousin of mine, David Stalberg, who was a retail broker for Merrill Lynch in Detroit. He was at the time their biggest producing retail broker.

And you got the job?

David said, “Have him meet me; I can get him a job at Merrill Lynch.” I drove down to Detroit and talked with him, and next thing I know I get a call from Merrill Lynch in Canada — back then it was called Merrill Lynch Royal Securities. They had bought Royal Securities. I was brought in for an interview and they offered me more than the other guys did to become a retail broker. I took political science and psychology in school. But I took the Canadian securities course while I was in university.

How was your experience at Merrill Lynch?

One, it was a true branch plant. The president was an American and it was all directed from the U.S. Two, I was 21 years old, and didn’t know anybody or anything. Third, I got my licence in October of ’73 just as the Six-Day War finished in Israel and the Arab oil embargo raged on. The markets only went down every day. A big day of volume in Toronto was half a million shares. A big day in New York was five million shares. There were no options markets that you could trade in Canada. Interest rates kept going up the whole time. And here I am, a kid, not knowing anybody or anything. It was impossible to do business.

Volatile environment.

Every day, I would ask myself, “Why call this client today when tomorrow it’s going to be cheaper?”

You must have felt conflicted.

Yes. But the bottom line was, it was a disaster for me. I was not meant to be a retail broker. And I wasn’t meant to be one in that situation. At Merrill Lynch they send you down to New York for a few months for their training program. They had a whole school there, they probably still do, where they teach you about markets and you have to pass various tests. But more time is spent on teaching you how to sell, which I learned was the case again when I worked at Nesbitt Burns. Brokers are salesmen. They’re not investors. People think they are; they are not. They are salesmen that just happen to luck out and be in the investment business, which pays more than any other business. They could have been car salesmen, or shoe salesmen, or whatever. They happen to be in that business, though.

Did you eventually quit?

So I started with Merrill Lynch in May of ’73 and in November I got my licence. The following August I was walked into the boss’s office and he said, “You’re not generating enough commissions, we can’t carry you anymore.” At the time, this was the end of the world.

You were young and full of optimism.

I was 22.

How did that shape you, and how quickly did you bounce back?

Well, I didn’t know what I wanted to do and so I went on various interviews, but in the end I decided I should get an MBA. However, I discovered it was too late to get into Canadian universities in September because I hadn’t written the GMAT and it was too late to write it. So I chose Syracuse University in the U.S., which, until I got there in January of ’75, I had no idea that it was in the snow belt [laughs].

You were hoping to escape the Canadian winters?

Right. So I got my MBA there. I started looking for a job from Syracuse. I wasn’t interested in staying in the U.S., and they weren’t recruiting Canadians. And no Canadian companies were going to Syracuse to recruit.

You were caught in the middle.

Yes, so I would send out letters and come home on weekends for a few days or on spring break or whatever it was and do interviews. One of the interviews I went to was in Oakville at Ford Canada. I had an interview with the VP of finance there, a fellow by the name of Hymie Schwartz, which is interesting on its own because, in my opinion, Henry Ford was a huge anti-Semite.

Did you get the job?

I show up at the interview, and Hymie’s got his feet up on his desk and he’s reading Barron’s. He puts it down, and he says, “I see you used to be in the investment business.” I go, “Yeah.” He responds, “It’s in your blood, that’s not going to change, you don’t want a job here, let’s go have lunch” [laughs]. And he was right.

Straight-up guy. He knew your passion was in the investment business.

Right. But retail brokerage wasn’t it. I didn’t know the world of finance and investing then. So I started sending out resumés to financial firms. And I ended up getting hired by Crown Life Insurance, which no longer exists in that form. It got bought eventually by Canada Life, which then got bought by London Life, which then got bought by Great-West Life. Anyway, I got hired in May of ’76 in the investment department at Crown Life. The fellow who hired me was a fellow by the name of J.J. Woolverton, who’s an officer at Guardian Capital now. He still hasn’t retired yet. He hired me because of Syracuse. “I’m an American from upstate New York, and I went to Syracuse, too.” That was a research job in their investment department covering Canadian and U.S. stocks. So that was my first job on the buy side: my first real investment job.

You loathed the sales side. So you must have been very happy to get that new job.

And I really want you to talk about that in your book because most investors don’t understand that. Investment counsellors have a fiduciary duty. Brokers do not. We have to put clients into what’s best for them. Brokers only have to put them into what’s called “suitable” investments for them. Not best for them, but best for the broker. And brokers are no longer given much training in selecting individual securities. The huge push is to put clients into fee-based accounts and let somebody else manage it. They are salesmen, collectors of assets. Most people do not understand that. I told you, brokers are salesmen who happen to be in the investment business. Investment counsellors, such as us, are investors who’d rather not have to go out and sell and meet with clients and all that. But we have to eat.

Which stocks did you cover at Crown Life?

I covered the Hudson’s Bay Company. It was an independent company at the time. It was one of the stocks I had recommended and that we eventually bought and owned. There ended up being a takeover battle for it between the Weston family and the Thomson family.

Did you foresee its takeover potential before recommending the Bay?

Oh hell no. We bought it just because we liked the fundamentals. There was no such thing back then as the internet or cross-border shopping or any of that stuff.

How did you research companies at that time?

It used to be really different back then. It was much more difficult. You had to pore through books and annual reports. You had to do real reports [laughs]. Now, you can fake it out there. The Financial Post used to put out a book on common stocks. They still do it on bonds and preferred shares, though.

Which criteria did you use to analyze the Bay’s fundamentals?

I can’t recall. The interesting thing is that there ended up being a takeover fight for it, and in the end the Thomson family won. We thought that was a big win until my big boss John Burton, who was the treasurer of the company, took credit at the board level. That just pissed me off.

Rightfully so; it was your recommendation.

Yeah. So that was one interesting thing that went on there. Another interesting thing was that I had my first brush with the Securities and Exchange Commission back then. One of the stocks we owned was a company called Babcock and Wilcox, which made boilers for buildings, among other things. There ended up being a takeover battle for that company, too, between United Technologies and a company called J. Ray McDermott.

Who won that takeover battle?

At the time, United Technologies was run by this guy, Harry Gray, who had a big personality. The other company, J. Ray McDermott, was based in New Orleans, and was more an oil service type company. At one time Harry Gray called me to try to get us to tender our shares to them, which I thought was pretty neat. At around the same time, the management of J. Ray McDermott came up to Toronto and had a meeting at what’s now the Hilton. It used to be called the Hotel Toronto back then. In that meeting, the president of J. Ray McDermott said stuff about the takeover that was pretty confidential. He shouldn’t have disclosed any of it. One day later we got a phone call from the SEC wanting to find out what exactly the president of J. Ray McDermott disclosed in that meeting. We weren’t guilty of anything, though. I was just there, but of course had to get the company’s lawyers involved. It was scary — I was a kid. But that was my first and only brush with the SEC.

And the winner?

In the end, J. Ray McDermott bought Babcock and Wilcox.

Where did you go after Crown Life?

Canada Trust. Running money at Canada Trust was a combination of Canada Trust money, pension fund money, estates, and trusts. It was a big bureaucracy. Every stock you bought had to be on an approved list. If you wanted to get in on the approved list there was red tape to do so. You could never be timely on something new.

That’s unfortunate.

Yeah. And back then they would not allow us to own anything on NASDAQ. It was viewed as being too risky.

What was the market like in this point of history?

In the summer of ’82, Henry Kaufman, who was the chief economist at Solomon Brothers at the time, made a pronouncement that interest rates had peaked and were coming down. Subsequently, the stock market took off, interest rates came down, and that was the beginning of a big bull market.

What was the actual sentiment back then, though? I recall the famous Businessweek article —

“Equities Are Dead.” Or “The Death of Equities.”

Exactly. So was that the common sentiment?

Business Week is known for having, or was known at the time for having, front-page headlines that were entirely poorly timed.

Do you invest against the crowd, against common sentiment?

We are, being value investors, somewhat contrarian. So, yes, we do that.

How long was the bull market that started in 1982?

It went straight up until ’87. That’s when we had the crash. But then it went straight up again until the tech boom and then the tech bust in 2000.

You must have naturally benefited from that bull market.

I was managing a small-cap pool pension fund. Pension funds would buy units in that fund. And the first year I ran it, it was the number one pension fund in Canada, performance-wise. I loved it. Small-cap stocks were a lot of fun to invest in.

Why small-caps?

In the Canadian market, they had been ignored, and there were great values in that space.

What were the multiples?

They were tiny. When I first got in the business, multiples were single-digit. Because interest rates were so high and there was this thing called the Rule of Nineteen or the Rule of Twenty. Inflation plus P/E multiples used to have to equal 20, or 19, whatever it was. Wall Street has this stuff all the time. It’s way too simplistic but they fawn over it. So multiples were really low back then.

If you were investing in the ignored small-caps space, what were others investing in?

Everyone else was investing in large-caps.

What is your investing process?

Well, remember, back then we didn’t have the internet, so I had to read a lot. You would read lots of brokerage reports, newspapers, and magazines to get your ideas. You’d have to meet with management. In small-cap stocks, meeting management is absolutely critical.

Is meeting management still critical today?

Even today it’s critical.

Philip Fisher referred to that as “scuttlebutt.”

Yes, in smaller companies, meeting management is critical. Especially entrepreneurial companies. And I learned to do facility tours, too. Go and see their physical plants. Because I had more than one instance where there was nothing there. It was a façade. Or, there was one company called Lumonics based up near Ottawa that had a huge multiple because it was a laser company. Anyway, I went up there to see them and some other companies for plant tours. Lumonics turned out to be a machine tool company that happened to use lasers in what they did. I couldn’t sell that stock fast enough.

Was it easier to get an edge in the markets back then because information wasn’t as readily available to the masses as it is today?

You had to find this stuff on your own. That’s why going to see companies, talking to people, was much more important.

What do you think about the Efficient Market Theory?

That’s what they teach you in school, but it’s crap. The market is hugely inefficient.

How so?

If the markets were efficient, you wouldn’t have the volatility. At all. There’s emotions. I can’t remember names of books, but I read many books on human behaviour and investing. It’s so critical to understand how people think when they invest. They’re not efficient at all.

How did you react during the mass crash in ’87?

In ’87, I was at an investment counselling firm called E.J. McConnell and Associates. In October of ’87, on the day of the crash, I was in Montreal visiting one of our clients, a printers’ union. I had lunch planned with one of the analysts, Marty Kaufman, who was the retail analyst at Nesbitt Thomson in Montreal. I met with the union but it was a very difficult meeting because you’re aware that things were not okay. After that visit, I went across to Nesbitt Thomson’s offices, and we watched the tape. We just had our jaws drop watching the tape. That’s where I was that day, in Nesbitt Thomson’s boardroom, watching that.

Did you exit positions the next day?

I went back to the office the next day, or that night, and obviously we had a meeting as to what’s going on. One of the guys in our office said, “We have to sell everything we own because they’re going to ratchet this market down.” Thank goodness we didn’t listen to him.

You would have realized all those losses if you’d listened to him.

Yes. So we didn’t do that.

Was it a buying opportunity then?

It was a huge buying opportunity. But we didn’t realize yet at the time that it was a huge buying opportunity. Unfortunately, the CEO panicked. We were specialists in Canadian and U.S. small- and mid-cap stocks. What happens when there’s a major crash in the markets is that the interest in small- and mid-caps goes away. Anyway, the CEO panicked and said, “We have to shift our focus to large-caps, because small- and mid-caps are going nowhere when the recovery comes, but large-cap stocks will go somewhere.” He was worried about not picking up performance. That was a huge mistake that ultimately ended up hurting the business a lot.

That’s unfortunate. The small- and mid-cap stocks resumed their marvellous run. Do you invest in small-caps today?

No. That’s not what our clients hire us for. We are for the most part mid- and large-caps. We do have some small-caps, but for the most part, no.

Small-caps can be extremely volatile. On the topic of volatility, you recently stated that the commodity super cycle has come to an end.

Yeah.

Why is that your conviction?

Commodity markets move in decade and even multi-decade cycles. Recently, there was a huge cycle that ended, but we’re only about four years into commodities being out of favour. To me, it’s far too early to buy into commodities again now. Nothing goes straight up and straight down in the market. You get these rallies and people get sucked into them. I would rather lose some opportunity on the way up than lose capital on the way down. So I would rather see commodities stop going down, probably tread water for a long time, or even form a V, and then buy them when they’re starting to go up again. Also, commodity stocks are not value stocks. And they never will be.

They’re not value stocks? Is that because their business is dictated by market prices?

Yeah. They are actually stocks that you would buy on momentum and off the charts as opposed to buy based on value. So they can be great value today, which will show up in 10 years, but I don’t care. I’ve got lots of time to go back to them.

What is the makeup of the equities that you actually buy?

We’re global in what we buy. We’re value investors, and we tend to be contrarians. You know, this is not always, but we look to buy things that are out of favour that have good balance sheets. But, for whatever reason, they also happen to be out of favour because of some bad headlines, a temporary bad quarter or two, and so on.

Can you elaborate? What are your other criteria?

If it has lots of debt, we’re not interested. We want good balance sheets. We want to be confident in management. We don’t buy industries, and we don’t buy countries; we buy stocks. And we look all over the world for them.

Where do you see the most value now?

The most value now is not in North America. The U.S. market’s at an all-time high because of free money. Valuations are quite stretched. We hold U.S. stocks, but we can’t find any new ones to buy now. Recently, we doubled our position in U.S. banks because we found that the financial sector is the only area that we find attractive in the U.S. right now.

I would imagine that the eventual increase in rates will boost revenues at U.S. banks. When U.S. market valuations are stretched, where in the world do you invest?

So in Canada, because our market at any given time is 70% to 75% resources, financials, and materials, it’s hard to buy in Canada when resources are out of favour, especially when you find other countries’ financials more attractive than yours. Canadian financials, especially the banks, were the best part to be in for like 10 years. But we don’t think they are anymore. We only own one. We own one Canadian bank and we own two non-banks.

Which Canadian Bank?

We own Scotiabank, because it has the smallest footprint in Canada. Most of its assets relative to the other banks are outside of Canada in Central and South America and in Asia.

With Euro QE [quantitative easing] happening for the next three-plus years, are you allocating money into European stocks?

We were early buying in Europe. And we’re still in Europe. The markets are attractive there but the currency’s been killing your European investments. Especially if you look at it through U.S. dollars. In Canadian dollars not as much though because we’ve gone down, but the euro’s gone down more. But you have to look at currencies as well here. Japan was a great market to be in as long as you didn’t have to translate it back to dollars. As soon as you did, all the gains were gone. One of the areas we’re actually looking at right now is Swiss companies. We already own one or two Swiss companies, but we’re looking at another one. Its currency’s been doing better. We’ve got some Asian assets, too. We’re not there yet, but we think that soon will be a time to start looking in Latin America. We go where people don’t want to go. And being value investors means, by definition, you’re going to be early. And you’re going to be wrong for a while. Sometimes longer than you think.

When did you enter into the European markets?

We went into Europe when nobody wanted Europe. When Europe was falling apart and the first time Greece was speculated to leave. We went in there, and we bought multinational companies based in northern Europe. The problems were in southern Europe. Most of the northern European multinational companies assets are outside of Europe. But the market didn’t differentiate that. “You’re in Europe, eh? I don’t want you.” We made a lot of money doing that.

Great foresight. I assume you’ll hold on to those European stocks.

Yeah, we’re not looking at selling any of our European stocks right now.

Russia seems to be going through the same turmoil as Europe was in 2011. Would you invest there now?

We never invested directly in Russia. But in the past we’ve invested in companies that have large Russian holdings. PepsiCo has a big Russian holding. Carlsberg, which we don’t hold anymore, had its biggest market in Russia due to an acquisition they made there. So, no, we’ve never invested directly in Russia. Also, we’ve never invested directly in China, or in India, but that’s subject to change in the future. Basically, their security markets are not mature and do not have the safety standards of markets we like to invest in. If I go buy Chinese companies, we’ll buy ones that are listed in Hong Kong.

You’re worried about the lack of market checks and controls.

Right. Whereas Hong Kong is a legitimate, well-governed market. Corporate governance is very important.

From what I’ve heard, it sounds like you first identify undervalued markets in the world and then second, invest in those securities, either directly or indirectly.

No. We look at companies. We never buy countries. We’ve never woken up one morning and said we’ve got to buy Germany or we’ve got to buy China or whatever. We buy companies.

So you’re a bottom-up, fundamental investor. Can you walk me through your framework with an actual example?

The best call we ever made was BCE. If you remember, a number of years ago the Ontario Teachers’ Pension Fund was buying it until they weren’t anymore. The day that the Ontario Teachers’ Pension Fund announced the takeover was off, we bought BCE stock when it plummeted in the market. Our thought process was that OTP was offering to pay too much for BCE and so the value was going to come way down after the takeover inevitably fell apart. To us, BCE was great value but everybody was bailing out because the takeover was off. But nothing changed with BCE. It was the same company except now nobody was taking it over. Anyway, we bought BCE when it was in free fall and it’s been a fabulous investment for us since. The dividend keeps going up. The yield on the original investment is huge.

On the other hand, have you bought into a mispriced stock that didn’t work out?

Oh, that happens all the time. I don’t know if the other guys have told you, but if you’re a genius in our business, you’re right 60% of the time. So you’re wrong 40% if you’re extraordinary.

That’s why it’s important to have a diversified portfolio.

You got it. That’s why you’ve got to have a diversified portfolio. Because you’re going to be wrong a lot.

How many stocks should one own in their portfolio to be diversified?

Institutions usually own 40 to 45 stocks. When I worked for Ted McConnell we owned 30 stocks. For retail investors, I would suggest around 20 stocks. And they should be diversified. Too many people don’t diversify. Investors out in Alberta only want to own energy stocks. I would have big fights with them over that, because their portfolios weren’t diversified.

It seems that you don’t buy cyclical stocks at all then.

Yeah. There’s lots of people that I run into that only own Canadian banks. And their idea of diversification is owning five or six of them. That’s their diversification. I would say, “You’re not diversifying at all,” then they would say, “But they’ve been so great.” Yeah, but one day maybe they won’t be. Look at the U.S. banks and what happened to them in ’07 and ’08; nobody thought that would happen until it did.

Citigroup, a “blue-chip” stock, got clobbered.

Oh, yes. Citi has done a one for ten consolidation. It’s just a $10 stock.

Would you buy into Citigroup now?

No, no, it’s a different company than it was then, with different management. We don’t own any “money-centre banks.” We only own regional banks right now.

What are the biggest holdings in your portfolio? Are there commonalities across the stocks?

Our biggest holdings tend to happen because either you’ve bought a whole lot of it compared to other stuff, or it’s gone up a whole lot.

Do you add on to your winners, though?

Sometimes. We recently did that in two U.S. bank stocks. We doubled our positions. But our biggest position is a company that most of your readers won’t know. It’s a big successful Canadian multinational company called CCL Industries.

I’m kicking myself for not investing in that company.

It is a 10-bagger for us.

Why did you buy into CCL Industries? How did you have the conviction back then?

It was a value stock. The dividend would grow regularly. It had good management and a good balance sheet, and it was restructuring itself. It started off as a maker of private label goods. CCL was Connecticut Chemicals, or something like that, and they would make aerosol products for companies and stick their names on it.

It was a sleepy stock though. There wasn’t much movement in its price.

Yeah, sleepy stock. But then they got more into the label business and that’s when they started to grow.

That was a catalyst for growth. If you buy into value stocks, do you want there to be a catalyst?

Yes. If you own a value stock that doesn’t have a catalyst, it might go down and out. There’s a thing called the value trap. If there is no catalyst to change the company, it’s always going to be a value stock, and that’s the trap. People get sucked in to that all the time, saying, “Well, the stock is cheap.” That’s not a good reason to buy it. What’s going to change it from being cheap is the question, not is it cheap?

Is it from your experience that you understand what the catalysts are across different industries and businesses?

Well, you look for it and sometimes you’re wrong. As I said, you’re wrong 40% of the time if you’re really good. But you try to identify a catalyst. So the catalyst here was that CCL Industries went into growth mode. They identified that the pressure-sensitive-label business was that growth product.

What about buying stocks after they’ve had a run-up? Will you pay more for great companies?

We have. But we won’t pay too high a multiple.

When have you broken that rule, though? Paid a much higher multiple for a stock?

I don’t think we own anything currently where we’ve broken that rule. No, these are all companies we’ve identified as really good value at reasonable prices.

So back to the value equation: how do you determine whether a stock has a margin of safety?

That’s a difficult thing to answer, and there’s not just one answer for it. But you’re trying to say you’re buying this stock that people aren’t paying a lot for, so if something goes wrong it’s not going to get hurt a lot because nobody’s bid it up. When somebody’s bid a stock to what we call “priced to perfection,” nothing stays with perfect forever. The bigger you are, the harder you fall. That’s what happens. If you buy something that’s already down and out, yeah, you may get hit a bit temporarily, but then it usually just comes back, unless it’s a value trap, of course.

How important is risk management?

We may be in the investment business, but we’re really in the trust business. Our clients trust us to protect their capital. Earning money is really nice and a lot of people are fixated on return, but smart investors are more interested in protecting their capital, and then a return on that.

So what annual rates of return do you target?

We don’t have any target whatsoever. You can’t have a target; a lot of people get hurt by targets. If somebody asked me, “What are you going to return for me this year or next year or the next five years?” I’ll respond, “I haven’t got a clue.”

Historically, what has been your biggest blow-out year?

The biggest blow-out year was when I was managing money at Nesbitt Burns. It was probably in ’99, when my portfolio was up 48%.

What were the contributing factors to that 48% return?

I had some technology stocks, but the portfolio wasn’t full of technology stocks. I was a value investor, actually. Back then I was more of a GARP investor — growth at a reasonable price. Small difference to value, but there is a difference. I still remember, in the early part of 2000, brokers calling me up, “Oh you had such a phenomenal year last year, I’m putting my clients into your fund.” But I was saying, “That was last year. Don’t expect that again.” Some people don’t understand the market — they chase performance. You shouldn’t do that. If you’re an investor, and you’re paying 48% more than you would have a year ago, how stupid is that?

Human nature — chase the hot trend. Did you foresee that that bubble was going to pop? What was the sentiment like in 1999?

Things were crazy. Back then I used to short stocks in my own portfolio. I don’t do it anymore. I made some good money doing that, and I lost some good money doing that.

Which stocks did you short?

A couple that really taught me my lesson back then. One was a semi-conductor stock, and I can’t remember the name, but it was trying to be a competitor to Intel in the microprocessor market. I thought that was crazy. I think I shorted it at about 20 bucks, and then it went up to 80 bucks, before coming back and eventually going to zero.

The market can be highly irrational in the short term.

It just went crazy. And if you shorted stock you would need to put up more money to cover that position that’s going up. A lot of times, you’d just throw up your hands and give up. I don’t short stocks anymore, but it taught me that just because something is overvalued doesn’t mean it’s going to soon drop. If you want to short stocks, wait until they’re going down. Follow the trend going down.

Did you ever trade options?

I would dabble with options when I worked at Canada Trust; they had me writing options against the company’s portfolio, just to gain extra income. I don’t do that anymore either.

Do you think that rates will go up anytime soon?

Maybe, because everybody’s been wrong up to now.

What actions does an investor need to take once the U.S. Fed raises interest rates now or any time in the future?

Well, there’s a saying: “Never fight the Fed.” And generally that’s true. If the Fed says that they want to send interest rates down and keep them down, don’t bet against them. The opposite is also true.

How do interest rates affect the stock market?

Interest rates have been declining since 1982. Therefore, most people only know a declining interest rate environment. They have no idea what happens when interest rates go up. When I first got in the business, interest rates only went up. And that was accompanied by high inflation, too, which we don’t have anymore. Now they’re worried about deflation. In a high interest rate environment, P/E multiples get compressed and lots of people put money into fixed income because they can earn x% and not have to worry about it. When interest rates are close to zero, as they are now, fixed income becomes very unattractive. We have our lowest allocation to fixed income that we’ve ever had here, because it’s so unattractive. So what that’s done is driven all kinds of money into the stock market. Because people are searching for returns, and searching for yield. So that’s why we believe the U.S. stock market is so overvalued because all that money is going in there searching for yield and searching for returns because they can’t get it in fixed income. Once interest rates start going up, money starts to leave the stock market and heads into fixed income.

What areas should you be investing in the stock market when rates go up? Or should you just pull out completely?

You want to own financials, because they benefit when interest rates go up. You want to own companies that have real growth. You get hurt in companies that people have only bought to get the income. So utilities, for example, will suffer, because money will start going out of them into actual fixed-income products.

That makes sense. Any more advice, Norman, before we wrap up?

Don’t fall in love with what you own. Most investors fall in love with what they own. It’s a stock. It doesn’t know you own it. It doesn’t care that you own it. Don’t be afraid to sell something because of the capital gains tax. You’re in the business of making money. Paying taxes along the way is part of the game. Many times there’ve been instances where investors didn’t want to sell something because of the capital gains tax, and a great example of that was BCE back in 2000. I was working at Nesbitt Burns at the time, and telling the brokers, “You should get your clients to sell BCE because it’s pregnant with Nortel.” Back then, the value of Nortel was more than the telephone company, BCE. “How could I sell that? Look at the capital gains we’re going to have to pay.” Well, in the end, there were no capital gains. And every one of those clients today would tell you, “I would have gladly paid the capital gain.” So don’t fall in love with stocks. Be prepared to change your mind.

The best sale I ever made was in Philip Morris, the tobacco company. I was working at E.J. McConnell at the time, and we had bought a position in Philip Morris. Two days after we bought it, we got a visit from an analyst who was the tobacco analyst at a company that doesn’t exist anymore called Kidder, Peabody and Company. He came in and his story was that the tobacco business was about to go through a dramatic change, that generics were eating up more and more of the tobacco business and making companies like Philip Morris vulnerable. He thought something had to give, and would not own the stock. We had bought the stock two or three days earlier. The next day we met and said, “We’ve got to get out of this thing.” The next day was Marlboro Friday, as it’s called, where Philip Morris cut the price of Marlboro dramatically and Philip Morris dropped 25% almost immediately.

It’s important then to keep an open mind. You can stick to your thesis but risk losing it all.

Yeah, and the other thing to keep in mind is don’t trade. Unless it’s absolutely necessary. Buy good stuff and keep owning it as long as it’s good stuff and the company’s doing well. I’ve been here 11 years, and we hold stocks here that we had when I got here. There hasn’t been a reason to sell them. These stocks continue to do well, and, more important, the dividends continue to grow. And we have stocks that have gone up multiple times, and the yield on which you originally bought has gone up multiple times as well. It’s fabulous.

Norman Levine is an incredibly observant investor who constantly prowls the market for opportunities in areas that are overlooked by most others. For example, buying multinational companies based in northern Europe when other investors were staying away from the continent as a whole. Here is Norman’s overarching investment strategy, as summarized on the Portfolio Management website:

We are long-term stewards of capital, not traders. Thinking long-term allows us to purchase stocks for sale at value prices due to temporary issues but where we believe a reversion to prior operating levels is probable. We look for catalysts that will allow this thesis to occur and buy low before the often myopic market is able to see it. Our focus on the long-term prospects of a company allows us to put the short-term news flow into the background and focus on more meaningful long-term trends.

In addition to solid Canadian and U.S. assets we have found that non–North American exposure offers significant return and diversification opportunities. Our clients benefit from a global value orientation which increases industry diversification and provides exposure to areas of the world that have either faster growth prospects or alternatively where there is a great amount of pessimism embedded in stock prices. We have substantial and tenured expertise in international investing.

In assessing individual companies and their management, we are guided by four key principles:

MASTER KEYS

NORMAN LEVINE

1) “If the markets were efficient, you wouldn’t have the volatility. There’s emotions. It’s so critical to understand how people think when they invest. They’re not efficient at all.”

2) “Commodity markets move in decade and even multi-decade cycles.”

3) “Nothing goes straight up and straight down in the market. You get these rallies and people get sucked into them. I would rather lose some opportunity on the way up than lose capital on the way down.”

4) “I would rather see commodities stop going down, probably tread water for a long time, or even form a V, and then buy them when they’re starting to go up again.”

5) “Commodity stocks are not value stocks. And they never will be.”

6) “We don’t buy industries, and we don’t buy countries, we buy stocks. And we look all over the world for them.”

7) “We’ve never invested directly in China, [Russia,] or in India, but that’s subject to change in the future. Basically, their security markets are not mature and do not have the safety standards of markets we like to invest in.”

8) “If you’re a genius in our business, you’re right 60% of the time. So you’re wrong 40% if you’re extraordinary. That’s why you’ve got to have a diversified portfolio. Because you’re going to be wrong a lot.”

9) “For retail investors, I would suggest around 20 stocks. And they should be diversified. Too many people don’t diversify.”

10) “We don’t own any [U.S.] ‘money-centre banks.’ We only own regional banks.”

11) “If you own a value stock that doesn’t have a catalyst, it might go down and out … It’s always going to be a value stock, and that’s the trap. People get sucked in to that all the time, saying, ‘Well, the stock is cheap.’”

12) “A lot of people are fixated on return, but smart investors are more interested in protecting their capital, and then a return on that.”

13) “You can’t have a target [price]; a lot of people get hurt by targets. If somebody asked me, ‘What are you going to return for me this year or next year or the next five years?’ I’ll respond, ‘I haven’t got a clue.’”

14) “If you want to short stocks, wait until they’re going down. Follow the trend going down.”

15) “‘Never fight the Fed.’ And generally that’s true. If the Fed says that they want to send interest rates down and keep them down, don’t bet against them. The opposite is also true.”

16) “Most people only know a declining interest rate environment. They have no idea what happens when interest rates go up. Once interest rates start going up, money starts to leave the stock market and heads into fixed income.”

17) “Don’t fall in love with what you own. Most investors fall in love with what they own. It’s a stock. It doesn’t know you own it. It doesn’t care that you own it. Don’t be afraid to sell something because of the capital gains tax.”