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Why putting the investment odds in your favour is so hard

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Norman Rothery’s ranking this past weekend of the 250 largest stocks on the TSX pointed out the advantages of tilting the odds of investment success in your favour by focusing on company-specific financial measures (called factors). Mr. Rothery focused on both value factors, such as a low ratio of share price to earnings per share (the P/E ratio), and share-price momentum. As was pointed out in the article, combining value and momentum improves the chances of investment success.

Other factors that have been proven to improve long-term returns include size of the company and shareholder yield. The largest 20 per cent of companies in any stock market tend to underperform. And companies that pay healthy dividends and/or buy back their own shares are more likely to outperform.

Yes, of course there are exceptions to these general rules. In each case, this is only true on average when looking at a large sample size over time. But that is exactly how you determine probabilities.

When using factors, you are taking an outside view. Instead of looking at a particular business and forecasting its future, you are looking at a very broad range of companies and looking for connections between their financial characteristics and future increases in their stock price. Because there is a strong long-term correlation, as well as a logical causation, between certain factors and future investment returns, it is reasonable to conclude that by following this approach, you are increasing the probability of outperforming the stock market average.

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The ability to think probabilistically is crucial. This is how Warren Buffett’s partner, Charlie Munger, has graphically described its importance: “If you don’t get this elementary, but mildly unnatural, mathematics of elementary probability into your repertoire, then you go through a long life like a one-legged man in an ass-kicking contest.”

As you would expect, combining several factors has been proven to further improve returns.

Focusing purely on factor investing for both buying and selling stock has proven successful for tax-sheltered entities such as pension funds and insurance companies. If you pay taxes, however, the resulting high portfolio turnover (frequent buying and selling of stocks) would increase your average tax rate.

To avoid this, taxable investors can elect to use factors only to define which companies they will consider investing in – and not be in a rush to sell the companies they purchase. You might, by way of illustration only, say, “I will only consider buying companies that are trading at a P/E ratio of less than 20, that have a history of buybacks or dividends providing a shareholder yield of at least 2 per cent per year, have a market capitalization of less than $50-billion, and have a return on equity (ROE) of greater than 16 per cent.” Once the field has been narrowed to companies that are more likely to outperform, you can consider other characteristics, such as debt levels, historical growth in revenue and profits, and your view of the competence of management, before deciding whether to buy.

This approach will not result in outperformance every single year, but over time it has, and likely will in the future. Most importantly, in every given year, and for every given purchase, it tilts the odds in your favour.

Unfortunately, investing in this manner runs counter to human nature. People find it easier to think about a single example than about a large sample. A quote often attributed to Stalin identifies this, perhaps inadvertently: “One death is a tragedy. A million deaths is a statistic.”

Many people believe they can predict a company’s future, and often confuse anecdotes with evidence. “If we followed those rules, we would never have bought Amalgamated Consolidated Widgets, which was a winner!” Correct. But that doesn’t change the fact that following the rules would have produced a better long-term result for the portfolio. Or that buying Amalgamated Consolidated was somewhat like winning at the roulette table in Las Vegas. The odds were against you and the happy outcome was based on luck, not skill. Over time, anyone operating with the odds against them will be disappointed.

Just to hammer home how difficult thinking this way is for most people, let’s take another example from everyday life. Your friend Frank buys a lottery ticket. You point out that the purchase was a mistake because the odds were dramatically against him. He replies that either he’ll win or he won’t. And once he knows whether he won, the odds will be irrelevant. Perhaps you instinctively agree with Frank’s view. Most people see no reason why a sample size of one is not sufficient to draw a conclusion. However, if you don’t adjust your thinking about future outcomes to focus on the probable, rather than the actual, result, you will never enjoy the benefit of going through a long life with the odds in your favour.

All of us are hard-wired to think short-term. Most people who do adopt an objective approach and know rationally that the strategy will succeed over time will abandon it if it does not produce the desired result in the first year or two.

Identifying the correct evidence-based approach is important. What is harder is having the discipline to execute that approach and stick with it through hard times.

Biff Matthews is the chairman of Longview Asset Management Ltd., a Toronto-based investment management firm.

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Canada expected to buck trend of big investment banking layoffs – Reuters

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TORONTO, Jan 26 (Reuters) – Some of Canada’s top investment banks plan to maintain staffing levels to meet client expectations for the same level of coverage through the ups and downs of business cycles, head hunters and industry executives said.

U.S. investment banks, including Goldman Sachs (GS.N), began cutting over 3,000 employees on Jan. 11 citing a challenging macroeconomic environment, raising fears Canadian banks may follow suit. Like their global peers, many Canadian investment banks had staffed up during the pandemic only to see dealmaking slow last year.

At Royal Bank of Canada (RY.TO), the country’s biggest lender, for instance, headcount at its capital markets division jumped by 71% over the two years ending Oct. 31, 2022 to 6,887 employees.

But in the meantime Canadian dealmaking fell 39.7% last year to $89.7 billion. That is more than the 36% drop in global deal values to $3.8 trillion following a stellar 2021, according to data from Dealogic.

Yet, Canadian banks have not announced layoffs and some even say they may increase headcount, though dealmaking in the new year is down nearly 50% to $3.2 billion from a year ago, according to Dealogic.

“Right now there is a sense that there isn’t a need for cuts in the system,” Dominique Fortier, partner at recruitment firm Heidrick & Struggles’ Toronto office, told Reuters.

“When there was an upswing in 2021, it happened so quickly that there was no corresponding increase in hiring and so I don’t see that we’ll have the same decrease in terms of headcount coming.”

Toronto Dominion Bank (TD.TO), which last year agreed to buy New York-based boutique investment bank Cowen Inc (COWN.O), expects to continue to grow its global investment banking business as it work towards closing the deal, a spokesperson said.

Desjardins, another Canadian lender, will continue to invest in its growing capital markets division, a spokesperson said.

EXPENSIVE PROPOSITION

Bill Vlaad, a Toronto-based recruiter who specializes in the financial services sector, said that while there was some nervousness around the stability of investment banking teams, Canada is unlikely to see U.S.-level redundancies aside from the annual cull of poor performers called “maintenance layoffs.”

“The U.S. is very nimble. They will go in and out of hotspots very quickly. Canada doesn’t have that same luxury and has to stay relatively consistent in coverage,” said Vlaad.

“You have a consistent group of people working…and they don’t fluctuate all that much year to year, decade to decade.”

But another down year for dealmaking could see bonuses taking a hit.

RBC, which was ranked No. 2 in Canada M&A, equity capital markets and debt capital markets last year according to Dealogic, has no layoff plans for investment banking in Canada, a source with knowledge of the matter said.

Spokespeople for JP Morgan, which topped the M&A league table last year, Scotiabank (BNS.TO) and Canadian Imperial Bank of Commerce (CM.TO) declined to comment. BMO did not respond to requests for comment.

Headhunters and lawyers say it’s less expensive to lay off bankers in the United States compared to Canada.

Howard Levitt, senior partner at employment law firm Levitt Sheikh, said Canadian investment banking employees would be entitled to somewhere between four and 27 months severance with full remuneration depending on their status, re-employability, age and length of service.

Reporting by Maiya Keidan
Editing by Denny Thomas and Deepa Babington

Our Standards: The Thomson Reuters Trust Principles.

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Weaker Orders, Investment Underscore Ailing US Manufacturing – BNN Bloomberg

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(Bloomberg) — US manufacturing showed more signs this week of succumbing to the Federal Reserve’s aggressive interest-rate hikes that are taking a bigger bite out of demand and risk upending the economic expansion.

The government’s first estimate of gross domestic product for the fourth quarter and a report on December factory orders for durable goods pointed to sizable downshifts in both spending on business equipment and bookings for core capital goods.

The durable goods report Thursday showed orders for nondefense capital goods excluding aircraft — a proxy for business investment — dropped 0.2% in December after no change a month earlier. Over the fourth quarter, bookings for these core capital goods posted the weakest annualized gain since 2020. Shipments, an input for GDP, decreased for the third time in four months.

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“Taken in tandem with the output data where industrial production has declined in six of the past eight months, it is increasingly evident that the manufacturing recession is well underway,” Wells Fargo & Co. economists Tim Quinlan and Shannon Seery said in a note to clients.

Also on Thursday, the GDP report showed outlays for business equipment dropped an annualized 3.7%, the largest slide since the immediate aftermath of the pandemic. That decline was part of a broader demand slowdown, which included a smaller-than-forecast advance in personal spending.

While GDP growth beat expectations, details of the report that offer a clearer picture of domestic demand were decidedly weak. Inflation-adjusted final sales to private domestic purchasers, which strip out inventories and net exports while excluding government spending, rose at a paltry 0.2% rate — also the weakest since the second quarter of 2020.

Last month’s retreat in core capital goods orders indicates manufacturing output, which already registered sharp declines in the final two months of 2022, may struggle to gain traction this quarter.

Read more: Weak US Retail Sales, Factory Data Heighten Recession Concerns

The slump in housing is also spilling over into producers of non-durable goods. Shares of Sherwin-Williams Co. tumbled this week after the paintmaker pointed to pressures stemming from a weak residential real estate market and inflation.

“We currently see a very challenging demand environment in 2023 and visibility beyond our first half is limited,” Chief Executive Officer John Morikis said on a Jan. 26 earnings call. “The Fed has also been quite clear about its intention to slow down demand in its effort to tame inflation.”

An accumulation of inventories only adds to the headwinds. Inventory building accounted for about half of the 2.9% annualized increase in fourth-quarter GDP. For the year as a whole, inventories grew $123.3 billion, the most since 2015.

With demand moderating, there’s less incentive to ramp up orders or production as companies make greater efforts to sell from existing stock.

In addition to the aforementioned data, the latest surveys of manufacturers show sustained weakness. Measures of orders at factories in four regional Fed surveys have all indicated multiple months of contraction. 

All surveys released so far for this month are consistent with an overall contraction in activity that extends back through most of the second half of 2022. 

Next week, the Institute for Supply Management will issue its January manufacturing survey and economists project a third-straight month of shrinking activity.

©2023 Bloomberg L.P.

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Opinion: Now is the time to invest in post-secondary education – Edmonton Journal

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If the last few years have taught us anything, it’s that the world — and the global economy — can go through seismic shifts in a relatively short amount of time. Since I began my term as president of the University of Alberta in 2020, we have witnessed a pandemic and a corresponding global recession, followed by an economic rebound. We have turned the corner, perhaps more quickly than any of us could have imagined. Alberta’s economic outlook is now positive, with ATB Financial predicting 2.8-per-cent real GDP growth in 2023.

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To ensure a prosperous future, we must maintain an Alberta that attracts and retains talented people and investments. With a strong post-secondary learning system, Albertans can get the high-quality training and skills they need — right here at home — to meet the labour market needs of tomorrow’s economy.

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The province is facing a continuously tight labour market. The Government of Canada’s October Labour Market Bulletin for Alberta warned: “While the province has been experiencing an economic windfall recently, labour shortages in key sectors, especially the health-care sector, continue to threaten growth.” By 2030, experts predict an acute need for more engineering, health care, science and business professionals.

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We are fortunate that our province is home to a young and growing population. The number of Alberta high school graduates is projected to grow by 20 per cent in the next five years. To accommodate this demographic boon, we urgently need to grow Alberta’s post-secondary sector so that these high school graduates will have the opportunities they need to thrive in Alberta’s growing economy.

We are tackling this challenge head-on at the University of Alberta, where we are home to 25 per cent of Alberta’s post-secondary students. In partnership with the province, we’ve been actively investing in enrolment growth to support these areas of greatest demand. We now have record-high enrolment, with over 44,000 students, including over 1,600 Indigenous students.

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Last year, the U of A received $48.3 million from the provincial government’s Alberta at Work program to support enrolment growth. This investment is paying dividends, enabling us to grow by another 2,600 students, increasing the number of young Albertans who can study at home at one of the world’s top 100 universities. But we’re not going to stop there. We’re aiming to increase our enrolment to over 50,000 students by 2026.

With Alberta’s upcoming 2023-23 budget on the horizon, we have proposed to the Government of Alberta an ambitious plan to grow by another 3,500 students, targeted to the areas of greatest employer and student demand. With this expansion, we can reach our goal of over 50,000 students by 2026. We are keen to play our part in continuing to meet the needs of tomorrow’s labour market, ensuring a bright future for the province.

University of Alberta graduates are critical drivers of economic growth and prosperity. Over the last decade, 84 per cent of our graduates have stayed in Alberta, helping to grow and diversify the economy. Ninety-four per cent of our graduates are employed two years after graduation, with 97 per cent of graduates working in a job related to their field of study.

When the U of A grows, everyone in Alberta benefits.

Bill Flanagan is president and vice-chancellor of the University of Alberta.

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