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On the hunt for bargains

Illustration credit: David Anderson for The Globe and Mail

THE MARKETS

On the hunt for bargains

Online brokerages are seeing surprising increases in business as investors step into one of the roughest bear markets in history. Are they timing it right?

By Gavin Adamson

Pietro Satriano represents a wave of retail investors who are responsible for a major up-tick in activity at online brokerages in the midst of the current market turmoil. He may also be among the first wave of online investors to learn from a market cycle.

The Oakville, Ont., resident says he has been sitting on the sidelines in several accounts with TD Waterhouse, the bank-owned online brokerage and Canada's largest, with his money in cash, and slowly buying into the market when prices seem low enough.

"I might not have bought at the bottom, but I might be near it, and as prices have dropped I've kept buying in, averaging down," says Mr. Satriano, 45, sounding very much like Warren Buffett, the global guru of value investing.

"And if it is the bottom, then I'll have higher-than-average gains in two or three years."

He insists he's no savvy investor, but Mr. Satriano seems to have the fundamentals of value investing down pat: If you have the cash on hand and you have the appetite for short-term volatility, value fund managers say this is a reasonable time to start wading into the market.

But are they right? Or should investors be extra wary of possible bear traps out there? Cue the likes of Doug Coulter, president and chief executive officer of RBC Direct Investing Inc., Canada's second-largest online brokerage.

In tough markets you would expect investors to fold up the tent, he says, but it doesn't seem to be the case this time - even in the midst of one of the toughest bear markets in history.

"Everybody's raising their eyebrows a little bit, because it's counter-intuitive," Mr. Coulter says of the activity at online brokerages.

"People are looking at valuations, making decisions about their entry points, and setting their portfolios up for the longer run because they believe that the valuations now will prove attractive two or three years out," Mr. Coulter says, noting that the rising trend began as markets dropped, especially in the second half of the year.

Net year-over-year account growth at RBC is at 47 per cent, Mr. Coulter says. New accounts in October were up 87 per cent compared with October, 2007. Equity and option orders were up 52 per cent in the same period.

Online brokerages have many masters, Mr. Coulter notes.

Account holders include retirement savings plan investors who don't trade a lot - risk-averse retirees who like his firm's large fixed-income offering. Trading in that asset class was also up 56 per cent in October, compared with a year earlier.

Online brokerages, which earn fees from trading commissions, profit mostly from those who trade heavily. These more risk-tolerant investors try to ride price swings on stocks for profits.

Whatever the type of investor, Mr. Coulter says the numbers undeniably indicate that account holders like the valuations they are seeing in the market.

Brokers say they are doing almost nine in 10 trades online. TD Waterhouse, for example, last month reported an 80-per-cent increase in applications in late September and October over the same time a year earlier.

Kim Shannon, a Toronto-based value fund manager, says retail investors are right to see value in the market right now. That's not to say there couldn't be some wild swings, especially in specific stocks, but she believes values are reasonable.

Toronto investing expert Kim Shannon sees value in the current market.

Still, there's no question that many investors are stuck on whether this it the time, or the right time, to buy stocks.

"Unfortunately, no one gets out there and rings a great big bell and says, 'It's the bottom,'." Ms. Shannon says.

The online investing trend is evident not only across the industry in Canada, but also in the United States, where the economy is reeling from a flood of bad news.

Bill Doyle, an analyst at Massachusetts-based Forrester Research Inc., says U.S. discount brokerages are seeing the same type of growth in accounts. In a report last year, his company predicted that a 5-per-cent drop in the S&P 500 index would mark slower growth for the North American industry. But the current activity is proving that wrong.

And research has shown that retail investors do not usually act this way.

Meir Statman, a professor of finance from the Santa Clara University in California who studies investor behaviour, says his analysis of the findings of Gallup polls in the U.S. market found that the average investor is usually swept up by the euphoria in bull markets - and then is too scared to buy as markets fall.

Investors usually tend to correlate how markets perform in the previous 12 months with how they predict the year ahead.

For example, when American investors were asked in Gallup surveys whether they agreed or disagreed with the statement "Now is a good time to invest in financial markets," the highest point of agreement was in February 2000, just before the tech bubble burst. The height of disagreement was in March 2003, just before the bull market began.

"So after high returns they think there will be high returns, and after low returns they think there will be low returns," says Mr. Statman, who also works for the Winnipeg-based boutique brokerage firm Wellington West Capital Inc. on its investment committee.

Potentially worse, when markets fall, frightened retail investors can overestimate the possible risks.

"We are on guard, like we're hearing a suspicious knock at the door," Mr. Statman explains.

But he notes that humans can learn. If investors realize that fear gives them a heightened sense of risk when markets fall, and that they should not necessarily extrapolate from recent events, their behaviour can alter.

Mr. Satriano, a self-directed investor for about 15 years, says he learned some hard lessons from what happened when the markets went off a cliff in 1987.

He sold - and then the markets went back up again.

"And I said, 'I'm not going to do that again.'"

But it isn't easy, emotionally, to step into a bear market. "Fear is huge, you feel your stomach turn," Mr. Satriano says. He relies on the value investors' standard tools: He compares price-to-book and price-to-earning ratios over the long term and takes it slow.

And Mr. Statman cautions that while it's probably true, on average, that markets will perform better in the 12 months following the height of investor pessimism, it's "hardly a sure thing."

"I want to make sure that I don't tell investors, 'Now everybody's afraid, jump in with both feet,'" he says.

"Even if the odds are that markets will go up rather than down, you venture into markets with no more money than you can afford to lose ..."

Investors should rely on a detailed, realistic financial plan based on what they own, what they earn, and their goals, he says. The plan will likely result in a more cautious approach.

"Trying to figure out when to get in and out is really a loser's game," Mr. Statman says.

"What you should do instead is go back to yourself rather than look at the market all the time. How much do I need to have such that I can have a secure retirement? And how much can I venture in the equity markets?"

Special to The Globe and Mail

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