circling sharks,good reading

Publisher's Notebook: Beware the Rapture of the Deep
Tuesday, February 7, 2006
By Darin Diehl

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Keeping an eye on circling sharks
There's an expression among recreational scuba divers that describes the sort of trance-like state you can find yourself in while surrounded by the underwater flora and fauna of a tropical coral reef. This "rapture of the deep" can leave divers so enthralled with the spectacular vistas before them that they can become unaware of lurking danger - such as a circling shark or an air tank nearing empty. I recall several years ago noted American financial advisor Nick Murray using the term in his address to a professional advisor conference in Canada. His point was that investors - and advisors - can find themselves similarly spellbound by the rapture of a bull market. When things are going great, we can forget about the inherent risks that exist in any investment environment.

Put another way, risk tolerance is increasing - as it often does in bull markets. Oil, gold and mining stocks powered Canada's TSX to a record close Monday above 12,000. And yes, there are analysts who see it continuing to climb as high as 14,000. On StockHouse, many of the most active BullBoards forums focus on the energy and mining sectors. Even though most recognize that the bull market is getting long in the tooth, it's still hard for many to consider trimming equity positions that continue to pay off so well.

But you don't have to look too hard to find a circling shark. Bank of Canada governor David Dodge warned in a speech Monday that global imbalances could lead to recession. The imbalances, to which he refers, have to do with the large and persistent current account deficit in the United States, which Dodge notes "is mirrored by large current account surpluses elsewhere, especially in Asia and in many oil-exporting countries." While financial markets have been able to absorb these imbalances, Dodge warns that "the sheer size of these financial flows into the United States is not sustainable indefinitely." He says eventually, domestic savings in the United States will have to increase. "Should that occur suddenly, we could see global economic growth slow sharply, unless there was corresponding growth in domestic demand outside the United States," Dodge warns.

Wall Street strategists are also worried about the higher risk of inflation and the ever-present geopolitical uncertainties. Some have begun to trim their equity positions for their recommended asset allocation. A Bloomberg News survey of strategists notes that Prudential Equity Group's Ed Keon has dropped his recommended equity weighting to 55 percent from his previous very bullish 100 percent weighting.

None of this is meant to be a warning to head for the hills - or to take a flight to safety. Just as there's inherent risk in every market environment, there's also inherent opportunity. However, it's never a bad idea to revisit the question of just what your tolerance for risk is and then to measure that against the asset allocation of your overall portfolio. Consider it the investing equivalent of checking your air supply gauge and glancing over your shoulder before you venture further along that oh so entrancing coral reef.

In future columns I'll ask some top Canadian advisors for their view on this subject