Don’t abandon markets because of Nortel

Last week I had lunch with a mutual fund manager from Mawer Investment Management of Calgary, one of those little-known companies with a fine track record of building wealth for their clients.

Inevitably the discussion turned to Nortel Networks (TSE, NYSE: NT). This was a couple of days before the latest profit warning, so at the time we didn’t know that yet another bombshell was about to be dropped.

Their analysts had been watching the stock closely, the manager said. They had concluded that Nortel’s intrinsic value was somewhere north of $40. As a result, they started acquiring the stock for their portfolios when it was in the $30 range. They had been surprised to see it fall below $20 (it was trading in the $19 range at the time), and felt it represented good value at that level.

One might be tempted to say that if it was good value then, it must be a terrific buy at $15.17 (US$9.86), where it closed on Friday. But, of course, we now know more about the bad straits the company is in.

Right price strategy
I should add that Mawer is not known for gung-ho aggressive investing. The firm takes a conservative approach to portfolio blding, using a ‘growth at the right price’ style. They don’t chase after overvalued stocks and they don’t normally buy companies with a lot of downside.

Yet here is Nortel, down about 50 per cent from the point where they felt it represented good value and started adding it to their portfolios. What in the world is going wrong here?

If you glanced through recent newspapers, you know what’s wrong. Investors are panicking. Almost everyone in Canada has lost money in this dizzying plunge. If you didn’t own the stock directly, you probably had an indirect interest in it through a mutual fund or pension plan. We haven’t seen the stock market cause such widespread distress since the Great Depression!

Some people have suffered more than others. The front page of The Globe and Mail, Saturday June 16 featured the story of an airline pilot who had dropped a quarter of a million dollars on Nortel. One has to wonder why a pilot would invest so much of his savings in a single stock, but the fact is that he did and is so upset by what happened that he has vowed never to venture into the stock market again.

Stock market scars
I fear that may be the reaction of many others. I’ve seen it before. I had a friend that I used to golf with (he passed away last year) who adamantly refused to put a single penny into stocks, preferring to invest in low-interest GICs. He’d been badly burned by the stock market at a very young age, and it had psychologically scarred him. Never another penny, he vowed and stuck to that view for the rest of his life. Talk about once bitten, twice shy!

So I can understand, and sympathize with, the airline pilot. But the answer is not to turn your back on the stock market, which has been the world’s leading source of wealth-creation for more than a century.

The answer, as always, lies in building a well-balanced portfolio that is not over-exposed to any one stock or sector and that contains a prudent mixture of equities and fixed-income securities.

Adjust portfolio
Your rule of thumb should always be this: If at any time you are uncomfortable with your investment portfolio, it needs to be adjusted. Discomfort is a clear signal that the mixture is not right for your temperament and peace of mind. A negative gut reaction is usually a signal of trouble ahead.

The moral of the story is that if you think you’re right, hold your ground. Always remember, it’s your money – not the broker’s.