Prem Watsa wants some of his bearishness to rub off on any seniors who are loading up on stocks.
The chief executive officer of Toronto-based insurance and investment firm Fairfax Financial Holdings Ltd. has a lot of concerns about the stability of global financial markets. So he was shocked to find out that a friend's 90-year-old grandmother was relying heavily on dividend-paying common shares for retirement income.
A financial adviser had helped invest 85 per cent of her savings in stocks – a risk exposure that would have been unheard of a decade ago.
And she's not alone. In an environment of low interest rates, stocks that pay a healthy dividend can be a compelling alternative to the shrunken returns on bonds and guaranteed investment certificates. But even the shares of blue chip companies are not always stable – the S&P/TSX composite index has declined about 9 per cent in the past year. At times, investors may wrestle with the urge to sell at the wrong time.
"What happens with these low interest rates is that you have people searching for yield and taking risks that they may not understand, that they may not know," Mr. Watsa said. He believes that the world could be hit by a brutal financial downturn with devastating consequences for pumped-up stock portfolios.
Not everyone agrees that stocks are for the dogs. Globe and Mail Personal finance columnist Rob Carrick recently looked at retirees who have turned to stocks and stomached the churning market conditions, all to make enough money to live on. The column also explored annuities, where a purchaser pays a large sum of money up front in an insurance contract that guarantees a flow of monthly income for life.
Mr. Watsa favours neither of these options, though he concedes that there is no perfect solution. His suggestion is to try to live on less income, or even to take some money out of the market and spend it instead.
"There's no easy answers here. In the past, the cardinal rule was don't eat into capital. You invest your money, you get investment income – spend it, but don't encroach capital. The problem is, that doesn't work today," he said.
And even dividends aren't always a sure thing. Mr. Watsa points to natural-resource juggernauts such as ConocoPhillips, Rio Tinto Group and BHP Billiton Ltd. – all of them have cut their quarterly payouts since the start of the year amid industry pressures.
Fairfax, which was founded by Mr. Watsa, is known for making contrarian investments. He has generated spectacular profits from some of his bets, such as a large position in credit default swaps that soared in value after the U.S. housing market collapsed.
Other bets have yet to pay off, such as investments in BlackBerry Ltd. and one of Greece's largest lenders, Eurobank Ergasias SA.
In the past few years, Mr. Watsa has been troubled by a disconnect he sees between stock markets and the underlying economic instability of countries around the world, as well as the implication that deflationary conditions could have on markets. Fairfax cranked up the hedges on its equity portfolio to 100 per cent this year from 88 per cent at the end of 2015 – that's how concerned management is about a possible financial storm.
For older investors, there might not be time to recover from the damage. Mr. Watsa's worry is that a market downturn could mimic the stock market crash of 1929, where it took more than two decades for the Dow Jones to reach precrisis levels. And unlike the 2008 financial crisis, Mr. Watsa said, central banks are now mostly out of ammunition. "We just want to make sure people realize there are risks."
In the meantime, Mr. Watsa wrote in his annual letter to shareholders that he will be trying to get his friend's grandmother to see stocks his way. "I have not given up on changing her mind – but it will not be easy!"