First Quarter 2016

Market Review Quarter 1, 2016

First Quarter

Equity Markets                                                                                                   % Change (in Cdn$)

S&P/TSX Composite                                                                                                       4.5%

S&P 500                                                                                                                       -5.6%

MSCI/Europe                                                                                                                 -1.5%

MSCI/Far East                                                                                                               -9.6%

TSX Energy                                                                                                                    8.9%

TSX Financials                                                                                                                3.7%


Interest Rates                                                                              March 2016                                  December 2015

Cdn 91 day T-Bills                                                                                  0.46%                                             0.50%

U.S. 91 day T-Bills                                                                                 0.18%                                             0.26%

Cdn 10 year Bond                                                                                  1.23%                                             1.41%

U.S. 10 year Bond                                                                                 1.77%                                              2.27%


Commodities (in U.S.$)                                                               March 2016                                   December 2015

Oil                                                                                                         38.16                                                37.15

Natural Gas                                                                                              1.96                                                 2.35

Gold                                                                                                   1234.40                                            1060.20



Portfolio Management Strategy


What Worked                                                                                      What Didn’t

– Canadian Dollar                                                                                  – European Stocks

– Gold                                                                                                  – U.S. Financial Stocks

– Mining Stocks                                                                                    – Healthcare Stocks


                                                          Canada Rebounding? – NL

After telling you last quarter what a great deal geographic diversification was for your investments, of course the Canadian stock market then proceeded to become one of the best performers in the first quarter of 2016.  The quarter certainly didn’t start out that way with Canadian stock markets, oil, and the Loonie all falling off a cliff until late January, when all three appear to have bottomed and begun to recover.  Clearly, in hindsight, all three had gone down too far, too fast.  It’s still too early to say that it is onward and upward from here, but it is nice that the world is not coming to an end, something that wasn’t altogether clear just three months ago.

We make it a point to try to meet as many CEOs as possible.  Not only are they great sources of information on their companies, but also on the economy at large.  Recently, I had the pleasure of having lunch with Mario Plourde, the President and CEO of Cascades, Inc.  They are in the tissue, boxboard, and containerboard business.  While not a company we would currently invest in (its debt level is way too high for our liking), his insights on the Canadian economy were fabulous.  As a boxboard and containerboard manufacturer, they are very close to the ground as far as how Canadian manufacturing is doing. Almost everything manufactured must go into some type of box for shipping and display.  If Canadian manufacturing is picking up, Cascades will be ramping up production.  If it is slowing, Cascades will be cutting production.  It was great to hear that a combination of a low Loonie and a reasonably strong U.S. economy have combined to create a rebound in Canadian manufacturing and a recovery in its Canadian packaging operations.  At a time when commodity prices are a fraction of where they were a year ago, it is heartening to hear that a major part of our economy, which has been hurting, is starting to come back.  Not only is manufacturing recovery good for Canadian companies and their employees, but, it is also positive for the goods and services sectors due to the multiplier effect (the jobs and spending created by suppliers to those industries).  Hopefully, the recovery of the Loonie won’t get carried away and cut this manufacturing recovery off just as it is beginning.

As a result of this improvement in Canada, and the fact that valuations south of the border and in Europe remain somewhat stretched, you can expect to see us reducing our currently hefty cash positions and devoting that money mostly to Canadian stocks over the next few months.

We like to invest mostly in companies that pay dividends, especially those that increase their dividends on a regular basis.  I recently wrote an article on dividend investing for The Huffington Post Canada (http://www.huffingtonpost.ca/), the gist of which I have provided below:

Dividend stocks, especially ones with above average yields, have been excellent performers for the past few years. But with uncertainty dominating the broader economy and stock markets, a growing number of investors have raised the question of whether the good times can and will continue.

As a refresher, a common stock dividend is the distribution of a portion of a company’s earnings, decided on by its board of directors, to shareholders of its common shares. Dividends can be issued as cash payments, as shares of stock, or other property.  Typically in North America, dividends are handed out quarterly, which allows investors to regularly receive cash for their shares.  International companies, more often than not, pay their dividends annually or semi-annually.

Dividend-paying stocks have long been considered a smart buy for obvious reasons: Combined with regular distributions and long-term stock price appreciation, dividend-paying stocks as a whole tend to outperform their non-dividend paying counterparts over the long-term.  More importantly, “dividend growers” – companies that steadily increase their dividends over time – tend to do better than those that simply pay out a distribution, but never or rarely increase their distribution rate.  And when total return (dividend yield plus capital gain) is looked at (as it should as that is what investors actually earn), dividends tend to make up over half of that return over the long-term. Additionally, in taxable accounts, dividends from Canadian corporations have quite a tax advantage over dividends from foreign corporations or interest earned.  For example, for 2016, residents of Ontario pay tax at a rate of 39.34% for eligible Canadian dividends while they pay 45.3% for non-eligible dividends and 53.35% for interest income.

Companies that pay hefty dividends have seen a spike in popularity over the past few years as central banks around the world have instituted near zero interest rate policies (ZIRP), some even imposing negative interest rates (NIRP). Utilities and REITs have been the biggest beneficiaries of this funds flow.  As a rule, we like to invest in companies that not only pay dividends, but are “dividend growers”.  We will almost always choose a company with a low but consistently growing dividend over one that has a high but static dividend.  An excellent example is Canadian label producer CCL Industries (CCL.B-T).  It currently yields a very modest 0.8% based on an annual dividend of $2.00 per share.  Just five years ago, however, the annual dividend was $0.70 per share (a then-yield of 2%) and the share price was 1/7th of where it is today.  Had you bought CCL in 2011 at $35, the yield on your original purchase would be 5.7% today (and your capital gain 640%), and you could expect the dividend to keep growing.  Investors often make the mistake of chasing companies with high absolute yield rather than buying companies with low but growing yield.  Companies with high, static yields are quite often problem-laden companies whose dividend payments are quite often at risk, whereas companies with growing dividends are usually companies whose earnings and fortunes are improving.

A lesson learned the hard way over the past year has been that not all dividend payouts are safe.  I am referring here to dividends from resource and highly cyclical companies.  These are companies whose fortunes are tied either to the price of the commodity it produces, or are heavily reliant on the ups and downs of economic cycles.  In no uncertain terms can these dividends be considered safe, especially when compared to dividends from most consumer, financial, or industrial companies.  These companies are price and volume takers, and for the most part are unable to control much of their own destinies.  It’s easy to become enamored with these companies’ generous yields when times are good, but always remember, in the back of your mind, that their dividend payments will become suspect once their fortunes begin to turn.  And, all companies will tell you their dividend payouts are safe until the moment they tell you that they are being cut or eliminated.

One thing dividend chasers should be aware of is that the shares of companies with above-average dividend yields are currently quite expensive, due mainly to the ZIRP mentioned above, as investors continue to search out and chase yield.  An ever present risk associated with high-dividend yielding stocks is that they tend to fall as interest rates rise. This hasn’t been much of an issue since the early 1980’s as interest rates have pretty much only gone down since then. However, with interest rates currently on either side of zero, eventually rates will begin to increase, putting the valuations of these stocks somewhat at risk.

As always, the best advice I can give is to have a broadly diversified portfolio, one that contains stocks from many industries and countries as usually not all stocks go up and down at the same time.  This is how we manage our clients’ portfolios and how I recommend you manage yours.


                                                                               Risk – On – RD

Oh how quickly things have changed.  At the beginning of the year the U.S. Federal Reserve was expected to hike interest rates several times throughout 2016.  That was not viewed positively for stock valuations.  China was believed to be on the verge of a major slowdown as it shifted economic drivers from export led investment to one based on domestic consumption.  Oil dropped below $30 as supply exceeded demand and the Canadian dollar plunged below 70 cents in response.  Half of the developed world had negative interest rates (NIRP ie lenders paying borrowers) and stock markets around the world plunged.  But that was just in the first 5 or 6 weeks of the year.  Since then equities have climbed a wall of worry as anemic growth has led the Fed to downshift on the number of interest rate hikes planned.  This is in part due to currency strengthening challenges that arise from increases in rates while other countries remain in negative interest rate territory.  China has made several attempts to boost economic activity and reassure the world of its growth rate and oil has risen from levels of despair.  In just 6 short weeks this has made our positioning for downside risk protection look ill-advised – for now.  Global economic growth has been sputtering and that is why negative interest rates have been introduced.  These negative rates are a significant reason for caution as it raises more questions than answers.  Lurking in the background is the question that should the economic growth engine stall, is there anything left in the realm of monetary policy that can keep stock valuations up just as low interest rates have been doing.

Negative rates are unprecedented in history and how they work will be instructive for the future.  However, we are in the present and your assets need to be managed now, albeit through uncharted territory.  In general, earnings growth ultimately requires economic growth.  We are not convinced that global stock markets haven’t just glossed over the challenges and hence we are not shifting markedly away from our conservative stance just yet, however, we are taking this time to look at adding to our Canadian stocks.  Stock positions outside of Canada are a performance drag when the Canadian currency strengthens.  Usually currency moves take place over months and years, not weeks, but at any rate we think it’s reasonable to start looking more seriously within Canada for the first time in a long time.  As always though there are strong arguments to maintain geographic diversification given the narrow industry offering within the Canadian stock market.

                                                                  How We Think of Risk – FB

Risk.  What is it and where is it present in today’s market(s)?

As I’ve mentioned many times previously, our focus is on making an absolute return for our clients over the long term.  One of the elements in that process is risk, and I thought I would use this forum to expand on how we identify risk, where we think its present in today’s markets and what we are and can do to reduce risk as much as possible.

I think the logical first step in the process is a definition of risk.  The academic world, the media and the brokerage businesses want market participants to view risk as price volatility.  That’s because a) it gives them something to write about and b) their focus is on the short term.  For anyone with a time horizon longer than the end of next month a proper definition of risk is “a permanent loss of capital and thus a permanent loss of purchasing power”.

Using that as a definition leads to an examination of where risk exists in today’s markets.  I believe operating weakness that leads to financial weakness is an excellent signpost for an inquisitive investor who would like to avoid “permanent loss of capital”.  Trying to make a long economic and investment argument as simple as possible, I think the best illustration of financial weakness is summarized in one word, debt.  It’s not rocket science to postulate that the more debt on a balance sheet the weaker the reporting issuer is, be it a public company or a government entity. If debt is growing or if it remains in place then the obvious question is “why?”  Not doing the homework necessary to properly answer that has led to many a serious financial injury.

When looking to make profitable investments for clients we take strengths and weaknesses into account and thus we do our best to avoid issuers who either owe too much or issuers who give the impression they wouldn’t mind owing a large sum at some point.  Avoiding weakness just makes sense and it has helped us keep away from estate reduction opportunities.

Combining all the above and applying it to making profitable investment decisions means we try and help the short term thinkers with their self-made short term problems.  In English that translates to when the short-termers are in fear or panic mode we are buying and conversely when they are exuberant we are likely sellers.

That formula has been working over my 37 years in the capital markets and I don’t see any reason why it won’t continue though, as always, past results will not be indicative of future returns.

Partner changes

In early February of this year a change occurred among our managers as Darren Sissons and Portfolio Management Corp parted ways.  Darren had been with the firm 5 years and brought talent and ambition with him to the office and in the handling of client portfolios.  We wish him all the best in his future endeavors.

As our normal professional compliment is four, Darren’s departure meant we were short in the international research area.  In a stroke of good fortune Mr. Peter Walter, whose retirement preceded Darren’s joining the firm and who has a long track record in International Value investing, has agreed to come out of retirement and help us for an undetermined period while we search for a permanent replacement.  For those clients who joined the firm in the last five years and thus don’t know his reputation, Peter was an integral part of the firm’s success and contributed both through his sound investment decisions and his excellent judgement in general.  To say I skipped home the evening that we agreed to terms with Peter would not be an understatement.  And that was before my recent hip replacement surgery!

Apr 2016

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