First Quarter 2013

Market Review First Quarter, 2013

Equity Markets

S&P/TSX Composite

S&P 500


MSCI/Far East

TSX Energy

TSX Financials

First Quarter
(% Change in Cdn$)







Interest Rates

Cdn 91 day T-Bills

U.S. 91 day T-Bills

Cdn 10 year Bond

U.S. 10 year Bond

March 2013





December 2012





Commodities (in US$)


Natural Gas


March 2013




December 2012




Portfolio Management Strategy

What Worked

– Railroad Stocks

– Healthcare Stocks

– Telecom Stocks

What Didn’t

– Gold & Mining Stocks

– REIT’s

– Utilities

Climbing The Wall Of Worry – NL

For as long as I have been in the business, I can remember people older and more experienced than me saying that the best equities markets occur when the market climbs a wall of worry.  Now that I am older and more experienced (over 35 years in the business), I must admit that I concur.  The first quarter was a prime example.  Among other events, markets had to deal with the fiscal cliff and sequester crises (manufactured though they might have been) in the U.S., the banking crisis in Cyprus, the election mess in Italy, North Korea rattling its swords again, and a stagnant economy in Japan. Despite (or maybe because of) all this, every major market in the world, with the exceptions of Shanghai and Hong Kong, advanced during the quarter.  Some were up quite strongly.

Why does this phenomenon occur?  Doesn’t it make more sense that markets would advance the most when times are good and everyone is optimistic?  Shouldn’t all these problems be sending share prices reeling?

The mistake most individual investors (along with many professionals, as well) make is to let their emotions take charge of how they invest.  I am still saddened when I remember the panic that took hold of a few of our elderly clients at the end of 2008 and into the first few months of 2009.  With share prices declining almost daily, they were afraid that their capital was going to be eroded and that they would outlive their money and be destitute.  The fact that we had severely reduced their equity weightings and the stocks that remained were highly defensive in nature was irrelevant to them.  They were scared.  They couldn’t sleep at night.  Telling them their dividends were safe and still being paid didn’t matter.  They wanted out.  NOW!  A few had already committed to buying 5-year GICs paying about 2.5% which, when combined with selling out at the bottom when their capital was at its lowest value, virtually assured that they would have a good chance of outliving their money.  Four years later the U.S. stock market has more than doubled from its lows and all other world markets (including Canada) are also up substantially from that period.

The opposite is also true.  I remember 1999 and 2000, when I was the strategist at BMO Nesbitt Burns and technology stocks were all the rage.  Brokers were crying to me that they were losing clients because the brokers were value investors and value stocks were languishing and many of their clients were only interested in chasing technology stocks, no matter that the valuations were ridiculous or that some of the companies did not even have real businesses (only pie-in-the-sky ideas that the market placed billions of dollars of value on – temporarily, at least).  Get me in.  Buy at any price.  They were only going higher. Until they weren’t.  And then they crashed and burned.  Emotions ruled again.  Sell at the bottom, buy at the top.

The best investors anticipate.  The worst investors react.  Investors forget that markets usually look forward 6-9 months.  The hardest thing to do is look out through the daily noise and the headlines and look at the long-term picture.  As we talked about in last quarter’s Commentary, we feel that much of Europe will be in recession in 2013 but that corporate valuations have been punished to bargain levels.  As Darren Sissons notes in his comments following, we have bought and intend to continue to buy European equities, particularly ones with most of their business outside of Europe, as a year from now we anticipate Europe will begin its economic recovery and the valuations of its quality companies will be much higher than they are presently.  In the U.S., we continue to believe that recovering housing and automobile markets will propel the economy higher than most economists and investors believe.  When investors see the strong economy and get comfortable with buying equities again and start selling their bonds, we anticipate valuations will be higher than where they are presently.  Once again they will be reacting and buying high.  Somebody has to be there to sell at the top to the newly optimistic.  Hopefully it will be us.

A word or two about investing in Canada versus internationally.  For ten years, riding the commodity boom and reflecting the strength of our banks when all others were in trouble, the Canadian stock market was the place to be.  Resources, materials, and financials made up about 80% of the capitalization of the TSX/S&P Composite Index.  Nice while it works but not so nice when that narrow group of industries stop being market darlings.  Commodity prices and demand for them have declined.  Trapped Canadian crude oil sells at bargain prices until much needed pipelines are approved and built.  Canada’s banks remain pillars of strength but their earnings outlook is tepid, especially when compared to banks elsewhere.  Opportunities and valuations outside of Canada currently appear superior.  We have been increasing our investments internationally and we expect that trend to continue.  By no means are we abandoning Canadian stocks.  We are just putting our emphasis elsewhere at this time.

We also talked last quarter about the bond market and the negative risk reward ratio it presents.  During the quarter, bond interest rates did increase until the Cyprus crisis hit.  Scared money fled Europe and bought U.S Treasury bonds and Government of Canada bonds in a flight to safety, trimming yields in both the U.S. and Canada in the process.  We believe this to be a temporary situation and, due largely to our economic outlook, still believe interest rates on bonds will be higher a year out.  Over the remainder of the year we will continue to trim our bond positions as well as reduce the term and duration of the bonds we hold in order to minimize interest rate risk.

Spring Thoughts – FB

The calendar says its spring.  The thermometer says something else.   Perhaps that’s why the stock market has been so strong over the past few months – it absorbed all the sun’s energy and used the power to produce a fine quarter.

The North American Economy continues to show mediocre results plagued as it is by too much debt and stubbornly low consumer spending.   I would expect the debt reduction and reduced spending trends to continue for the foreseeable future.   On the other hand Mr. Bernanke (chairman of U.S. Federal Reserve) whose grand plan envisions a different future.  He is expecting that flooding the economy with liquidity by way of cheap money will result first in asset inflation followed, hopefully, by increased consumer spending powered by the wealth effect.  The expected increase in consumer activity would presumably produce economic expansion, job growth and finally increased tax revenues to be used, hopefully, to reduce government debt levels.  The complicating factors include an aging demographic who will gladly accept the increase in assets value (asset inflation) but due to age will be resistant to spending increases.

Hopefully the economy strengthens and the excessive debts are repaid before the world’s creditors demand higher interest rates.  It will be interesting to see how the script unfolds over the coming quarters and years. 

On an administrative/investment note many clients will notice a change in the vehicle we use to hold cash reserves.  During the quarter we started using TD’s Investment Savings Account as it pays 1.5%, a substantial premium to previous alternatives.  Deposits are a direct obligation of the TD Bank and carry the CDIC guarantee on the first $100,000 held.

Why Europe is Different – DS

Is Europe Different?  When the U.S. faced its financial armageddon in 2009, investors were subsequently able to buy a plethora of high quality U.S. companies at rock bottom prices.  So why, given the stream of negative news we hear daily from Europe, have we not seen more European equity market weakness?  Where are all the discounts?  Are European economic fundamentals correctly priced?  Why did the European markets rally so strongly last year?  These issues naturally beg the question, is Europe different?  The simple answer is YES.  We, as human beings, tend to project what we do know as a basis for understanding what we don’t.  Therefore, given the root cause of the U.S’s current financial troubles lie in its over inflated housing market prior to the 2008 global financial crisis and the extremely low levels of equity of that time (think: no money down, 5% or 10% equity deposits) on their homes, it is natural for Americans to assume housing is also the root cause of financial troubles in other countries.  Here in Canada, while housing has definitely become less affordable since the onset of the global financial crisis, we Canadians typically still have large amounts of equity invested in our homes.  It’s not uncommon to hear of equity commitments of 25% or even to hear of people without a mortgage.  So we are not the same as Americans.  Our economy and financial markets, along with those of Australia, Brazil, China, Europe, Japan and Russia will all respond differently to macroeconomic problems because the economic foundations are not the same.  A simple enough fact but how simple facts play out against a back drop of global investment fund flows is less clear.

So yes Europe is different.  Then, what is the root cause or causes of this pricing imperfection?  Where is my bargain?  The answer or at least one of the answers is that a large number of European companies have defensive shareholder bases as many are still family owned or controlled and they typically have large employee shareholder bases.  Consequently, even when times are bad there are fewer sellers and a marginal buyer either drives up the share price or at the very least stabilizes or provides a downside cushion against a major fall in the share price.

The fact that some European share prices can be relatively less volatile or can recover more quickly from a sharp price decline than the rest of its local equity market constituents makes for an interesting opportunity when constructing an investment portfolio.  The inclusion of defensive European equities such as Boskalis, Carlsberg and Kone in our portfolio will, in addition to the benefits of diversification, lower the average volatility and improve the overall performance of the portfolio

The Euro, which is the currency of the Eurozone, has fallen from an average of C$1.62 per Euro in 2008 to approximately C$1.30 per Euro in 2013 or by 20% over that period.  This currency drop has benefitted a number of European companies, in particular the heavily export-oriented Germans and Scandinavians.  Canadians can now buy European securities for 20% less than in 2008.  We are also generally able to buy Eurozone companies at lower valuation multiples versus historical levels due largely to the on-going European financial crisis.  Should these discounted European companies have the defensive shareholder characteristics noted above, have lower valuations vis-à-vis history and also be export-oriented, then Canadian and U.S. investors are effectively able to buy growing European companies at heavily discounted values with some protection against volatility due to the stable shareholder base.

So yes Europe is different, BUT in a good way.

We will continue to be on the lookout for attractive European opportunities.

April 2013

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