Market Review Quarter 1, 2017
Equity Markets % Change (in Cdn$)
S&P/TSX Composite 2.4%
S&P 500 5.5%
TSX Energy -5.5%
TSX Financials 3.5%
Interest Rates March 2017 December 2016
Cdn 91 day T-Bills 0.52% 0.47%
U.S. 91 day T-Bills 0.79% 0.56%
Cdn 10 year Bond 1.63% 1.72%
U.S. 10 year Bond 2.39% 2.44%
Commodities (in U.S.$) March 2017 December 2016
Oil 50.81 58.80
Natural Gas 3.19 3.74
Gold 1251.10 1152.30
Portfolio Management Strategy
What Worked What Didn’t
– Emerging Market Stocks – Energy Stocks
– Technology Stocks – Canadian Stocks
– Spanish Stocks – Russian Stocks
Eyes on Europe and Asia– NL
Stocks in the U.S. have generally been on fire since the Presidential election (The Trump Bump), especially financial stocks. Not so much in Canada. We did somewhat mirror the U.S. move as our market is not only dominated by financials but, unlike the U.S., also energy stocks. First, the energy stocks failed as the prices of oil and natural gas declined rather than increased during the quarter. Something had to give, and it was the overvaluation of energy stocks. Financials in the U.S. were on a tear based on hopes for less regulation and higher interest rates, enhanced by a steepening yield curve. Canadian financials followed suit. A lighter regulatory environment is still the most likely outcome from the Trump administration and higher yields are also likely, but the market was pricing in interest rates going straight up and that doesn’t appear to be what’s happening. Hence, we believe we are in the early stages of a much needed pause, if not a correction. Valuations on most companies in the U.S. were getting ahead of their fundamentals. We view a correction as a buying opportunity as we believe that a stronger U.S. economy will be good for corporate earnings and that the U.S. economy will drag weaker economies in other parts of the world along with it.
That said, it was a positive quarter for equities as the S&P/TSX Composite Index rose 2.4% and the S&P 500 Index gained 5.5%, both as measured in Canadian dollars total return. It was however, the least volatile market since 1965, with only a single day showing more than a 1% move during the quarter. Remember, though, that we invest globally. The MSCI/Emerging Markets index rose 6.9% while the MSCI/EAFE (Europe Asia Far East) jumped 10.8% in the quarter, all again Canadian dollars total return. On their own, those were significant moves but, more importantly, they signified the breaking of a decade-long period of underperforming the S&P 500. This has caught our attention and you can be sure that we will be scouring Europe and Asia for investment opportunities as their stocks are significantly cheaper than those in North America, especially the U.S. The latest addition to Portfolio Management Corporation, Anish Chopra (whom Fred will be formally introducing a little further down) will be spearheading that search on our behalf.
Last quarter, I wrote briefly on fixed income, and stated our belief that the 35-year bull market in bonds could be coming to an end. I would like to reiterate that thought. In 1981, I renewed a one-year mortgage on my first house at 19.5%. Fortunately, I didn’t catch the top, which came later that same year at 21.25%. Close enough, though. Today you can get that same mortgage for about 2.3%. Similarly, Government of Canada 10-year bond yields peaked at that same time at about 18% and appeared to bottom last fall at under 1%. Currently they are at about 1.5%.
Experiences in the U.S. were similar but not as extreme. During the first quarter of this year, the yield on 10-year U.S. Treasury Bonds hit 2.6%, but they have since pulled back to the 2.3% level at time of writing. We are monitoring them extremely closely as a move through 3.0% would end that 35-year downtrend.
Stock market bull markets usually average about 8 years in length and bear markets usually average about 1.5 years. They are generally cyclical moves. Nothing like this bond bull has ever been seen in the stock market. If and when it ends, it will be a secular and generational change.
There are ‘experts’ who expect bond yields to fade again and remain in their long-term downtrend. There are just as many ‘experts’ who feel we are about to make history and go back to somewhat higher interest rates. We don’t know who will ultimately be correct, although our current bias is leaning towards higher rates, eventually. When it comes to fixed income, we are not in the betting business. We leave that to our stock picks. In fixed income, we are hedging our bets by not sticking our noses out too far one way or the other until we have more clarity. We own bonds and preferred shares to generate income and because they usually behave differently than stocks. Any capital gains that may be made would simply be an unintended, but very nice, bonus.
The Human Touch – FB
I started in the investment world late in 1979 and in the intervening 37 plus years I’ve witnessed many a fad. One of the latest is the media’s fascination with low cost alternatives for the investing public. Specifically Robo advisors and ETF’s have been receiving lots of coverage because they help manage money for very little in the way of fees. Don’t get me wrong; I’m in favour of any development that is in the client’s best interest. And while I agree the above methodologies carry low fees what they don’t provide is equally important and has, in my reading anyway, been left unsaid.
I’m sure many clients have heard me on the emotional component inherent in the capital markets. In brief the market sets prices in the short term based on two emotional inputs, fear and greed. In the long run it is much more empirical as prices result from the economic performance (or lack thereof) of the underlying investment.
The current media love-in with the lowest cost money management options miss that both Robo advisors and ETF’s count on high level involvement from the individual investor. Granted the do it yourselfer is no longer picking individual securities but he or she is still making asset mix and timing decisions. Both can be fraught with emotion and thus are open to poor decision making.
The benefits we provide our clients include experience, full time involvement and impartial, unemotional decision making. Our biggest advantage is quite simple – it’s not our money. When I see a new method of managing money that is in the client’s best interest I will embrace it wholeheartedly. However, I believe the current rage about Robo advisors and ETF’s will be proven incorrect in the fullness of time.
Before writing this next piece I was reading the resume of an investment professional and I must say I was reading it with some envy. Several of the entries stood out in my mind –
Chartered Accountant (Ontario)
Chartered Financial Analyst and former Chair, CFA Society Toronto
Chartered Business Valuator (Canadian Gold Medalist)
University of Waterloo, Waterloo, Ontario
Master of Accounting degree, specializing in finance and accounting (Gold Medalist)
Unfortunately those entries aren’t on my resume. They are, however, on the resume of Anish Chopra who recently joined Portfolio Management to help us with security analysis and portfolio management. Anish was previously with the investment department of one of the large Canadian banks and we are extremely happy he chose to throw his lot in with us. The above items on his resume are accompanied by many more. I’ve just presented a few highlights so you can imagine how wonderful it is to have Anish on our team. Initially he will be heading our international research efforts as Peter Walter has again decided to ride off into the sunset. I’ve said it before and it’s no less true now, Peter is a wonderful asset to any organization and our clients have been extremely fortunate to have his expertise. So, all best wishes to Peter and Anish for a healthy and successful “next chapter”.
The Art of the Sell – RD
We reduced the equity weighting in many of our client portfolios this last quarter. We became uncomfortable with the sheer volume of articles justifying the strong stock market moves post the Trump election win. The upswing in markets, according to various pundits, is justified based on the Republican Party replacing the Affordable Care Act (ACA) that would free up tax revenues to pay for a lowering of tax rates and increased infrastructure spending. Lower tax rates help corporate earnings (good for stocks) and can boost spending which can result in a virtuous circle of benefits to the overall economy. Yet, optimism hasn’t even been dampened post the failure of replacing the ACA. We don’t think tax reform is necessarily a layup either. We tend to want to reduce equity risk when we feel excessive optimism is hampering our ability to find value opportunities. This led me to think it might make sense to write about how we arrive at decisions to sell stock. Sometimes it’s as much art as science but I will attempt to provide an overview of some general selling guidelines.
To understand how we approach selling decisions requires a brief comment about our stock buying strategy. This is because the buying and selling strategies work hand-in-hand; they are intertwined. We look for stocks to purchase that will do well over the long term. Another way of saying this is that we strive to purchase stocks that we can successfully hold for a long time before selling.
There are times, however, when the specific circumstances of a stock require it to be sold even if it has not been held for a long time. Take, for example, our sale of SGS this quarter. This stemmed entirely from a decision to lower the equity exposure in client portfolios. While maybe not as scientific as one might think we discussed various stocks that we felt were potential sell candidates and SGS was the ‘winner’. In this case it was really less about that particular stock and more about our higher level decision to reduce our equities.
Last year we trimmed our position in CCL Industries. We liked and continue to like the company but the stock price had increased so significantly over the past several years that we were uncomfortable with its concentration in individual portfolios. It had grown to a bigger percentage, in relation to other equities, in many client portfolios so that if the stock went down it would have a more noticeable impact on the overall return of the portfolio. Accordingly, we felt it prudent to reduce the amount of risk tied to one company. We cashed in on some of the profits already made on CCL Industries stock and “trimmed” the amount of that stock held so it had a more balanced weighting with other stocks in client portfolios.
Other times a sell might be executed because the hoped for ‘turnaround’ in a company that was struggling has already taken place so the stock price has had a good run and further increases are more difficult to attain. Think Callaway Golf. Callaway had impressive returns but those resulted in the stock price then appearing expensive relative to its earnings. This favoured selling the stock for capital preservation purposes (i.e. to avoid a potentially overvalued stock from going down). When a stock has risen to a point where it is expensive in relation to its earnings, future returns are usually better achieved by moving to other equities with more opportunity.
Lastly there are the sells where the initial basis for investing in the stock has come into question. The sale of Teva Pharmaceutical being an example. Often as value and contrarian managers we have a healthy level of anxiousness when we purchase a stock that is widely unloved and, accordingly, is “on sale”. We were well aware of the issues that put the stock in the penalty box before we purchased it. Those issues had already resulted in a deep discount in the stock price but we viewed the issues as temporary. However, one must not become dogmatic once the purchase decision has been made. A good money manager needs to be open to re-evaluating whether new facts that emerge challenge the assumptions previously made as to why the stock was a good purchase. Soon after we purchased Teva, the CEO abruptly resigned. That sent our anxiousness through the roof. While we anticipated some bad news (as that’s why the stock was on sale), this was news we did not expect. The sudden resignation of the captain responsible for steering the ship put all our previous assumptions in question. The unknowns and risks were now potentially bigger than we had previously thought so we made the decision to immediately jettison the position. It is safer on shore when the seas are choppier than expected. It is difficult to encapsulate the over 100 combined years of investment experience that my partners and I have into a few general selling guidelines. Guidelines are just guidelines and we need to remain responsive to changing facts about the companies, industries and countries we invest in. Decisions need to be made without complete information. It’s being comfortable with that opaqueness and still being able to make a decision that is the product of experience.