Fourth Quarter 2014

Market Review Quarter 4, 2014



                                                             Fourth Quarter                                  Calendar Year

Equity Market                           % Change (in Cdn$)                                          2014__   

S&P/TSX Composite                          -2.2%                                                          7.4%

S&P 500                                             9.2%                                                        17.9%

MSCI/Europe                                      3.7%                                                         -8.1%

MSCI/Far East                                    3.9%                                                          8.9%

TSX Energy                                      -16.6%                                                        -7.8%

TSX Financials                                    1.0%                                                          9.8%



Interest Rates                                December 2014                                December 2013

Cdn 91 day T-Bills                                   0.91%                                                   0.89%

U.S. 91 day T-Bills                                  0.04%                                                    0.07%

Cdn 10 year Bond                                    1.79%                                                   2.77%

U.S. 10 year Bond                                   2.17%                                                    2.97%



Commodities (in U.S.$)                December 2014                                December 2013

Oil                                                         53.71                                                   98.16

Natural Gas                                             2.91                                                     4.34

Gold                                                  1183.20                                                1204.80



Portfolio Management Strategy     Year over Year 2014


What Worked                                      What Didn’t

– Long Bonds                                         – Energy Stocks

– U.S. Dollar                                          – Metal and Mining Stocks

– Health Care Stocks                              – Russian Stocks




It Isn’t Easy Being Early – NL

A year ago, I penned a Commentary titled ‘Woe Canada’ where I bemoaned the fact that Canada was not currently that attractive a place to invest. Turned out I was only half right.  Led by high oil prices and therefore strong energy share prices, Canada’s stock market (S&P/TSX Composite Index) was actually a pretty good place to be in the first half of the year.  Turning on a dime, though, things began to unravel as the second half of 2014 began, when the price of oil began to slide.  And then the slide became a landslide. While the price of West Texas Crude finished the first half at an exceeding profitable US$105.48, by year-end it was at an exceedingly unprofitable US$53.71 and at time of writing, it had sunk even further.  Natural gas hasn’t fared a whole lot better, finishing the first half at US$4.44 and the year at US$2.91.

Yes, the Canadian market finished with a fairly decent positive return for the year, but much of that was early on and it was quickly losing steam as the year came to an end (and that trend has continued early in the New Year).  The problem has to do with how the S&P/TSX Index is constructed.  Due to the fact that a great deal of our economy is either foreign or privately owned, our stock market is not necessarily representative of our economy.  There are whole major industries where there are little or no Canadian public companies in which to invest and some which are vastly over-represented.  For example, whereas oil and gas represents about 3% of Canada’s GDP, oil and gas stocks still represent over 20% of the value of the S&P/TSX Index, despite their huge price declines.  Metals, Materials, and Financials are also over-represented in Canada to the point where all of those groups together (including energy) aggregate over 70% of the value of Canadian publicly-listed common stocks.  So called ‘experts’ love to tout index funds and ETFs (exchange traded funds) as the perfect solution for equity investors.  Caveat emptor!  Stock selection is far more critical in Canada than in most countries as buyers of Canadian index funds or Canadian market ETFs are not buying the Canadian economy.  They are buying a highly distorted version of Canada.  We are not invested in this distorted view.  There is a time when you want to be.  As commodity prices relentlessly head south, this is not one of those times.  While we do have holdings in the energy, mining, and financial sectors in Canada, they are small in both absolute and relative terms.

The U.S. equity markets, on the other hand, had a banner year.  It was the best place to be invested in 2015, especially large capitalization U.S. stocks. For Canadian investors it was a win-win with the combination of strong stocks and a weak Canadian dollar leveraging returns.  That was last year.  We, however, look forward when we invest and outside of a few industries, we find the U.S. market to be fairly fully valued, if not downright expensive.  Its valuation, as measured by the S&P 500 Index, has nearly tripled since its bottom in March 2009, with only a single correction in that time frame of over 10%.  The combination of multiple campaigns of Quantitative Easing (designed to keep interest rates low and drive investment into riskier assets) and a strong U.S. dollar has drawn huge amounts of capital to U.S. stocks, just like flies to honey.  This capital is attracted by momentum, the upward momentum we have witnessed in recent years.  After a while, though, momentum isn’t enough.  While share prices can get way ahead of valuations for extended periods, eventually reality sets in.  As we find it harder and harder to find stocks we want to buy in the U.S. due to their extended valuations, we are increasingly attracted outside North America.

Major equity markets in Europe and Asia (excluding the wild-west Shanghai market that was only recently opened up to Westerners for investment) did not fare particularly well in 2014 and prognostications from most investment strategists call for much the same in 2015.  These same ‘experts’ are almost universally calling for the stock market party in the U.S. to continue.  I love when the consensus is so unanimous because my almost 40 years in the investment business has taught me to do the opposite when everyone is on the same path and convinced they are right.  As value investors who like to look where others are not, we are attracted to Europe and Asia.

It isn’t easy being early.  Usually, like last year, it means you make your purchase decisions based on favourable earnings outlooks and valuations, only to discover that nobody else cares.  For some time.  They are still having too much fun at the momentum party.  That means you languish for a year or two, sticking to your style and convictions, waiting for others to discover what you already know.  As long-term value investors we are used to being, by definition, wrong in the short-term but right in the long-term.  It is a style that has served our clients well in the past and we have every expectation that it will continue to do so in the future.


Day of Reckoning – FB

For most of the five year period since the great recession North American GDP growth has averaged 2% annually.  During that same time the federal government in the US has committed incredibly large sums trying to stimulate the consumer.  The results have been a stronger than warranted stock market, a debt which given political will can hardly be repaid and consumer spending which is nowhere close to what it should be given the money invested.

All the recent economic and capital market news has centered around the fall in the price of oil.  While significant in that it should give consumers a boost, good, it will also hurt government tax collections, bad.  It will be interesting to see if the falling oil price results in stronger economic results as it has in the past or whether the aging boomer decides to save the cheap oil windfall.  If it’s the latter then true deflation could be around the corner.

The day of reckoning when falling tax revenues (demographics) meet continued failed political efforts to stimulate the consumer has receded from mainstream thought.  However, that doesn’t change the probability of occurrence.  As long term readers will know, I’m not a believer in government indebtedness.  It reduces government’s ability to provide social assistance to those in need, especially as the looming retirement bulge further reduces tax revenue.  I hope I’m wrong but the falling price of oil might be the harbinger of a deflationary period that will severely punish those in debt, including all levels of government.

One of the topics that is in the mainstream financial media regularly is volatility.  The generally accepted view is that volatility equals risk.  I disagree as I believe risk is better defined as permanent loss of capital or permanent loss of spending power.  Academics and journalists are forever prattling on about how volatility is a proxy for risk.  They equate their inability to predict the market as meaning it defies logic and thus is risky.  Yes, investors can lose money in the market.  Of course, they have to sell first, most likely after listening to someone “in the know” telling them that volatility will not go away and thus their investment is at risk.

I believe that investors should think about extending their time horizon, hold good investments through the inevitable downturns, and leave risk reduction by timing the market to avoid volatility for the traders and speculators of the world.  I know my bias is easily visible but so is the list of history’s best investors, and it includes names like Buffett, Hawkins and Lynch none of whom were traders or market timers. They all used volatility as their friend.  After the market has made a move then react according to the values and prices then available.  It’s called value investing and over the long term it works.  It’s boring holding the same investment for 10 or 20 years but if the underlying investment is appreciating in value then I’ll take boring all the time.

Another year has come to a close, and again we have been the beneficiary of many client referrals over the course of 2014.  Our most heartfelt thanks to anyone who passed our name along, those referrals are an important source of new business for our firm and they are most appreciated.

On the admin front January and February are prime TFSA and RRSP contribution months. The 2015 TFSA contribution limit is $5,500.  The 2014 RRSP limit is $24,270 and, if you are one of those frugal and well organized individuals contributing in advance, the 2015 RRSP limit is $24,930.  The deadline for making RRSP contributions eligible for the 2014 tax year is Monday, March 2, 2015 but in order to avoid the confusion associated with the deadline if you are planning on making a contribution to your RRSP please have either the instructions or the cheque (payable to NBCN Inc.) in our office by the preceding Thursday, February 26th.

January 2015




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