Fourth Quarter 2016


Market Review Quarter 4, 2016

                                                                                              Fourth Quarter           Calendar Year

Equity Markets                                                           Total Return (in Cdn$)                 2016       

S&P/TSX Composite                                                                      4.5%                            21.1%

S&P 500                                                                                        5.9%                             8.1%

MSCI/Emerging Mkts.                                                                    -2.1%                             7.7%

MSCI/EAFE                                                                                   1.3%                            -2.0%

TSX Energy                                                                                    7.0%                          35.5%

TSX Financials                                                                              11.5%                          24.1%

Interest Rates                                                                    December 2016        December 2015

Cdn 91 day T-Bills                                                                          0.47%                           0.50%

U.S. 91 day T-Bills                                                                         0.56%                            0.26%

Cdn 10 year Bond                                                                          1.72%                            1.41%

U.S. 10 year Bond                                                                         2.44%                            2.27%

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

Oil                                                                                                   58.80                         37.15

Natural Gas                                                                                        3.74                          2.35

Gold                                                                                             1152.30                     1060.20


Year over Year 2016

What Worked                                                                                      What Didn’t

– Resource Stocks                                                                                 – Healthcare Stocks

– U.S. Dollar and Cdn. Dollar                                                                   –  International Stocks

– Financial Stocks                                                                                  – Government Bonds


The Clamour to Index — NL

Exactly a year ago, I wrote in these pages, “Thank goodness we are global investors and had over half of our clients’ equity money outside of Canada during the year”.  Canadian stocks declined, along with the Canadian dollar, and foreign stocks went up.  Our clients had a fabulous year as a result.  What a difference a year makes.  2015 was a horrible year for Canadian stocks and January of 2016 didn’t start off any better.  Commodities and the Canadian dollar both fell precipitously until mid-January when, after a climax bottom, they both started to climb and didn’t look back throughout the year.  While the S&P/TSX Composite index was one of the worst performers in 2015, it proved to be the best performing major index in the world in 2016, due totally to its outsized weighting in commodity and financial stocks. Investors with significant equity holdings outside of Canada, especially in Europe and Asia, did not fare as well.  Diversification was a dirty word.  This provides me with a perfect example of why we choose to be long-term investors, buying shares in a diverse selection of excellent companies (businesses, really) no matter where in the world they may be headquartered, at what we consider to be reasonable valuations.  It may not work every year, but our style has proven itself over the years.

One thing of note I would like to highlight.  As many of you are probably aware, bond yields peaked in 1982 and have been declining, almost constantly, ever since.  Last year, however, was the first year in recent memory where bond yields actually increased year-over-year.  This trend has so far continued into 2017.  If this trend continues, it could signal the end of the 35-year bull market in bonds.  Only time will tell.  If so, it will trigger a change in the way investors view fixed income investments.  The immediate result of this change in direction in bond yields is that for investors who hold bonds in their portfolios, the returns on their portfolios were somewhat muted in 2016 due to the drag on returns from their bond holdings.  We are taking a conservative view towards fixed income until it becomes clearer whether or not we have a new reality or whether last year was just an anomaly.

Lots of talk these days by journalists and many others about how many active stock managers (stock pickers) have underperformed in the past number of years.  Many of these supposedly learned people are recommending that investors move all their money from active management into indexed ETFs and mutual funds (passive investing).  Talk about near-term bias.  Their recommendation is based almost solely on what has happened in the past few years in the U.S.  If they look back further, and in Canada, their recommendation doesn’t work so well.

Our experience has been that index products are difficult for active managers to keep up with in rapidly advancing markets as they are always fully invested and, by definition, keep investing more money into the stocks that are rising the most.  The big get bigger and it feeds on itself.  Until it doesn’t.  This is momentum investing, not value investing, which is what we do.

This is the type of market we have seen in the U.S. since the bottom of the financial crisis in 2009 and this is the time period most of these people are basing their opinion on.  It is also reminiscent of the late 1990s when technology stocks totally dominated the S&P 500 and Nasdaq.  By the end of that bubble in March 2000, 5 out of the 500 S&P stocks accounted for almost all of the total daily movement of that index.  Most of the Nasdaq leaders of that year no longer exist.  Speculation runs wild but, if you were a passive investor, you owned those stocks.

I’m not so sure these people were touting passive management for a number of years after that debacle. They have waited for their ideal conditions to do that again.

In gently rising, flat, or down markets, active stock managers tend to beat index products. The U.S. has not really seen this type of market for quite some time. Not since 2008.

But it will again and then watch out.  Remember how poorly indexes did in 2000 and 2008.  Also, let’s go back in history in the U.S. (most reliable and longest available data) to 1906-1926 or 1936-1950 or 1965-1982 when markets were flat.  Nobody would have made any money in index products then, had they existed, but stock picking managers would have had a field day due to market volatility.  This can and will happen again.  Maybe sooner than most people think.

Canada is a different story as our market is dominated by resource and financial stocks, which make any index product, based on our stock market, an extremely poor product for anyone to sell or buy.  The S&P/TSX Composite Index bears absolutely no resemblance to Canada’s real economy.  Actually, the S&P/TSX Composite Index has historically been the worst constructed major index in the world. Takeovers and privatizations over the years of many of Canada’s biggest and best companies ensured that.  Whole major industries have disappeared from Canada’s public markets.  Besides its resource and financials bias, the S&P/TSX has, over the years, often been dominated by one single stock.  Think Nortel, Blackberry, Valeant, and others.  How did that work out?  If you were invested passively in Canada, what would your returns have looked like?

We believe that investors should invest with a specific goal in mind and that equaling or beating an index is not an investment goal.  Indexes are irrelevant for individuals.  They are relevant only for some fund managers as a benchmark for how they are to be paid or for those same managers to be hired and fired by pension funds and their consultants.  They don’t mean anything for anyone else. Individuals should have goals based on their long-term needs and risk tolerances and ignore the swings in the stock market.  They are irrelevant to you and your goals.

Being contrarian thinkers, our antennas are up when there is such a powerful push towards passive investing and massive amounts of money are flowing into these products.  Can anyone say ‘bubble’?


Interesting Times — FB

As I’m composing this piece the Presidential Inauguration is in progress.  I wouldn’t have voted for Mr. Trump as he projects as an odious person but as the head of the U.S. it will be interesting to see what transpires during his presidency.  Predicting his effect on the North American economies, never mind the capital markets, is impossible as his comments have been, to say the least, contradictory on many issues.  The one issue he seems set on is free trade, or more properly, changing those existing free trade agreements such that the US is seen to benefit at the expense of its trading partners.

The shakeout from a restriction in trade is likely to be higher prices for goods, meaning inflation could be on its way back and with it, a rise in interest rates.  Given the state of many government balance sheets, that would be a cause for worry.  The possibilities are endless but most would involve slower economic growth and a reduction in return from the capital markets.

I’ve mentioned before that one of the advantages to having a third party managing your capital is emotion.  Most investors allow emotions to influence their investment decision making process and that is rarely a good thing.  One of Mr. Trump’s strengths would appear to be making comments that are so inflammatory they evoke emotional responses within the capital markets.  Hopefully that continues as the resulting volatility should allow us to find better value as we scour the markets for bargains.

At the end of the calendar year it seems logical to 1) remind you that the deadline for 2016 RRSP contributions is March 1st but having said that we need a day or two to make sure the deposit makes it to NBCN so please ensure cheques (payable to NBCN Inc.) make it to our office by Monday February 27th  and 2) say a very sincere Thank You to those of you who gave our name out to a friend.  Those referrals are most appreciated and valued.

We appear to be living in interesting times; hopefully they will also be profitable.  All best wishes for a healthy and successful 2017.


How Strange Was That — RD

The year that just passed I mean.  January 2016 was a really rough month in global stock markets and reflected concern of worsening conditions everywhere.  Investors saw major markets down close to 10% in the first few weeks of January.  However, markets started to recover the next month.  There was a scare when the UK voted to leave the European Union (Brexit).  That turned out to be a momentary blip as markets powered on again, seeming to disregard the uncertainty until something more tangible was known about the mechanics of the actual exit.

Global markets weakened again due to the uncertainty of the November U.S. election, which culminated in a win by a prior dark horse candidate, Donald Trump.  There was sheer panic in the markets for some hours prior to the next day’s stock market opening.  However, at the markets open, fear was transformed into significant optimism that the change in President was better than the uncertainty of the unknown that had preceded the vote.  Are you still following?  The day after the election, stocks resumed their climb and kept up that trajectory into year end.

Last year, countries had been stepping over one another in a race to lower interest rates in efforts to stimulate what was then a moribund economic growth outlook.  There were general fears of deflation and, in the summer of last year, CIBC became the first Canadian bank to sell bonds ($1.8B euro-denominated) with a negative, yes negative, yield (minus 0.009%).  Even negative rates were not dissuading investors despite a guarantee that they would lose money if they held the bond to maturity.  It was a surreal environment with rates hitting their lows and deflation fears peaking.  Brexit marked the peak of deflation fears and soon after, rates started to climb upwards, reaching at least an interim peak soon after the US election.  Specific sectors like utilities and consumer staples went from darlings in a low interest rate environment to sources of selling.  A higher rate environment generally signifies an improving economy and fund flows moved towards more cyclical areas that would be more able to benefit from Trump’s perceived simulative policies.

Even Brazil’s strangely coloured pool water, putrid sailing water, ill equipped sewer systems and other negative data points during the RIO Olympics didn’t hinder its stock market from being one of last year’s best (even better than Canada’s albeit largely on the back of the same commodity recovery theme).  Clients opening their statements but once a year are excused from the notion that it was a relatively uneventful positive year.  Positive for equity returns yes; uneventful, no.

Looking ahead in 2017, one of the most important questions is what to make of the recent upward move in interest rates?  Does it portent a long period of rising interest rates or will it end after a shorter time frame, with only a modest number of rate increases.  Knowing the answer to this would allow the stock picker to choose the type of stock that would be attractive in either of those 2 scenarios.  If interest rates continue increasing for a long time then the previous stars, dividend oriented stocks that benefitted from a desperate search for yield, will be out of favour.  If increase rates do not move very far then those stocks can still do well.  Even before last year’s election, interest rates started to move upward and we saw investors switch from stable dividend paying businesses and move toward more cyclical stocks.

I wish we knew the answer to the above, but no one does.  Our reaction to all this uncertainty is the same as it has always been: look for interesting businesses that appear to be undervalued based on their historic valuation ranges and potential earnings. Typically, the more uncertainty, the greater the chance for undervaluation.  For example, when we purchased MetLife in the 3rd quarter of last year, we wrote about various initiatives management was taking to unlock value in a difficult (low interest) market environment and then we wrote that a bonus would be if interest rates started to increase.  The stock has worked well over the short run for reasons we didn’t envision happening so quickly.  However, if we had waited until the good news was already evident, the stock would not have been as undervalued.  We had Stantec, an infrastructure company, teed up to buy for several months before it reached a price we thought reflected a good buying opportunity.  Both Brexit and the uncertainty leading up to the U.S. election finally resulted in the stock price dropping to the level we had hoped to purchase the stock at.   However, sometimes we do all the stock analysis to determine the price point at which a particular company’s stock will be a good value but market conditions prevent the stock from reaching the ‘good value’ price.  In those instances we go back to the drawing board and look for other opportunities.  This is all to say that despite a year where sentiment about the market environment was varied, our approach was typically uniform.  We continued to look for solid companies with reasonable valuations that would increase in value over time.

Trump won the Republican ticket but he has historically vacillated between Democrat and Republican.  Whether he is a pragmatist or an opportunist will sort itself out over time.  More importantly, right now it is unknown which of Trump’s stated policies will be implemented or what the consequences are likely to be on earnings, the most important aspect of a stocks valuation.  It’s likely that uncertainty will continue and it will be a bumpy ride, at least for a while.  What we do know is that there’s always a wall of worry over something and, accordingly, various stocks that are being unduly discounted.  We will endeavour to find more of those to purchase as typically, over a longer time horizon, they are the winners.


January, 2017


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