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Third Quarter 2016


 Market Review Quarter 3, 2016

                                                                       Third Quarter                                                                        

 Equity Markets                                    % Change (in Cdn$)

S&P/TSX Composite                                          5.5%

S&P 500                                                            5.1%

MSCI/EAFE                                                       7.8%

MSCI/EM                                                         10.5%

TSX Energy                                                       6.2%

TSX Financials                                                   5.9%

Interest Rates                            September 2016              June 2016

Cdn 91 day T-Bills                                  0.50%                            0.49%

U.S. 91 day T-Bills                                 0.31%                            0.25%

Cdn 10 year Bond                                  1.00%                            1.06%

U.S. 10 year Bond                                 1.59%                             1.47%

Commodities (in U.S.$)            September 2016              June 2016

Oil                                                         48.06                          48.40

Natural Gas                                             2.90                            2.93

Gold                                                  1319.10                       1324.70

Portfolio Management Strategy

What Worked                                      What Didn’t

– Technology Stocks                            – Agricultural Commodities

– Palladium                                          – Japanese Yen

– Lumber                                             – Italian Stocks

Let’s Get It Over With and Move On — NL

Markets quite often climb a ‘wall of worry’ and the latest quarter was no exception.  Canadian stocks, as represented by the S&P/TSX Composite index rose 5.5% while U.S. stocks, as represented by the S&P 500, grew 5.1% in Canadian dollar terms.  In U.S. dollar terms, however, that market has traded sideways in a very narrow band since the middle of July.  Quite a long time, actually, in market terms.  Many international stock markets scored impressive gains.  All while impediments such as the upcoming U.S. election, Brexit, Syria, ISIS, sluggish economies, negative interest rates and high price/earnings multiples weigh on investors’ minds.

We also worry about markets, but we don’t lump every stock together.  There are many stocks that have gotten quite ahead of themselves, especially in the U.S.  We are choosing not to invest in those momentum-type of stocks.  On the other hand, there are many stocks that have yet to participate in a meaningful way, and they have caught our attention.  As value investors, we are always on the lookout for good companies whose shares have been ignored for a variety of reasons but whose underlying fundamentals remain strong.  We are also vigilante about pruning expensive stocks from our portfolio and are not against taking a profit in order to protect our clients’ capital after a stock has had a big run.

Also trending sideways were most commodities as well as North American bond yields.  Only since the end of the quarter have mid-to-long term bond yields started to stick their nose up.  Gently, so far.  Lots of money has been lost by investors who have expected interest rates to rise, only to be disappointed, repeatedly.  We say this with great trepidation but, we think this time is different.  Low, and in many cases zero interest rates have caused the stock market to go up a lot, it’s caused the bond market to go up a lot, but it hasn’t caused the economy to go up a lot.

We believe the Federal Reserve in the U.S. is behind the curve and interest rates should, at this point, be higher.  We find it hard to believe that a quarter-point or half-point move higher in rates is going to be harmful.  What it would do, however, is give both consumers and business a confidence boost, as opposed to the siege mentality both have exhibited since the financial crisis.  As a side benefit, higher interest rates would be quite welcome and extremely helpful for savers and pension funds.  They have been the collateral damage and big losers from this extended period of low rates.

We believe it is time for central banks to abandon their losing strategy.  It isn’t working.  Gently start to move interest rates higher.  Get it over with and we can move on.

The Politics of Investing — FB

Everywhere I turn of late I find myself listening to people discuss the US election and, for the most part, say what an embarrassment Mr. Trump is followed by how Ms. Clinton is not a great candidate either.  Long time readers will know I’m a financial conservative and a social liberal neither of which is relevant to either US politics (I don’t have a vote in their election) or making profitable investments.

What is relevant is the effect the election might have on the North American economy and the North American capital markets.  Usually a Republican presidential win would be viewed as good for business and thus the equity markets.  This time the future is skewed by Mr. Trump’s inability to enunciate a sensible economic platform.  His remarks about undoing most if not all of the free trade agreements that the U.S. has entered into over the past 25 years are also troubling.

I appreciate that the polls say he is unlikely to get elected, but the same polls predicted that Britain would stay in the EU.  So, assuming he is elected, what might be some of the possible economic outcomes?  Well, he has allowed that he wants to do away with free trade and that would, I think, cause some significant upset.

We have long been believers in low inflation rates in North America due in large part to business’ access to inexpensive raw materials and cheap third world labour.  If that access is denied through a lack of free trade then inflation could well be driven higher with a commensurate increase in interest rates.  Need I remind readers that interest rates, as described by Warren Buffett, work on security prices the way gravity works on matter.  Or, in English, if interest rates rise security prices will decline.  So free trade IS important as is the U.S. election.  That is one example of the dominoes that might start falling after November 8th.

If Ms. Clinton is elected there is a good probability that large pharmaceutical companies in the US will face political headwinds as she has a history of making an issue of that industry’s profitability when assessing the needs of the voters versus the profits of the drug companies.  We have recently moved some of our “Pharma” holding outside of the US and into a European based company, Sanofi Aventis SA., to best avoid the “Hillary effect”.

We have written previously about stretched equity valuations, excessive debt levels and other signs of potential future trouble but I don’t believe I’ve touched on the risks associated with chasing yield.  I should, as that trend is approaching the ridiculous stage and portends trouble.  Over the past decade, as interest rates declined, income seeking investors moved towards investments that carry a higher income, yet the reasons behind why that higher income is paid are often overlooked.  It should go without saying that if a deal looks too good to be true … it is.  We have been the subject of some criticism regarding the size of our cash holdings with interest rates on cash being so low.  We have refused, and will continue to refuse, to stick our client’s necks into the noose called “high yield” bonds.  Ultimately, that stance will be to the benefit of our clients for I’m as sure as I can be, the chase for yield will end poorly for those most exposed.

On an administrative note the continuing increase in regulatory oversight has led us to the decision that our client contract needs updating.  You will be hearing from Kathy Tevlin in the relatively near future as we proceed with “re papering” all our client agreements.  I apologize in advance for any inconvenience.

October 2016


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