A Comment -- General Comments From an Expert (A Commentary)

Energy. Company’s earnings have been fantastic. They mostly have hedges in place until the end of the year, so they are doing lots of production, which forces the price of oil up. He thinks oil is going up a little bit higher when all these hedges come off at the end of 2015.

Which ETF for a best one-year return, oil or gold? A lot of companies are selling oil at a lot higher prices, $75-$95, so they are continually pumping out production. But in 2016, those hedges are going to come off and he thinks production is going to cease in 2016, and a barrel of oil will go higher which will create a demand situation. Remember that the oil situation is not about demand, it is about supply. He is not a “gold” guy. There is no demand from India or Central Banks for gold. He would not be buying anything gold for the next 12 months.

Impact of interest rates on US healthcare or multifamily residential REITs? REITs are basically leveraged companies. They borrow money to buy assets. Rates are still extremely low. If they are 50 basis points and they go up to 60 basis points, it is not going to really make much difference. He has no problem with interest rates going higher. Residential US REITs is a good buy.

How do you screen and start into ETF’s? You have to think of whether you want a broad sector, a healthcare sector, a bank sector, etc. Try to pick a sector, and then you can find a listing for all the ETF’s for that sector. Then you need to look at what the MER’s are. Some can be quite large. Also, look to see what the weighting is; is it market cap weight or equal weight.

Maximum holding of any one ETF in a portfolio? A 5% position would not be overly diversified. If you are looking at a broad ETF, he would hold no more than 7%. If you are looking at a sector ETF, you are basically looking at one security, so he would limit it to 5%, or 7% if you are feeling really confident about the sector.

Markets. It has been an interesting ride. Really hard to assess whether we have seen the market bottom. The last couple of days have really made us feel a little bit more confident. This has been a “made in China” correction. Who knows what kind of policy will come out that will either impress or “not impress” investors. There could be a retest of lows that investors should be aware of. Thinks the present bout of volatility is going to last days or weeks, rather than quarters or years. Doesn’t think we are going into a prolonged correction, certainly not a bear market. He has been taking the opportunity of buying some large cap names that he has been watching for some time. Really impressed with how cheap they became. Had about 15%-20% cash and as of today is down to about 10%-15%, still a high cash component, to take advantage of any possibilities that still may come.

Markets. Resources have been beaten up for couple of years now, and with the slowdown in China that sector has really suffered to the detriment of some of the other sectors on the TSX, which have become terribly expensive. Some examples are Consumer Staples, Consumer Discretionary, Healthcare. They have come down to reality and we are seeing them as reverting to the mean. It creates opportunity on the small and mid-cap side, but the large-caps are terribly overvalued. Thinks Canada has been really oversold here. There are a lot of bargains out there.

Markets. Feels we are in a little bit of No Man’s land and that we are in the later innings of the correction. Corrections are always defined by extent, time, duration, percentage, etc. and he looks at it a little differently. He wants a Correction to have the effect that it is intended to have, i.e. to basically weed out the weak holders in the market, to remind everybody that equities is a risk phased asset and that the risk/reward is intact. Thinks this one is having that affect. What we normally see in Bull Market corrections are the short, sharp corrections versus the Bear Market effect of just wearing you out. This is showing all the markings of a Bull Market correction, with the extreme volatility, reversals, volume fluctuations, etc. We may have a little bit more to go, but he would remind everyone that equities are long term assets, so keep your eye on the horizon and don’t sell into this through any form of panic. This isn’t the end of anything, this is normal. We can move to new highs, but investors have to be selective. Rather than looking at percentages of the depletion of their various stocks, they should be looking at fundamentals. Do they have real growth of revenues, cash flow and earnings? That is going to be the thing that will allow these stock prices to move higher. Just the fact that they have corrected 10% or 20%, doesn’t give them the right to move to a new high.

Industrials? The core issue of the industrials is their international exposure, and the fact that the FX translation has taken anywhere from 5% to 10% off the table for them. He has sold some of his holdings. Had seen that there was a headwind there that wasn’t likely to abate.

Energy. The implosion we have had rivals the great recession, and in fact is worse. In some cases names are trading at all-time lows. Negativity in the energy sector is unparalleled and is really historic. There are 3 reasons he feels people are so bearish on oil. 1.) We are told demand is very weak and there is a fear of Chinese demand falling. 2.) We are awash in oil with Iranian oil hitting the market and US production still up. 3.) The forward Strip with oil below $50 is all the way out to 2017. You can see why people are being far too negative. 1.) Demand today is at record amounts. Year-over-year growth rate is as strong as it has been since coming out of the great recession, so we consume more barrels today than we ever have in history. 2.) We know Chinese demand is weak, but he would love to see the data points that people actually have, because the numbers he has shows record oil imports into China and record gasoline consumption in China. Their demand has been flat lining for 3 years, so it is not a new story. If you remove China, emerging economic oil demand has been growing by 1 million barrels per day, each year for the past decade. At current oil prices, it is impossible for US production to grow and we are months away from it being down year-over-year. Even at $45-$55, US oil production could be down by half a million barrels per day by next year. The worst case of Iran is about 800 hundred thousand barrels a day to come onto the market. That represents 6 months of demand. For the past 5 years, outside of OPEC and the US, production has been falling while the average oil price has been over $100. There are companies that can theoretically still drill wells that have a positive rate of return, and yet are still going bankrupt. This is because the amount of cash flow most companies generate is not enough to offset their decline. 3.) The oil Strip tells us we should be negative. He believes we have to go to 2017 until oil is over $50. Looking historically at the predictive capability of Strip, the R squared is less than 1%. That means that one time out of 100 the Strip is actually accurate.

The valuation of these energy companies is unparalleled. You can get so much value for free, because everybody is so pessimistic. It is a waiting game of maybe 1-2 quarters. If he can buy stocks that are trading at 5X cash flow where he is getting possible reserves, their dividend, of which many are sustainable when we get a rally, stocks can go up by 50%-100%. He personally thinks we will recover to around $55-$60 at some point next year.

Markets. Every now and then the market goes through a chaotic period where it kind of loses itself. It detaches itself from fundamentals and you get either a selloff or equally you get a huge run in the market, but we don’t consider that to be a problem when it is going up. This is the 1^st really serious correction in about 4 years and is probably overdue. The important thing is to not lose track that earnings, generally speaking, are coming in line. It is really an issue of supply/demand for stocks as opposed to a big reaction to what is happening on earnings. Ultimately earnings drive where the market is going, and as a consequence this will come to pass in the not too distant future and will be back into a good market. His thesis on growth stocks, which will very much affect the NASDAQ, is that the knowledge based industries are often the most attractive place to be. These stocks can have very volatile moves to the upside. These stocks have been cruising for very, very long time, so if they check back by 10%-15% it might seem like a pretty severe correction. It is a normal course of events that the market has deposits from time to time and sorts itself out. The key thing is that nobody can time the short term movements of the market or trade it. Focus on resilient business models that can grow under any economic circumstances, and when you find you are in a market like this, just ride the storm out.

How do you assess what constitutes a competent and astute management team? When he meets with a new company, the first meeting is to take a measure of the CEO, not the company, and find out what his story is. His theory is that people are not mediocre for 30 years and then become superstars. There are usually a whole bunch of signs of exceeding expectations or outperforming all the way through their career. The smaller the company, the more important the jockey. He would then check out the management team.

Canadian Banks? Excellent quality and pay good dividends. They don’t have a high enough ROE for his fund, but for somebody who is doing their own thing, having a weighting in banks is terrific. Given all the macro issues in the world right now, he wouldn’t actually buy a single bank. You can own any one of the pick 6 banks. They are all well-managed.

Markets. A couple of weeks ago, he had said there were notable signs of decay. Markets had the narrowest trading range in 90 years. It broke late last week giving you a more dramatic move. He was looking for the S&P 500 to come off somewhere between 10%-15%. Once we broke 10% this morning and got towards 15%, the extremes of the market, it was down more than 15%, but the buyers stepped in. Had been positive on gold in buying the dips, but sold it all out on Friday. It was an anaemic bounce on gold considering the rout on global equities. If gold can get a flight to quality trade, inflation is not coming back anytime soon, so he is out of gold. REITs are a place in the Canadian markets where you get great yields. When you look at how far they have come off the top, it is a very good correction for the yield seekers out there. He would look for a bounce of 4%-5%, which could take weeks, followed by another move down of 15%, maybe 20%. Doesn’t think we are going into a major global bear market.

Markets. He had been talking about a 5%-10% correction, so at about 7 AM, if you took the 4% decline right across the board and added them to last Friday’s declines from the highs, you are between 10% and 15%, so he thought it was possible that we might have a bounce. We had our correction and he is quite positive going forward. This tells him that sentiment was in the hands of the traders. They saw an opportunity to make a buck, and they did. The majority of investors probably didn’t sell into the decline, being in it for the long-term. In the very short term, he has a list of things that he wants to buy. Some have come down precipitously, much more than the market, and others that haven’t budged very much. As prices approach Buy points, he will cautiously step in. Since 2008-2009, people have not trusted this market. Probably one of the most heated Bull markets in history. He has counselled his clients to be patient. The US is improving rapidly. Wildcards are China, Japan and Europe.