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

Markets. Because he is focused on mid-caps, there are only about 450 names that are listed in Canada. This gives a relatively narrow pool. This is narrowed down more because he doesn’t invest directly in resources. When you take away the non-resources and focus on mid-caps, there is a fairly decent pool of about 200 names that he is interested in. Currently, he is about 90% Long and about 50% Short, so his net exposure to the market is about 40%. If you have a 40% net position, you have about 60% cash, so if he sees something he likes, there is no need to sell something to get it. Constantly looks at the liquidity of his portfolio to make sure that he is able to get out. As a general rule, he wants to be able to liquidate 85% of his portfolio within 5 trading days.

Markets. We are in a secular bull market for stocks. This is a multiyear period where 2 things happen. Earnings grow, but as people become more confident, multiples that people pay for those earnings expands. One of the hardest things to do in a secular bull market is to stay invested. All the way through the 90s, more value oriented investors felt that multiples were getting too high. If you sold stocks when they started to look more expensive in the early 90s, you missed a big part of the bull market. Against the backdrop of low interest rates, which are likely to stay there for a while, the return that an investor can get buying equity with a dividend, and get dividend growth, is very attractive. Unless you think rates are going to go up a lot, the relative return available to an equity investor is still very compelling. There are several sectors or themes where there are some big macro shifts that have taken place that can support expanding valuations for a few years. We are likely to see more volatility over the next 5 years, then what we saw 2007 through 2011. There were a lot of negative expectations built into the market, but that was more short-term weather driven. Those secular themes are likely slowly kicking in and will be good for industrials, consumers, technology and healthcare.

Markets. All of the problems he was worried about in December, still exist. Valuations really haven’t changed much. This really validates what his concerns were. You have a rapidly rising US$ and a fairly robust domestic US economy, but you have dislocations. Europe is doing a little bit better and getting a bit of a break on energy prices, which is somewhat transitory. The strong US$ has been a big headwind for US multinational corporations. Whenever you have a strong US$, you tend to have emerging market crises, and we are on the verge of one. There is no question that US domestic businesses have done better than US multinational businesses. His cash levels have built up pretty substantially and he is now standing at 27%. You really have to search around in the weeds to find investment opportunities these days.

US$. Where there are free-flowing currencies, and countries have to repay interest and the notional value of the bond in US dollars, it is going to be a lot more expensive for them. This will likely cause some credit stress over the next year or so. He is pretty sure the dollar is going to remain strong over the next year or so versus most currencies, specifically the euro and the yen. For the first time ever, Chinese estate values are going down. Money has been coming out of there to feed the stock market. Chinese mainland stocks have doubled over the last year or so, more importantly the last 6 months. Margin requirements were raised on Friday, but to combat that a shift in the reserve ratios to kind of neutralize things, the market seem to be a little positive this morning that there is no worsening in the Greek situation. Year-on-year earnings are declining, most of it, not all, is coming from the energy sector. He expects this for the next number of quarters.

Fixed Income Suggestions. There are a couple of things to consider. You have credit risks. Corporate bonds, with the worse quality of these being high-yield or junk bonds. You will get a much higher yield, but those correlate a lot more with equity returns than they do with bond returns in general. If you don’t want a lot of interest rate risks, then a short term, 1 to 5 year laddered bond portfolio. All of the providers have them. If you fear that credit might be a problem at some point, then you want something with a bit longer duration on the government side. If stocks fall, government bonds will tend to do well. Longer maturities tend to do better than shorter ones when you have a flight to safety.

Gold. At $1150, he kind of likes some exposure to gold. If you are going to hold gold for a long period of time, you are probably better holding gold equities, as gold bullion yields nothing. If you are thinking about trading, ETF’s are fine for that. He would suggest 5% or 10% in your portfolio.

Natural gas ETF, based on an outlook prices will increase in 3-5 years. There are 2 ways to play this. In the US FCG-N is the large cap natural gas weighted ETF of the companies. You get a dividend on this. In Canada ZJN-T is the Junior natural gas weighted ETF. If you have a 3 to 5 year view, do not even remotely consider any ETF’s linked to the underlying commodity. The underlying NAV erosion, over a long period of time, could be toxic.

Greece. We are now in Act III of the Greek tragedy. No one knows for sure how this is going to play out. For a German taxpayer, who has just had his retirement age raised to 67, to use his tax dollars for his government to fund Greece, where a guy there retires at 55, it doesn’t add up. Feels it ultimately comes apart, but the pride in Europe is really strong and they are going to try to keep it together. A chart showing capital outflows as a percentage of GDP in Greece shows the intensity in the last 6 months is far greater than in previous ones. People with money in the banks in Cyprus actually lost money on their deposits. This is why money is fleeing Greece. About a year ago, Greece was able to come back to the bond market and issue bonds. They issued a 3 year bond at 3.38 which is currently yielding 27%. That is pricing in over a 50% chance of default. The European bank Index is still 60% below its peak before the crisis of 2008-2009. We are back up to the levels where we had seen problems. The vast majority of European banks failed the stress tests. He doesn’t think a QE is going to help and fix this.

Energy. Has sold all his energy producers and is out of energy completely, except for Pembina Pipeline (PPL-T) and Keyera (KEY-T). Hasn’t made a lot of money on energy, even in good times. Prefers owning companies that have strong pricing power, have the ability to raise their prices, and the ability to raise and compound capital over time, in a more certain business environment.

Markets. 25% of the Canadian Index is tied to energy or energy related companies, as well as other related plays in the index. Not easy to get diversified, so he has gone outside of Canada to get exposure. The great companies have PEs priced at excessive levels, because there is nothing else to buy. When you gravitate to looking for non-commodity related companies, everybody else is looking for them too, so valuations are too high. Because of this, he is looking outside of Canada and has found a lot of good ideas in the US. US and Canadian financials look extremely cheap. Also, healthcare and US technology also look attractive.

US currency and the US market? He wouldn’t put 100% of his clients’ money into the US, but currently is about 65% Canada and 35% US. The currency has worked in his favour recently, but that doesn’t mean it is going to continue to work in his favour. You have to own the best companies that you think are reasonable, cheap on valuation and are going to grow. Currency has a way of working itself out over the long-term. The companies he buys, he plans to own for 3 to 5 years or longer.

Currency hedging? His issue is that this is costly, and if you do it through a hedge product, it will eat into your fees or your dividend. Because of this, he doesn’t do it. He would be buying J.P. Morgan (JPM-N) or Goldman Sachs (GS-N).

Markets. There is a greater than average probability of a correction this summer, probably 10%-20%, or probably a bit higher. There are a lot of different factors involved. First of all there are formations on the market. We have not had a 20% correction on the S&P 500 for literally for 4 years. Lack of volatility is not a great thing. He is also starting to see some of the secondary indicators that are showing that volatility might return. When levels of the VIX (volatility index) get too low, we tend to not stay there forever. His chart show that we have been hanging around in the low end (10 to 13) for a couple of years. This can’t last forever and he thinks we are probably going to see a move up. Looking at Breadth, it basically says how much participation there is in the stock market. He is looking at a 40 day moving average of the new highs and new lows on the NYSE. The chart shows stocks are moving up, but the moving average is heading down. 71% of Dumb Money (unsophisticated such as retail investors) is very bullish, versus 35%-36% of Smart Money (basically professionals, i.e. insiders, pension managers, sophisticated investors, etc.) A 2 to 1 ratio. Not such a great thing when Smart Money is leaving the room and Dumb Money is piling in.

Economy. He is waiting for rising interest rates in the US and everywhere. What is fuelling the stock market is what he would call just free money. Worldwide investors have been pouring money into equities, because fixed income is either providing very little or nothing. Large US multinational companies are being hit with currency issues because of the strong US$. Has been scaling back his exposure to equities, as he has found it much easier to Sell than to Buy. Hasn’t been adding anything in the multinational area, but has doubled his position in 3 banks, 2 US and one Canadian. For the most part they don’t have the exposure. Also, valuations are much, much more reasonable than multinational companies, especially consumer stocks.

Markets. He looks at what drove returns over the last few years and he had stocks that were undervalued. There were earnings expectations where the bar was very low. As well as this, the US economy was recovering. Today stocks are no longer cheap, earnings expectations are no longer low, but the good news is that we are seeing the US economy continuing to recover, but there are just not as many inputs driving equities higher. For the last 4 years, he has favoured the US market over the Canadian market, primarily because when he looked at the TSX, which is made up of commodities and banks, he has been pessimistic especially on the commodity space. Equities as a whole, whether you are looking at the US or Canada, the easy money has been made and we should expect more volatility as we move forward.