October 2010 Update
THIRD QUARTER REPORT
“Unusually uncertain” were the words that Bank of Canada governor Mark Carney and Federal Reserve chairman Ben Bernanke used to describe our current economic state. We repeat those words because they are a fairly accurate description and reason why markets have remained largely range bound so far this year. The economic recovery that started last year has been fast and robust; however, this year’s growth continues but at a slower pace. This is “unusual” in that cyclical economic recoveries typically do not slow down in its rate of growth at this early stage. The reason of course is that we are recovering from a debt/balance-sheet recession as opposed to a cyclical recession; thus, debt deleveraging is keeping inflation and consumer spending in check. This is creating uncertainty towards the future, as we are growing but at an untypical uneven pace. Welcome to the “new normal”;, a market environment that is characterized by slower steady growth, higher savings, and high levels of monetary and fiscal stimulus.
So, how is an investor supposed to approach and invest in our “unusually uncertain” economic environment? Our approach is to focus on companies whose earnings are less reliant on cyclical growth, pay good dividends, and which are typically less risky. We have a preference for companies in the electric utility, consumer staples, and telecommunications sector; all of which are beginning to show some leadership potential. The upside is that we are looking for more steady growth; the downside is that growth will come at a slower pace and will likely be uneven in timing. Even though the market and Funds have been largely range bound for the year, we believe patience will eventually payoff as we move into next year.
As for the third quarter, the Canadian Fund continued to preserve its value, rising 0.1% and continuing its low volatile year. The TSX Index recouped its loss and gained some from the second quarter on the back of a rally in material and energy companies. After an exceptional second quarter, the World Fund gave back a large part of its 13% gain, by falling 9% in the third quarter. A bit disappointing in the short term, but still impressive over six months, rising 2.8% relative to the MSCI World Index falling 0.4%. Over a reasonable time frame, we still anticipate that the World Fund will likely outperform on an absolute and relative basis as we are finding value opportunities to be very abundant.
CANADIAN ADVANTAGE FUND
The Canadian Fund rose 0.1% in September, ending the month mixed but slightly positive. After a dismal spring, the TSX index bounced back by 3.8% last month led mainly by precious metals, materials, and energy companies. Speculation that the Federal reserve will provide further monetary stimulus helped provide a short term boost to more cyclically inclined companies, of which we do not have much exposure. The temptation is to dive into the more “high risk/fast reward” areas of the market with this boost in stimulus; however, we believe over the medium term there are better opportunities for capital appreciation in the “low risk/slow reward” companies in the utility, telecom, and consumer staples sector. Our best performers in September, were telecom companies Telus (+3.9%) and Rogers (+4.1%), while grocer’s Loblaw (-6.2%) and Metro (-1.1%) balanced out the net return.
WORLD ADVANTAGE FUND
The World fund saw a fairly sharp pullback in September, falling 7.25%. Overall, a disappointing snapshot, as many of our positions traded down to the bottom of their range in the last week of the month. At the same time, many of our companies saw double digit outperformance in the spring and even with the pullback are still positive over six months. Aside from the monthly return, the fund still remains up 3% over the last six months in what has turned out to be a short term volatile market. Our electric utility holdings in Asia saw a sharp correction in the last week of the month, as investors moved away from low risk dividend companies and more towards cyclical companies benefiting from speculation of new monetary stimulus. Given that interest rates are already very low, we believe that additional monetary stimulus will have only marginal benefits towards boosting growth and inflation; therefore, we continue to increase our positions in steady growth dividend companies. The Canadian dollar also strengthened last month, producing a 4% drag to the portfolio. Canadian international purchasing remains very high with the Loonie now over 10% overvalued based on purchasing power parity. Canadians with a medium to long term horizon should take this opportunity to diversify into international assets.
Van Arbor Asset Management is dedicated to creating wealth using a disciplined, value based investment strategy with an emphasis on preserving capital while generating superior long-term returns.
