The Quarterly:

October 2015

“Patience is power. Patience is not an absence of action; rather it is timing; it waits on the right time to act, for the right principles and in the right way.” Fulton J. Sheen


The purpose of this quarterly commentary is to communicate with you about our thoughts on the markets, provide some snap-shots of market metrics, and provide an overview of topical issues; however, it will also be married with some aspects of our recently initiated monthly commentary, in order to provide you with a succinct update of our views on the market, without the need for two separate communications.  We hope you enjoy this information, and that it allows you to better understand what we see going on in the market place.


The third quarter of 2015 saw a return of volatility, as a collapsing Chinese stock market led to short term international market panic. A strong retaliation from the Chinese government evoked uneasiness in the eyes of the Western World, as investors began to wonder if the Central Governments persistence to prop up an over-valued market was a negative signal of how the world’s second largest economy was truly performing behind the curtains. The VIX (a measure of volatility) spiked enormously over the period, with an opening oscillation which was too high to even register. Volatility remained elevated over the course of September, finally settling down to previous levels through the first weeks of October. The Shanghai Index lost a third of its value over the two weeks following ‘Black Monday’, pulling the S&P 500 and the TSX composite down over 11% and 8.5%, respectively, with it. Although the Chinese government’s efforts to stabilize their stock market eventually succeeded, and volatility eventually subsided, these two major North American markets have yet to recover the ground lost over this period of time. In response to this volatility and the related market declines, we published an interim commentary detailing why we thought this activity did not change our mid-to-long term view for North American investors. The only companies in any real danger are those heavily exposed to China, such as several base metals or energy companies, which we have remained underweight towards. If you did not get a chance to read this interim commentary, it can be found on our website on the ‘Content’ tab.


Trudeau North Strong and Free

Although all of our clients are undoubtedly aware of the recent historic election, we thought it would be of interest to detail some of the more interesting aspects of Canada’s recent decision.


Following almost 10 years of Conservative leadership, the Liberal Party, led by Justin Trudeau, was elected in a surprisingly dominant fashion, winning a majority government with 184 seats and 54% of the vote. The Liberals benefitted from seemingly strategic voting tactics in many ridings, where the ‘Anyone but Harper’ mantra resonated strongly. This effect was particularly evident on the East and West coasts, where personal issues caused the Conservative party to fall considerably out of favour. In the East, large pockets of veteran communities had been spurned by Harper’s recent cuts to their personal benefits. In the West, a heavy environmental sentiment and staunch opposition to the Northern Gateway pipeline caused an equal reluctance to vote for the Conservative party. This environmental tilt also led to the Green party’s only seat, where Elizabeth May, representing the Vancouver Island riding, regained her position. In Quebec, the Liberals benefitted from the waning NDP approval and the void left by Jack Layton. Many Quebec ridings previously held by the NDP were transferred to Liberal control. The only areas of strength across the nation were found in the Prairies, Alberta, Saskatchewan, and Manitoba. Following the defeat, Stephen Harper announced that he would be stepping down from his position as the leader of the Conservative Party.



Perhaps the most historic and important aspect of the election was the voter participation level. Of approximately 25 million eligible Canadian citizens, 68% of those voted either on October 19th or during the elongated four day advanced voting stage. Advanced poll activity increased by 75% over the prior election. This was the highest voter participation since 1993, and demonstrates the desire of Canadian citizens for change. We will have to wait in order to discover whether the incoming change of leadership will be for the better or worse, but here are a few of Trudeau’s stated policies that, if realized, will affect us as Canadians both domestically and internationally.


  • Trudeau has pledged to end our direct combat involvement in Iraq and Syria; a notion which he re-affirmed in a recent discussion with President Obama. The new Prime Minister has not given a timeline for our exit, but still advocates involvement in the conflict via training local troops and providing further humanitarian aid. This will be a stark contrast to our current direct involvement in the combat mission; we were responsible for 10 bombing campaigns in Syria over the last month alone.
  • Also in regard to the Syrian crisis, Trudeau has pledged to swiftly accept 25,000 government-sponsored refugees into Canada, with promises to increase that figure moving forward. He has also pledged $100 million of funds this fiscal year in order to improve refugee settlements and another $100 million in funds for UN refugee programs.
  • He has publically supported the completion of Keystone XL, but not the Northern Gateway pipeline. However, climate groups are not concerned, as they believe that Obama’s administration will not allow the project to happen, regardless of who the Prime Minister of Canada is.
  • In regards to the environment, he is committed to putting a price on carbon and shying away from setting – and eventually missing – arbitrary emissions targets. Within 90 days of the upcoming climate conference in Paris, Trudeau pledges to publicize a plan to address Canada’s contributions to climate change.
  •             Aboriginal rights and issues, which have been a hot-topic issue for Harper, will also allegedly receive further focus and funding under Trudeau. The new PM spoke of a “renewed nation-to-nation relationship with Canada’s indigenous people”, and has noted several specific initiatives as areas to ‘close the gap’ between the marginalized group of people. One aspect of this will be to immediately call to action and investigate outstanding missing and murder cases for Indigenous women, who have been found to be approximately 4 to 5 times more likely to be the victims of violent crime. Another is a pledged $2.6 billion for on-reserve education facilities. The last is to end all boil-water advisories that currently affect 132 aboriginal communities. All policies seek to close the gap in health, income, knowledge, housing quality, suicide and incarceration rates that plague these communities.

    ·         Although specific details and timelines of the plans are not yet available, the Liberals have pledged to spend an average of $4.2 billion per year for the next four years, funded by selling Canadian government bonds. This approach of deficits rather than surpluses during weak economic periods is meant to boost the economy through spending, as opposed to cutting.

    ·         Trudeau has also been fervent in his objective to boost the middle class, proposing a 2% cut to income tax rates for the middle class, while raising the top Federal tax bracket by 4%. He has additionally proposed reversing the recent increase to the TFSA contribution limit, as well as removing income splitting for families.

This is not necessarily an exhaustive list of Trudeau’s policies, but it does categorize the most high profile and imminent policies which he has stated that he will address.

How these initial policies will affect you personally will vary depending on your individual situation, but the most visible will be the changes to taxes, TFSA contributions and income splitting. If you would like to discuss any of these policies as well as how you should approach them, please feel free to give us a call or send an email.

In terms of the effect on the market, as with anything else, there will be winners and losers, and it will take time to properly identify them. Developers, Engineering firms and Infrastructure-related firms are the most visible beneficiaries, while it remains unclear what the net result will be on the oil sands and energy stocks. A local example, which jumped on the news of a Liberal majority, is Aecon Group. They are heavily involved in Toronto infrastructure projects, and have a long history of government contracts. With a majority Liberal government, a liberal Provincial government, and a Mayor who ran on an infrastructure-heavy mandate, there seems to be a good chance that we will see improved infrastructure and transportation spending on a local level. We can only hope this will assist in easing our commute times.

Downtown Toronto, specifically, was integral in the end result of a Liberal government, with a heavy shift from Conservative to Liberal voting behaviour in relation to the 2011 election. Although, the chart below suggests Torontonians may have had an ulterior objective. Coincidence? Maybe. But Toronto has had little else on their minds lately.

A Consumer-Driven Market

As stated frequently, in regard to the overall global economy, it seems to be the U.S., then a large gap, and then everybody else; they are very much carrying a fragile global economic environment. Much of this is due to their size, part of it is due to massive quantitative easing, but a lot of the country’s relative strength is due to how insular it is. 70% of the country’s GDP is driven by consumer spending, and currently, with generationally low gas prices, rock bottom interest rates, and a strong US dollar, the American consumer is in a strong position. This has translated into strong consumer spending data, as well as a rebounding of the housing market and improved consumer confidence. The most recent University of Michigan consumer sentiment gauge was published to be 92. Historically, economists state that this level of sentiment has resulted in an average annualized gain to consumer spending of 4%. 

However, the other side of the equation – manufacturing and industrial activity – have been fairly weak as of late. As Doug Porter of BMO Capital Markets states: “The stark dichotomy between the fortunes of consumers and exporters is playing out in a variety of stats and company results.” Industrial output slipped last month by 0.2%, with renewed weakness in oil and a significant drop in corporate investment and spending. The Markit Manufacturing PMI was listed at 53 in October, the same as the year prior, and the lowest reading since 2013. In addition to weak corporate investment, the manufacturing sector has been hurt by weak export data, largely thanks to slow economic global growth and a strong US dollar. Recent total export value for August were 10.5% below the level they were at a year prior. This weakness in spending and other structural headwinds within the sectors are beginning to show in corporate results, with many companies announcing missed earnings estimates and large swathes of layoffs.  

The chart below, taken from Business Insider, is apt at displaying the contrasting position of the consumer and the manufacturing and industrial sectors.  




By far, the consumer economy is much more integral in regard to US GDP, accounting for almost 70% of all GDP generation. On the contrary, manufacturing only accounts for 12% of the US economy. Understanding this allows you to see how the US economy can grow sufficiently, despite pockets of industrial weakness. However, it also evokes another iteration of the idea of the US economy supporting global markets; not only is the US economy in general holding up global capital markets, but, unfortunately, it seems that the US consumer is the key pillar holding everything up. The silver lining here is that it gives US economic consumer data a large amount of predictive power. If this data begins to turnover, the US markets – and, by extension, most other stock markets – will be in trouble. We continue to closely monitor all US consumer activity, and, in the event that this data shows signs of concern, we will be ready to take precautionary and preventative measures to protect all portfolios.


Technically Helpful

One of the things that we have frequently stated as a goal of this commentary is to provide transparency and insight into the finance and investing world in general. In the spirit of this, we thought that it would be of interest to detail technical analysis.

Technical Analysis is often seen and portrayed as some sort of financial ‘voodoo’ that only pariah geniuses can properly understand. Hollywood movies, as usual, definitely hold a portion of the blame, but we also believe that the designation’s proponents also do a poor job of presenting its tenets, typically.

On a top level, technical analysis recognizes that the capital markets are a culmination of millions of individuals, all with their own behavioural tilts, biases and irrational actions. These analysts use charts which outline historical price activity, as well as trading volume, and attempt to discern the most likely scenario for the stock or market moving forward. They focus heavily on attempting to gauge overall market psychology as well as the relative balance of fear or greed. This represents the most major misconception: technical analysis is more about psychology and sentiment than it is about math and charts.  A more accurate name, Michael Kahn of Forbes notes, would be ‘risk-reward analysis’ or ‘market psychology’. As the idiom goes “numbers don’t lie” and looking at the bird’s eye view provides a fresh and objective perspective on what is happening with one particularly stock or market.

In terms of execution, technical analysis is a useful tool that further informs our buy, sell or hold opinions. Specific patterns, shapes or ranges in stock charts are signals of the market’s opinion on the underlying stock, and a breaking of formation from the recent trend represents a changing of opinion or market psyche. If a stock price trades in a particularly pattern, it is because it is moving within boundaries which represent the average intrinsic valuations of the market participants.

A breaking of formation means that one side of the equation – those that value the stock lower than it is, or those that value the stock higher than it is – has changed their opinion. A price that was once considered expensive is now inexpensive, or vice-versa.

Traditional fundamental analysis is often layered on top, and is a useful supplement when attempting to discern why there has been a change of opinion on the stock or market. Typical fundamental data such as future sales, earnings, or management cost estimates are all subjective and volatile data points, so something concrete such as historical price and trade data also helps to supplement fundamental analysis.

The Rise of the ETF:

Recently, our friend Chris Mayer – a popular American newsletter writer and author of ‘100 Baggers’ – put forth a fascinating publication which details the effects that ETFs have had on the market. The findings and supplemental opinions of our own, to us, firmly re-assert our own opinions on how to outperform in the contemporary environment.

As most will be aware of, an Exchange Traded Fund (ETF) is a vehicle, which trades like a stock, and is meant to mimic and underlying index or basket of stocks, with proportional weightings that are the same as the underlying index or basket. For example, this means that if you own an ETF which tracks the S&P 500, the percentage of that fund’s assets which is invested in Apple will be the same as the percentage of the index which Apple constitutes. Doing so with all 500 stocks will allow the fund to track the same performance as the index.

These products have been revolutionary and extremely popular, however, the way that they operate has created a certain issue which ostensibly distorts the value of stocks which are heavily held by ETFs. 

Inherently, the managers of ETFs have no discretion over what is bought or sold in the fund – they are tied to whatever the underlying index or basket does, or however it is made up. Additionally, once new funds are invested into the ETF, new shares are issued, and the newly added funds are invested in proportional amounts, once again, to match the underlying index or basket. ETFs will traditionally keep cash levels which will allow them to handle moderate redemptions, however, if redemptions surge, the fund must sell the same proportion of stocks in order to facilitate the redemption and maintain the correct weightings. The resulting effect is a system where many large stocks are purchased or sold based on decisions extraneous to fundamentals. McDonald’s is a good example which Chris Mayer brings up in his publication. The company has been confronted with several headwinds as of late, especially domestically, as citizens adjust to healthier lifestyles or switch to competitors. Top-level revenue and same-store revenue has been falling fairly consistently. Despite this, and largely due to its large ETF ownership and size, the stock trades at 19x forward earnings. In Chris’ publication, Peter Doyle, the CIO of Kinetics Mutual Funds, outlines a few names which are much cheaper and exhibit a much better growth profile than McDonalds, yet trade at far lower multiples. McDonalds is a beneficiary of a massive amount of capital which is mandated to buy it regardless of its fundamentals. This has been referred to as ‘dumb money’ and works to distort the fair value of certain stocks, which makes it harder to find justifiable entry points in certain popular companies. Mr. Doyle goes on to state that “We don’t know when this is going to change. And after giving it a lot of thought, I don’t know what would change it either… Even if nothing changes, you have better upside owning growing firms at cheaper prices that may someday get into a big ETF.” 

While ETFs are mandated to purchase the stock of certain companies, the opposite is also true on the downside. In the event of a surge in redemption requests, these funds are required to sell a multitude of stocks in order to fund the redemption, also without regard to the strength of the underlying investment. This gives all large stocks a certain level of increased market or ‘beta’ risk, where they will exhibit weakness in tandem with the overall index, even if the underlying business is operating strongly. The net effect of this aspect of ETFs, to us, results in an inability to use large cap stocks as any form of proper diversification, regardless of their industry or business strength. The chart below is fascinating and confirms this belief. The Y axis indicates the level of correlation of the large companies, and the X axis is time. Significant periods are labeled. This not only shows us that the level of correlation among these stocks has increased over time, but also that everything goes down with the ship in the event of a correction or worse.  

Large cap stocks will always be an integral part of investing and will be the primary beneficiaries of long-term economic growth, however, we believe that this discussion reaffirms our belief on using proper diversification in order to protect portfolios in all market cycles. Things like gold and precious metal stocks or real assets have small or negative correlation to traditional large caps, and as such, they will work to protect your capital in the event that markets perform poorly. Additionally, we also believe that this highlights the importance of utilizing small cap or obscure stocks in order to achieve long-term performance. Obscurity and smaller size allows us to identify stronger companies which trade at more favourable valuations, with prices that are strictly linked to underlying fundamentals.


MacNicol & Associates Asset Management Inc.

October 2015