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

Companies borrowing to buy back shares. He disapproves of buy backs, preferring dividends. Share buy backs have a short term effect, but it does artificially inflate earnings. Interest rates ticking higher could really affect profits in this case.

Markets. As a value investor, it is hard to find value in this market, and it is getting harder. We’ve had a fairly good equity market for the last few years. This year in particular, Canada is already up on a total return basis of 15% or so, and the US is up over 8%, and it is getting a bit stretched. At this point in time, it is sort of prudent to have a little bit of cash on the side, which you can treat as an option or a little bit of protection. If there should be a setback, which would give a good opportunity to step in. Wouldn’t be surprised if we had a correction somewhere along here. It never hurts to take profits when you got them, so when balancing your asset mix, you can hold the cash on the sidelines so that you can step in again if an opportunity arises.

Oil. There has been a pullback and he sees this as an opportunity. Had felt the energy sector had gotten a little too frothy in April-May, so had taken the cash in his fund up to 34% and was adding some large caps, not the market he usually focuses on. Now deploying cash and is down to 10%, and has been selling his large caps. Oil price is high and the differential between Canadian oil and light oil has been shrinking. Also, the loonie has been falling. Canada is adding “take away capacity” via rail to the US. All of the major issues that investors had challenges with, and the reason they were not investing in energy stocks, have now disappeared. As a consequence there were a bunch of stocks trading at really cheap values. Fundamentals today are the best they have been in 4-5 years. Stocks have had too good of a run. We’ve had a pullback and now is the time to be adding. He is a long-term believer in a high oil price, $100-$110. Many of his Top names that he would hold can grow production by about 20% a year spending 1X cash flow or grow at 10% and pay a 5%-10% dividend yield.

Natural gas. Not as bullish on natural gas as there is a ton of low-cost supply. We have gone from a very bullish to a very bearish scenario in a month. At $4 there is enough plentiful supply in Canada and the US. Areas like the Marcellus shale have grown anywhere from 4 BCF a day to as high as 15-16 PCF, that is the equivalent of being the cheapest in 4 years. That 15 PCF is heading to 30 in the next 4-5 years. When he looks at natural gas names, they have to be very low-cost and preferably have liquids associated with the gas stream because that is where the majority of the economics are derived from.

Markets. He is a Value Investor so is having some trouble finding value in this market. Asia is really the only place where there is value and he probably has allocation for only one more Asian stock. The US, given 1% growth, is very expensive. Europe has recovered and valuations are somewhat ahead of themselves. Feels the China slowdown story is a little overdone. Starting to see some come back on the currencies in Europe, and if that happens, there might be some opportunities in Europe as well. In Canada, oil prices are high, and obviously a lot of the energy companies have picked up and done quite well this year. However, there is still the delivery problem. How do you get the oil from the middle of Canada out to the West Coast? Rail is a challenge and there isn’t a pipeline. Although values have risen on the back of higher prices, he still wonders if those values are sustainable. As interest rates start to move north, that will be a change for a lot of sectors.

Markets. Energy infrastructure is one sector he has identified as promising. There are generally a lot of large cap stocks that have not rebounded fully. Payouts are rising and income growth is plentiful. Technology, transportation, chemicals and are also leading sectors.

Markets. We are in a unique situation where there is so much money on the sidelines; people want to take advantage on any dip. We are not getting traditional corrections, but getting 3%-5% corrections, and then we see money flow positive coming to the market. On the other side, there is this healthy skepticism that is not allowing this to turn into a bubble, which is very, very good. So, while we are pushing the top end in terms of valuation ranges, earnings are coming in pretty healthily on an ongoing basis, quarter by quarter. As long as we keep the cap on and not get too exuberant, the market will work its way higher in a gradual way. There are a lot of people out there who are still feeling the effects of 2008 psychologically, and just not able to commit to the level of equity exposure that they would like to, or think they should to achieve their financial goals.

Small Caps. Historically these have outperformed large caps. They have an ability to move in a nimble way. At this point in the market, we are starting to sniff a little inflation, which is a good thing for small-cap companies. It gives them pricing power and the ability to adjust on the cost side in a much faster way than very large companies.

Markets. The average return, on the 1^st three companies he recommended in his newsletter 3.5 years ago, was about 800%. These were not speculations, but value companies with revenues and profits. It is a lot harder to find them today. He is a bottom-up investor, and it is harder to find things, so he just wants to build cash, and wait for a better opportunity. Cash holdings are probably in the 40%-50% range. There seem to be a lot of earnings misses, and PE multiples seem to be going up. Thinks earnings are going to have to catch up to what the stock market is doing. Feels central banks globally are orchestrating a campaign to keep equity markets healthy and give people confidence. However, there comes a point where valuations have to catch up.

Profit taking. Always take profits. It’s really simple. A profit in your pocket is a “real” profit. One that is on paper can be meaningless. You owe it to yourself to take some off the table. The riskier the stock, the more you should take profit.

Markets. Expects to see a pickup in global growth in the 2^nd half of the year, especially in the US. There are bumps along the way, and that should be favourable to the equity markets continuing to grind higher. Thinks that valuations are a little bit stretched at this point, so we need the earnings and the EPS to pick up a bit. Those positive trends hopefully will continue. So far this season, 1/3 of companies on the S&P 500 have reported, and 76% have been estimated so far. That is good news. Comparing equities to bonds, equities are probably the winner in terms of what is going to happen over the next 12 months. Interest rates should stay low until next year. Some of the geo-political tensions are getting a bit worse, so some of those things should be watched out for. Also, volatility low levels are way lower than what they should be. Well over 25% below long-term averages. He is moving cash up a little bit from 25% to 12%-13% right now, in order to take advantage of any opportunities. He continues to favour the more economically areas, the cyclical stocks whether they be technology, energy or industrials. These are the areas you want to be in right now.

Markets. Volatility has been benign for so long, that expectation would be that at some point we have to have volatility move up. With the geopolitical events last week, there was a one-day spike. When you have a very low volatility period for a long time, chances are at some point it is going to go up, and markets are going to get choppier. He is still positive on equity markets, and feels pretty good about the US economy recovering. Valuations are a little more stretched than they were a year or 2 ago. You have to be a little more selective on your stock picking, and hold a bit of extra cash. In his funds, he does a bit more hedging, and looking at short positions, and ways of hedging out some of the risks in his portfolios. Key themes are the US economy, which he thinks is going to surprise to the upside, and increased M&A activity.

Stop Loss. These are very difficult to use. You really have to be on top of them and adjust them along the way. You can’t just use them by keeping them static. If there is an unusual event in the market, stocks can move down quickly and back up, and you can get stopped out of your position at an unfavourable price. He generally doesn’t use them, and just tracks things carefully.

Economy. We were hit with the bad news of the weather in the 1^st quarter, which took the steam out of the US economy, and slowed things down. Just naturally you would see a 2^nd better half. Feels the things that will get things going in the US will be housing starts. Existing home sales were pretty strong. The last housing start number was a bit weak, which was a surprise, but it seemed to be weather related. Feels the US domestic economy is going to have a very good 6 months, and that will get things going. The US needs at least 1 million housing starts every year.

Markets. He has never seen a Bull market that is so disliked by so many people, primarily professionals. More in the US than in Canada. However, the market just keeps marching up. As long as short-term interest rates are zero, if you are not in the market it is like being Short. The S&P 500 was grossly overvalued in February 2000, in the tech boom. It took 10 years to reconcile that, which was then followed by a financial crisis.