Market Watch Weekly - October 3, 2014

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As we have seen again in recent days, corrections are only considered “natural, normal and healthy” until they actually happen. Clearly, the equity market has some downward momentum that could continue, but the tactical backdrop, historical precedent and positive fundamental backdrop suggest any further weakness should be made up very quickly – and then some.

Although the current market does cause some stomach churning for many investors, let us remember that we have been speaking about and preparing for this correction for the past few months.  With 10% cash and 20% fixed income in our portfolios we are well prepared and will be looking to add to select positions over the coming weeks.  Our primary equity focus remains to buy companies that are inexpensive and not to sell them until they get above market price-to-value and then replace.  At that time we will replace them with those that are less expensive.   We will set stop losses occasionally, but our main goal is to be patient with our investments and wait for the value to be realized.  Period.

 

It also bears stating that we will always have holdings in our portfolio that may not be main stream investments.  Of course we will own the financials and have some resource exposure in our portfolios as these are the largest components of the TSX, but our real alpha will be generated from our positions in companies that may not make the mainstream analysts’ top buy lists.  Companies such as Westernone or Callidus, for example.  These are companies where management continues to exceed expectations and provide our shareholders with great returns.  But often with these smaller companies the liquidity is lower, and as such, volatile markets cause more wildly fluctuating prices.  We believe the timing is great to add to our portfolios and will be putting money to work over the coming few weeks.

 

Technically speaking, market-stress indicators point to risk aversion last seen in the summer of 2011 when equity markets incurred their last double-digit correction. Whether or not history repeats itself, October should be the month through which equity markets complete their correction. By November, stocks should have unwound the overbought conditions and the overly bullish sentiment that built at September highs.

 

And finally, another factor for us to weigh is the US$ appreciation.  We do not believe this is a negative to Canadians, especially when: 1) it is occurring at mid-cycle, 2) the source is superior US growth, and 3) lower commodity prices allow a broadening in reflation forces.  1993 and 2005 are two years when resource cyclicals outperformed defensives despite US$ strength. Though this could be a late Q4 story, we are staying positioned for a shift in sentiment where global reflation eventually outweighs US$ appreciation.  While previous cycles of US$ strength often short-circuited Emerging Market (EM) growth, the good news this time around is that EM currencies are no longer pegged to the US, hence allowing EMs to enjoy accommodative monetary conditions. Also, EM reflation has begun and lower commodity prices should accelerate the pace of reflation over the next year, hence improving global growth prospects. In fact, US$ strength leading to EM reflation is among reasons why investors should not capitulate on resource cyclicals.

 

On a more personal note, I just recently returned from China where my family and I (kids included since they had a bit of a break from school…) were visiting to accompany my wife Colleen to the latest Long Distance Triathlon World Championships.  It was quite an international field this year and attracted a large number of high profile pros to the race.  Colleen did exceptionally well and made her family proud by winning her age group, as well as coming in the top 5 overall in the age groupers.  I looked after the bike…

 

The trip itself was a bit of a reminder as to the strength in numbers of the Chinese economy.  We visited a city called Weihai – about 800 km southeast of Beijing, on the Yellow Sea.  Just a small town of 2.5 million people…  It was evident even in this location of some of the overbuilding that has occurred over the past few years in China.  Condos sitting empty and streets that were quiet in the resort area of the city.   Next we visited Beijing, a city with an official population of 21 million but unofficially the estimate is closer to 30 million.  What we found out through our conversations with the locals was that there was nothing for sale anywhere within the inner 2-3 ring roads.  If you didn’t know someone who wanted to sell you were not going to be buying.  I can’t help but think, that with the population of China being approximately 1.4 billion people and demand in the larger city’s being as high as it is, it would not take much for these empty buildings to be filled up.  Just a small fraction of the population needs to move into the middle class, which is continuing to happen.  I expect China will continue to have its stumbles, but they will certainly continue to be an economic power to be reckoned with for the foreseeable future.

 

Thank you for your trust.

 

As always, we welcome your feedback.  Have a great weekend.

The Dekker Hewett Group

 

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