Gauge Spring 2017
 
Despite all expectations to the contrary, equity market performance in the first quarter of the new U.S. presidential administration was empirically rather void of volatility.  The S&P/TSX Composite index earned a fairly average total quarterly return of 2.4%, whereas the U.S. S&P 500 index was much stronger, with a total return of 6.1%.  Notably though, stocks traded in very tight ranges for much of January and March on both sides of the border, so much so in fact that January was the 2nd narrowest trading range for U.S. stocks during the past decade with just 2.5% separating the high and low points for the S&P 500 index during the month, and the 5th narrowest monthly trading range for Canadian stocks with just 2.3% separating the high and low water marks for the TSX Composite during the month. 

As the deluge of fourth quarter earnings results were released in February, U.S. stocks surged, while Canadian stocks mostly just treaded water.  And as the quarter came to a close the quiet calm investors felt in January set in again in March with Canadian stocks eking out a modest advance while U.S. stocks mostly treaded water.  Bonds, for their part, paid their coupons and mustered small gains in price as rates fell and credit spreads compressed, such that the FTSE TMX Universe bond index earned a total return of 1.1% for the quarter, with corporate credit outperforming government bonds.    
 
Investors would do well to remember though that volatility, much like the man in Monty Python and the Holy Grail is “not dead yet”, but rather is merely subdued for the time being.  It will return, and rest assured, many pundits will then proclaim “I told you so”, and will sound the alarm bells over the state of the American government and the inevitable calamitous end of the long bull market cycle that began in 2011 in the United States. 

But none other than the Oracle of Omaha himself, Warren Buffett, in a television interview on February 27th, cautioned that “if you mix your politics with your investment decisions, you’re making a big mistake.”  Goodreid concurs and would view any such instances as buying opportunities. We reiterate our stance that the developed world, and Canada and the United States in particular, are on the cusp of an important secular regime change wherein the thrust of policy stimulus is transitioning away from monetary policy (low/negative interest rates, quantitative easing, etc.) and towards fiscal policy (tax cuts, infrastructure funding, etc.).  It is certainly true that markets correct from time to time, mostly because sentiment runs hotter and faster than underlying fundamentals. 

We can see some of these corrections in sentiment occurring despite the backdrop of an equity market where the primary trend continues to be upwards.  For instance, three of the “Trump trades” we discussed last quarter (rising interest rates given an inflationary and pro-growth agenda, strength in bank stocks given the intent to roll back regulatory red tape, and weakness in the Mexican peso given the protectionist trade rhetoric) all showed signs of fading or reversing their initial moves this quarter.   
 
 
 
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In light of the new government’s growing pains in their first few weeks in office and the difficulty they’ve had building consensus on issues like repealing Obamacare, these countertrend reversals are not surprising, but they do not negate the regime change which is occurring.
 
Closer to home, the Canadian economy has been cranking out new jobs at a blazing pace with 110,000 new jobs created year to date, and with the six months ended January, 2017 being the strongest six month period for job creation in over a decade.  Currency markets took some encouragement from this with the CAD$ strengthening roughly half a cent vs. the greenback, but the Bank of Canada in contrast remains very much mired in cautious rhetoric given ongoing weakness in business investment and foreign trade, amplified by trade policy uncertainty south of the border.  Accordingly, interest rate hikes in Canada are all but off the table for this year and likely for the first half of 2018 as well, even as the U.S. Federal Reserve hiked rates in mid-March and signalled the likelihood of several more increases in 2017. 

The federal government rolled out a budget in March with little fanfare as it was very much a status quo type of affair with little in the way of major changes to either tax or spending policy.  Investors collectively breathed a sigh of relief on that front, as rumours had swirled incessantly in weeks leading up to the budget about the prospect of increases in the capital gains inclusion rates or changes to the dividend tax credits which would have been investor unfriendly had they been enacted.  
 
While we are mindful of Buffett’s advice not to mix politics with investment decision making, we too were pleased to see that nothing incrementally hostile to capital and investment was brought to bear on either those Canadian corporations in which we invest, or upon investors themselves, on whose behalf we invest.  Capital in today’s day and age is highly mobile, and flows to places where it is welcomed and flees those jurisdictions where it is ransomed or taxed too highly.

A troubling sign of the times for the Canadian oil patch occurred during the quarter as two foreign supermajor oil producers sold their Canadian oil sands assets to domestic interests in blockbuster deals valued at $13B and $18B respectively.  Whether this proves to be a contrarian buy signal for Canadian energy stocks, as strong assets are shaken out of weak hands, or instead is seen as a watershed moment for foreign investment in an industry that is increasingly burdened with rising royalties and carbon taxes remains to be seen.  
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Goodreid Investment Counsel Corp.                              87 Front Street East, Second Floor, Toronto, ON  M5E 1B8  416.364.0890
 
Not surprisingly though, in light of this news as well as weakness in both oil and natural gas prices this quarter, and some of the logistical and pipeline constraints facing the Western Canadian energy industry, the energy sector was among the worst performing segments of the Canadian market this quarter, with a dismal return of minus 6.2%. This poor return was second only to healthcare which was dragged down 10.3% mostly by former wunderkind, and now pariah, pharmaceutical company Valeant.  At the other end of the spectrum, leadership was found in technology, with the TSX tech sector up 6.9%.  South of the border, retailers like Kohls, Target, L Brands and Under Armour were among the worst performing companies within the S&P 500 index as online shopping increasingly displaces bricks and mortar retailing. 

Our approach in facing this disruptive secular change has, for some time, been to avoid investing in most mall-based retailers, and more recently has broadened out to include investments in Shopify, which facilitates e-commerce for small and mid-size companies, and Fedex, which delivers many of these online purchases.  Conversely, leadership in the U.S. was also in technology, with the sector overall gaining 12.6% on the back of 800 pound gorillas in the space like Apple, Facebook and Netflix.

  For Goodreid, these events are encouraging as they underscore our belief that investing in companies with superior profitability, rapid growth, and reasonable valuations is the most consistent way to grow and compound wealth for investors over time.  Governments and central bankers will come and go but disciplined investment principles are timeless. 
 
As Goodreid has maintained for many years, a structured and disciplined approach to portfolio management will yield positive results. Today’s distractions and noise create an opportunity to outperform those who “take their eye off the ball”. As can be seen from Goodreid’s portfolio characteristics we continue to own better than average companies at attractive prices. Goodreid will continue to be focussed and rules-based, purging the emotional rhetoric of the day, to arrive at the best solution for the management of wealth.