Fund Manager
Eric Dzuba
“It is not a case of choosing those [faces] which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be.” (John Maynard Keynes, General Theory of Employment Interest and Money, 1936).
Over seventy years ago John Maynard Keynes compared the stock market to a beauty contest where one is more concerned as to where the crowd will “vote”, as opposed to choosing the “winners” on their individual merits. The herd mentality has gripped stock markets as market breadth narrowed over the quarter with few sectors contributing to the positive results.
The problem with looking at markets at an index level is that one needs to dig deeper to get a better picture of what is really going on in the market. For example, Q2 was yet another quarter that favoured large caps: The TSX Composite was up 8.4% over the quarter, while the TSX Completion Index (the former TSX Mid Cap Index) rose only 2.5%. The energy sector has also been the key driver of index returns year to date: excluding energy, the S&P TSX would be down 1% for the six months ended June 30, 2008, as opposed to being up about 4.5%. As a result, the S&P TSX is one of a very few major equity indices that isn’t in or near bear market territory this year.
The big picture is still troubling. As home prices in the U.S. continue to fall, so too does consumer sentiment. At this time the housing market does not yet look like its priced to clear, given that the housing supply is still over 10 months. The vicious cycle of delinquency and foreclosure has longer to play itself out. Against this backdrop are central bankers caught with inflationary pressures not seen in years.
We’ll know in time if the central bank lending to financial institutions will work. Over the quarter, bank stocks staged a recovery from a difficult March, only to give back most of those gains in late June as credit spreads began to widen and fears resumed again that more writedowns, and capital raises, are to come. Speculation is building again that other financial institutions in the U.S. are on the verge of collapse. Talk has shifted away from which bank might face what level of writedowns to daily rumours and denials about the level of confidence retail or institutional clients have in certain banks. Share price volatility will continue as long as the market trades on fear, making any fundamental call difficult at best.
The fund’s 5.8% return for the quarter continued to be driven by its resource holdings. Baytex Energy Trust and Fording Coal Trust contributed significantly to returns, as both climbed over 50% during the quarter (or in the case of Fording, since its purchase later in April). We began reducing our energy positions part way through June, as we believe that the equity market will begin to price in demand destruction caused by $140 oil before the futures market. One of the pillars of the energy argument-demand from emerging economies-looks somewhat shaky if one looks at equity market returns in India and China (down 33% and 47% respectively in 2008) as a leading indicator for the broader economy. Positions in agricultural related resources such as Potash Corporation of Saskatchewan and Agrium Inc. were also reduced during the quarter as share prices began to reflect our optimism on agricultural commodity prices.
Holdings in most other sectors finished the quarter more or less where they began, with any gains coming from reducing positions in May and early June. The discrepancy between returns for Canadian equity index and those of other countries can’t continue: either ours will fall or theirs will rise. This is not to say that opportunities won’t exist in Canada: The fund is defensively positioned, yet remains very liquid in order to capitalize on short term trading situations should they arise.
Eric Dzuba
Associate Portfolio Manager
Front Street Capital
ERIC DZUBA - Q2 2008 COMMENTARY
Date Published
Related Fund(s)
Fund Manager
“It is not a case of choosing those [faces] which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be.” (John Maynard Keynes, General Theory of Employment Interest and Money, 1936).
Over seventy years ago John Maynard Keynes compared the stock market to a beauty contest where one is more concerned as to where the crowd will “vote”, as opposed to choosing the “winners” on their individual merits. The herd mentality has gripped stock markets as market breadth narrowed over the quarter with few sectors contributing to the positive results.
The problem with looking at markets at an index level is that one needs to dig deeper to get a better picture of what is really going on in the market. For example, Q2 was yet another quarter that favoured large caps: The TSX Composite was up 8.4% over the quarter, while the TSX Completion Index (the former TSX Mid Cap Index) rose only 2.5%. The energy sector has also been the key driver of index returns year to date: excluding energy, the S&P TSX would be down 1% for the six months ended June 30, 2008, as opposed to being up about 4.5%. As a result, the S&P TSX is one of a very few major equity indices that isn’t in or near bear market territory this year.
The big picture is still troubling. As home prices in the U.S. continue to fall, so too does consumer sentiment. At this time the housing market does not yet look like its priced to clear, given that the housing supply is still over 10 months. The vicious cycle of delinquency and foreclosure has longer to play itself out. Against this backdrop are central bankers caught with inflationary pressures not seen in years.
We’ll know in time if the central bank lending to financial institutions will work. Over the quarter, bank stocks staged a recovery from a difficult March, only to give back most of those gains in late June as credit spreads began to widen and fears resumed again that more writedowns, and capital raises, are to come. Speculation is building again that other financial institutions in the U.S. are on the verge of collapse. Talk has shifted away from which bank might face what level of writedowns to daily rumours and denials about the level of confidence retail or institutional clients have in certain banks. Share price volatility will continue as long as the market trades on fear, making any fundamental call difficult at best.
The fund’s 5.8% return for the quarter continued to be driven by its resource holdings. Baytex Energy Trust and Fording Coal Trust contributed significantly to returns, as both climbed over 50% during the quarter (or in the case of Fording, since its purchase later in April). We began reducing our energy positions part way through June, as we believe that the equity market will begin to price in demand destruction caused by $140 oil before the futures market. One of the pillars of the energy argument-demand from emerging economies-looks somewhat shaky if one looks at equity market returns in India and China (down 33% and 47% respectively in 2008) as a leading indicator for the broader economy. Positions in agricultural related resources such as Potash Corporation of Saskatchewan and Agrium Inc. were also reduced during the quarter as share prices began to reflect our optimism on agricultural commodity prices.
Holdings in most other sectors finished the quarter more or less where they began, with any gains coming from reducing positions in May and early June. The discrepancy between returns for Canadian equity index and those of other countries can’t continue: either ours will fall or theirs will rise. This is not to say that opportunities won’t exist in Canada: The fund is defensively positioned, yet remains very liquid in order to capitalize on short term trading situations should they arise.
Eric Dzuba
Associate Portfolio Manager
Front Street Capital