Fund Manager
Eric Dzuba
It is an ancient Mariner,
And he stoppeth one of three.
By thy long beard and glittering eye,
Now wherefore stopp'st me?
The Rime of the Ancient Mariner,
Samuel Taylor Coleridge
Although we are being selective in our choice of verse, Coleridge's eighteenth century poem of guilt, penance and redemption provides a lyrical backdrop to a review of 2007.
The Ship was cheered, the harbour cleared / Merrily did we drop. The first half of 2007 saw calm seas and clear sailing as private equity firms binged on the public capital markets and investors in turn binged on the debt being issued to finance these leveraged buyouts. This debt binge had been going on for some time, primarily in the form of repackaged loans / bonds that many would come to know by their acronyms later in the year: CDO, CLO, and ABCP. Investors' thirst for yield had been satisfied by these debt instruments that carried AAA ratings and higher yields than comparable sovereign debt.
Indeed, looking back at our commentary at the end of 2006, we were concerned with rising interest rates in Canada and the impact on our dollar, given the relative strength of Canada's economy to that of the United States.
And now the Storm-Blast came, and he / Was tyrannous and strong. But a housing slump in the United States, which had begun in late 2005, was slowlymaking its way through the fixed-income world in 2007. Sub-prime loans—made to homebuyers who would have difficulty making real loan payments and often originated on the assumption of infinite home value appreciation—began to crack as foreclosures began to grow. Although these loans had quietly found their way into many structured debt securities, they became big news when large bank-owned hedgefunds collapsed in July.
As the AAA ratings of structured debt securities, let alone their value, began to be called into question, banks faced the prospect of writing down their holdings. The storm was now well under way.
And now there came both mist and snow, / And it grew wonderous cold. The freezing of the Asset Backed Commercial Paper (ABCP) market in August caught the attention of retail investors as there were fears that money market funds could faces losses or suspend redemptions. Equity markets also began their response to the possibility that liquidity was drying up and the big takeover premiums for stocks was coming to an end. Banking stocks also tumbled on fears of write-downs of structured loans held on their balance sheets: fears which would come to fruition in the fourth quarter.
Why look'st though so? With my cross-bow / I shot the Albatross. Central banks have responded to this liquidity banking crisis by, among other activities, lowering administrative rates. Although by the fourth quarter the US economy was showing pronounced signs of weakness – particularly the US consumer, for the first time since the recession of early this decade – prices for food and for fuel have been rising sharply for the last few years. So more money is going into the system to rescue banks at a time when real interest rates are negative. It's hoped that sound monetary management (the albatross?) has not been mortally wounded.
Day after day, day after day / We stuck, nor breath nor motion; / As idle as a painted ship / Upon a painted ocean. Finally, all of the above have left the markets musing at the end of 2007 as to whether we are entering into a 1970's style stagflation.
Although we don't think 2008 will end in the same fashion as our epic poem (Mariner's ship sinks in the harbour, he wanders the earth retelling his story), we think there will be more than a few storms at sea. Although 2007 was a positive year for the S&P TSX, it is interesting to note that less than half the members of this index had positive returns this past year. This fact places 2007 in the unlucky group of years such as 2002, 1998 and 1994 to experience negative market breadth. We continue to believe that global infrastructure spending will drive the earnings of companies with exposure to it, while companies in the agriculture space as well some more defensive sectors should position us well for the first half of 2008.
Eric Dzuba - Q4 2007 Commentary
Date Published
Fund Manager
Although we are being selective in our choice of verse, Coleridge's eighteenth century poem of guilt, penance and redemption provides a lyrical backdrop to a review of 2007.
The Ship was cheered, the harbour cleared / Merrily did we drop. The first half of 2007 saw calm seas and clear sailing as private equity firms binged on the public capital markets and investors in turn binged on the debt being issued to finance these leveraged buyouts. This debt binge had been going on for some time, primarily in the form of repackaged loans / bonds that many would come to know by their acronyms later in the year: CDO, CLO, and ABCP. Investors' thirst for yield had been satisfied by these debt instruments that carried AAA ratings and higher yields than comparable sovereign debt.
Indeed, looking back at our commentary at the end of 2006, we were concerned with rising interest rates in Canada and the impact on our dollar, given the relative strength of Canada's economy to that of the United States.
And now the Storm-Blast came, and he / Was tyrannous and strong. But a housing slump in the United States, which had begun in late 2005, was slowlymaking its way through the fixed-income world in 2007. Sub-prime loans—made to homebuyers who would have difficulty making real loan payments and often originated on the assumption of infinite home value appreciation—began to crack as foreclosures began to grow. Although these loans had quietly found their way into many structured debt securities, they became big news when large bank-owned hedgefunds collapsed in July.
As the AAA ratings of structured debt securities, let alone their value, began to be called into question, banks faced the prospect of writing down their holdings. The storm was now well under way.
And now there came both mist and snow, / And it grew wonderous cold. The freezing of the Asset Backed Commercial Paper (ABCP) market in August caught the attention of retail investors as there were fears that money market funds could faces losses or suspend redemptions. Equity markets also began their response to the possibility that liquidity was drying up and the big takeover premiums for stocks was coming to an end. Banking stocks also tumbled on fears of write-downs of structured loans held on their balance sheets: fears which would come to fruition in the fourth quarter.
Why look'st though so? With my cross-bow / I shot the Albatross. Central banks have responded to this liquidity banking crisis by, among other activities, lowering administrative rates. Although by the fourth quarter the US economy was showing pronounced signs of weakness – particularly the US consumer, for the first time since the recession of early this decade – prices for food and for fuel have been rising sharply for the last few years. So more money is going into the system to rescue banks at a time when real interest rates are negative. It's hoped that sound monetary management (the albatross?) has not been mortally wounded.
Day after day, day after day / We stuck, nor breath nor motion; / As idle as a painted ship / Upon a painted ocean. Finally, all of the above have left the markets musing at the end of 2007 as to whether we are entering into a 1970's style stagflation.
Although we don't think 2008 will end in the same fashion as our epic poem (Mariner's ship sinks in the harbour, he wanders the earth retelling his story), we think there will be more than a few storms at sea. Although 2007 was a positive year for the S&P TSX, it is interesting to note that less than half the members of this index had positive returns this past year. This fact places 2007 in the unlucky group of years such as 2002, 1998 and 1994 to experience negative market breadth. We continue to believe that global infrastructure spending will drive the earnings of companies with exposure to it, while companies in the agriculture space as well some more defensive sectors should position us well for the first half of 2008.