Fund Manager
Frank Mersch
It was a brutal quarter, despite the fact that the Fund held well over 20% cash. What happened? First, we did not have much of a gold weighting, as we liquidated much of our holdings in the first quarter. Second, our small-cap, non-resource stocks have been hit hard as liquidity and activity dried up. Third, we started to buy metal stocks too early, despite an already 30% drop. Finally, we found that holding cash really provides an opportunity rather than a defensive strategy. As such, for the quarter the fund was (11.75%) versus the S&P/TSX (6.17%) and the Dow (9.97%).
Overview
Stock markets are suffering through a correction that has exceeded previous bull market corrections of 8%; however, at 10 weeks in length, it matches the average duration of such corrections. The S&P is down 15% while the TSX is down 8%, due to a greater exposure to gold. In fact, the precious metal weight in the TSX has reached a record high.
This correction has been driven by fears of a double- dip recession or even a depression. History shows that back-to-back double-dip recessions are quite rare. Over the last hundred years, the shortest duration between recessions was 1980-1981 [12 months] and 1957 – 1960 [24 months]. In both cases, the second recession was caused by Fed-tightening, resulting in an inverted yield curve.
It seems the market is more concerned about macroeconomic forces. Because overall valuations are now indicating the market is undervalued, macroeconomic discussions revolve around inflation, deflation, interest rates, government debt (restraint vs. expansion) and the big one, a double-dip recession.
On deflation, deleveraging is a deflationary phenomena. Japan has experienced this for the past 20 years. However, we do not believe this will happen in Canada because we recognize the problem whereas Japan did not. Our demographics are better and we still foster immigration to address our workforce needs. On inflation, it is certainly not showing up in goods we purchase; all numbers point to very benign risk.
U.S. interest rates are unlikely to rise until next year. With all the talk of a double-dip and weak growth, it is very unlikely we will see rates rise. Perhaps we will see a further rise in Canada before year end, but it will be orderly and not helter skelter.
Now to the Fund issue: government restraint versus expansion. We need growth to finance government. We cannot have debt levels accelerate faster than nominal GNP, thus the debate of restraint now versus later. I believe we have begun to see the stimulus money slowly withdraw and are feeling its effects. Outside employment growth, the economy seems to be muddling along.
Corporate profits are not so bad and, certainly, productivity is high. The question becomes; when will corporations feel confident to hire? With all the rhetoric of double-dip, would you hire? Meanwhile, I have never seen so much cash on balance sheets (last count 17-19% of total assets). Something has to break. If some confidence returns, we could see the biggest M&A cycle in history. If not, at least corporate balance sheets can withstand the sovereign debt machinations that the rating agencies are putting us through.
Finally, PE and earnings yields point towards equities; copper is still $3.00, oil is $75, and every bear has his claws out. On the heels of 2008, everyone is very skittish. China and India motor on, and debate rages over Chinese growth at 13%, 15%, 17%. But, it’s growth, and they continue to keep the game going.
Perhaps we are due for something positive.
Frank Mersch
Frank Mersch - Q2 2010 Commentary
Date Published
Related Fund(s)
Fund Manager
It was a brutal quarter, despite the fact that the Fund held well over 20% cash. What happened? First, we did not have much of a gold weighting, as we liquidated much of our holdings in the first quarter. Second, our small-cap, non-resource stocks have been hit hard as liquidity and activity dried up. Third, we started to buy metal stocks too early, despite an already 30% drop. Finally, we found that holding cash really provides an opportunity rather than a defensive strategy. As such, for the quarter the fund was (11.75%) versus the S&P/TSX (6.17%) and the Dow (9.97%).
Overview
Stock markets are suffering through a correction that has exceeded previous bull market corrections of 8%; however, at 10 weeks in length, it matches the average duration of such corrections. The S&P is down 15% while the TSX is down 8%, due to a greater exposure to gold. In fact, the precious metal weight in the TSX has reached a record high.
This correction has been driven by fears of a double- dip recession or even a depression. History shows that back-to-back double-dip recessions are quite rare. Over the last hundred years, the shortest duration between recessions was 1980-1981 [12 months] and 1957 – 1960 [24 months]. In both cases, the second recession was caused by Fed-tightening, resulting in an inverted yield curve.
It seems the market is more concerned about macroeconomic forces. Because overall valuations are now indicating the market is undervalued, macroeconomic discussions revolve around inflation, deflation, interest rates, government debt (restraint vs. expansion) and the big one, a double-dip recession.
On deflation, deleveraging is a deflationary phenomena. Japan has experienced this for the past 20 years. However, we do not believe this will happen in Canada because we recognize the problem whereas Japan did not. Our demographics are better and we still foster immigration to address our workforce needs. On inflation, it is certainly not showing up in goods we purchase; all numbers point to very benign risk.
U.S. interest rates are unlikely to rise until next year. With all the talk of a double-dip and weak growth, it is very unlikely we will see rates rise. Perhaps we will see a further rise in Canada before year end, but it will be orderly and not helter skelter.
Now to the Fund issue: government restraint versus expansion. We need growth to finance government. We cannot have debt levels accelerate faster than nominal GNP, thus the debate of restraint now versus later. I believe we have begun to see the stimulus money slowly withdraw and are feeling its effects. Outside employment growth, the economy seems to be muddling along.
Corporate profits are not so bad and, certainly, productivity is high. The question becomes; when will corporations feel confident to hire? With all the rhetoric of double-dip, would you hire? Meanwhile, I have never seen so much cash on balance sheets (last count 17-19% of total assets). Something has to break. If some confidence returns, we could see the biggest M&A cycle in history. If not, at least corporate balance sheets can withstand the sovereign debt machinations that the rating agencies are putting us through.
Finally, PE and earnings yields point towards equities; copper is still $3.00, oil is $75, and every bear has his claws out. On the heels of 2008, everyone is very skittish. China and India motor on, and debate rages over Chinese growth at 13%, 15%, 17%. But, it’s growth, and they continue to keep the game going.
Perhaps we are due for something positive.
Frank Mersch