Fund Manager
Frank Mersch
With the bottom of the Credit Crisis panic seemingly hit in mid-March (the Bear Sterns rescue being the symbolic low-point), global capital markets are now operating in a fashion that we consider to be ‘nearly normal’. While the economic and corporate news remains mixed, markets are functional, assets are being revalued and if necessary disposed of (albeit typically at sharp discounts) and investor psychology has steadily improved. While these conditions are necessary for positive stock market returns, they are by no means sufficient, particularly as equity gains are increasingly confined to a rather narrow number of sectors.
The backdrop to this situation is a US economic picture that, although sluggish, has likely remained stronger than most investors would have expected. Thanks to growth in exports, the economy as a whole managed to expand at an annualized 0.9% in the first quarter of 2008, up from a previous estimate of 0.6%. Furthermore, while the much-maligned consumer reports being less confident in their economic prospects than at any time in the past fifteen years, their spending continues at a decent pace, currently running at 2.5% year over year. Even the ever-problematic inflation situation eased a tad during the month, coming in at a rate of 3.9%. Against this stabilizing environment it is important to bear in mind a few of the negatives as well: S&P 500 earnings estimates continue to fade with Q2 expectations now running at a decline of 7% year over year (the estimate for the financial sector is a decline of 43% in earnings); housing prices are declining at a rate of greater than 10% annualized and are having negative repercussions for consumer confidence; energy and food prices are surging, taking an ever-greater share of disposable income.
As we alluded to above, the investing environment has largely stabilized although equity gains have been by no means broad-based, with the energy sector responsible for the bulk of the increase seen so far this year. Over this past month, energy stocks have accounted for 60% of the gain on the TSX, while on a year-to-date basis the 25% rally in the energy sector constitutes 95% of the overall gain on the TSX. As we have written previously, our belief is that fundamentals justify the recent high prices in oil, although that said, the current ‘oil mania’ in the press has likely pushed crude to levels that are not sustainable in the short term. Our preference in the energy sector has been for natural gas producers, namely those with large, predictable, ‘resource-plays’ located in royalty-friendly British Columbia.
Beyond energy, we continue to hold significant weightings in agricultural stocks in an effort to capitalize on the soaring cost of food and the ever-present need to increase crop yields in the face of elevated emerging market demand and the requirements for bio-fuels. Lastly, given the greater than 10% rally on the TSX over the past two months we have elected to trim our equity exposure and are now holding a higher-than-normal cash level.
For the month, the fund was up 7.23% versus gains of 5.58% on the TSX, 1.07% on the S&P 500 and 4.55% on the NASDAQ. Not surprisingly, this out-performance can be largely attributed to our weightings in the natural gas and fertilizer industries and our ongoing underweight in the financials.
Front Street Canadian Hedge Monthly Commentary
Date Published
Fund Manager
With the bottom of the Credit Crisis panic seemingly hit in mid-March (the Bear Sterns rescue being the symbolic low-point), global capital markets are now operating in a fashion that we consider to be ‘nearly normal’. While the economic and corporate news remains mixed, markets are functional, assets are being revalued and if necessary disposed of (albeit typically at sharp discounts) and investor psychology has steadily improved. While these conditions are necessary for positive stock market returns, they are by no means sufficient, particularly as equity gains are increasingly confined to a rather narrow number of sectors.
The backdrop to this situation is a US economic picture that, although sluggish, has likely remained stronger than most investors would have expected. Thanks to growth in exports, the economy as a whole managed to expand at an annualized 0.9% in the first quarter of 2008, up from a previous estimate of 0.6%. Furthermore, while the much-maligned consumer reports being less confident in their economic prospects than at any time in the past fifteen years, their spending continues at a decent pace, currently running at 2.5% year over year. Even the ever-problematic inflation situation eased a tad during the month, coming in at a rate of 3.9%. Against this stabilizing environment it is important to bear in mind a few of the negatives as well: S&P 500 earnings estimates continue to fade with Q2 expectations now running at a decline of 7% year over year (the estimate for the financial sector is a decline of 43% in earnings); housing prices are declining at a rate of greater than 10% annualized and are having negative repercussions for consumer confidence; energy and food prices are surging, taking an ever-greater share of disposable income.
As we alluded to above, the investing environment has largely stabilized although equity gains have been by no means broad-based, with the energy sector responsible for the bulk of the increase seen so far this year. Over this past month, energy stocks have accounted for 60% of the gain on the TSX, while on a year-to-date basis the 25% rally in the energy sector constitutes 95% of the overall gain on the TSX. As we have written previously, our belief is that fundamentals justify the recent high prices in oil, although that said, the current ‘oil mania’ in the press has likely pushed crude to levels that are not sustainable in the short term. Our preference in the energy sector has been for natural gas producers, namely those with large, predictable, ‘resource-plays’ located in royalty-friendly British Columbia.
Beyond energy, we continue to hold significant weightings in agricultural stocks in an effort to capitalize on the soaring cost of food and the ever-present need to increase crop yields in the face of elevated emerging market demand and the requirements for bio-fuels. Lastly, given the greater than 10% rally on the TSX over the past two months we have elected to trim our equity exposure and are now holding a higher-than-normal cash level.
For the month, the fund was up 7.23% versus gains of 5.58% on the TSX, 1.07% on the S&P 500 and 4.55% on the NASDAQ. Not surprisingly, this out-performance can be largely attributed to our weightings in the natural gas and fertilizer industries and our ongoing underweight in the financials.