Dear Valued Client,
We apologize for sending out information like this by email “blasts”. We hope it doesn’t seem too impersonal but our purpose is to get these messages out as quickly as possible. We hope that you will contact us if there are any aspects of any of the correspondence that you would like to discuss further. We would be more than happy to take your call.
Even though January finished its last ten days with a bit of a flourish, portfolio values in the month still declined as a result of the breathtaking market drop of the first three weeks. We certainly didn’t expect this. In fact the trading in December looked to us like conditions were ripe for the usual “January Effect”, which describes the tendency for stock prices, particularly of small capitalization companies, to rise after tax loss selling late in the previous year.
One consequence of monetary stimulus is that there is lots of cash available for all kinds of market operations, including short selling. When uncertainty reigns, short sellers have greater traction and prices go down more than you might normally expect. Given the not-bad outlook that eminent institutions like the Federal Reserve have for the economy, the price erosion was greater than we expected because of this short selling activity. It also disproportionately affected some of our investments like Hudbay Mining. Even though our over-all exposure in the commodity sector is small compared to the indices, the shorting of Hudbay hurt because we had a full position in this company, which we felt was best-in-class.
Also unusual was the simultaneous decline of the over-all market and oil prices. Many economic models have equated a $10 drop in the price of oil with a ½ percent growth in the real economy. In other words, the drop in the price of oil should have been very stimulative for business and the consumer. However, the over-all market movement was very highly correlated with the downward price of oil, which caught most observers, including us, by surprise.
Finally, the stocks that were affected most in the market were the so-called value stocks and others that have gone up the most over the past four or five years. In our portfolios, they had become heavily weighted by the virtue of their success. These proved to be the easiest for the market to sell in the time of uncertainty, and so our portfolios did worse than the indices for most of the downdraft.
So, where does that leave us?
As you know, we don’t like to trade out of good companies in anticipation of downdrafts such as have just occurred, for the primary reason that we don’t know when they are going to happen. However, we do tend to trim when they achieve pre-determined prices or become too large a weighting in our portfolios by virtue of appreciation. This happened over the past two years and by mid-January, we had a reasonable amount of cash to take advantage of the bargain prices that were presented to us. We were net buyers throughout the month, which tended to hurt us in the short term but which will be beneficial in the long term. Nevertheless, we still have good reserves of buying power.
We believe that the supply of certain commodities, particularly oil, will remain high, but also believe that the US dollar is close to its peak. A drop in the US dollar will be good for the price of gold, industrial commodities, European stocks, Canadian stocks, and business in general as companies deploy large cash positions that have been building at the corporate level. We believe that the price of oil and the general stock market will again diverge.
Most importantly, we believe that this correction, while it may have further to run, will at some point get tired and that the share prices of the companies that we follow will again start to track their value creation. In other words, in spite of its severity and relentlessness, this correction will be like most others.
Please don’t hesitate to call us if this letter raises further concerns.
Your Team at Heathbridge