October 2017 | Caldwell Balanced Fund Commentary

Commentary: Reviewing Performance Year-to-Date (to September 30, 2017)

Performance this year has been frustrating. In some cases, its been justified while in many others, recent headwinds seem to be setting the portfolio up for stronger performance going forward. We discuss these below.

Unexpected Rate Rises Create Currency Headaches:

Through September, the U.S. market (S&P 500) was +12.5% year-to-date versus +2.3% for the Canadian market (TSX Index). This should have been a positive for the portfolio given its greater exposure to the U.S. market (~65% versus 35% for Canada), but strength in the Canadian Dollar "CAD" (or, relative weakness in the U.S. Dollar "USD") after two unexpected rate hikes by the Bank of Canada masked these results. At its recent peak (82.18 cents/USD on September 8th), the CAD was 10.4% higher than its 74.46 cent/USD level at the start of the year. That translates into an ~9% headwind on individual U.S. holdings and a 6%+ headwind on a portfolio with 65% U.S. exposure. Given that Canada's growth has been largely driven by consumer and government spending, which are debt-fuelled given underwhelming growth in business investment and exports, we were (and remain) comfortable with our USD exposure. The rate hikes were based on data that had very easy prior-year comparisons, making growth in Canada look un-sustainably high. As year-over-year compares get more difficult, we have seen more tepid economic results and are now seeing the Bank of Canada back-peddle on their decision in an effort to talk the CAD back down (a stronger CAD is not helpful to the Bank of Canada, whose plan entails stronger business investment on the back of higher exports - a stronger CAD makes exports less competitive, which creates a headwind to export growth).

Currency has Masked the Winners:

The portfolio's strongest performers have all been U.S. names (as expected, given the relative out-performance of the U.S. market). KKR, Steris and Cognizant are all up ~30% this year while Amdocs, Broadridge and Accenture have also made new highs recently. We continue to see attractive growth opportunities at these companies, all of which are industry leaders and/or are benefiting from strong end market demand.

Some Deserved Underperformers:

Energy: The portfolio has particularly struggled with its energy servicers positions, with Trinidad Drilling and ShawCor down 43% and 23%, respectively, this year. Our performance in the Energy sector has been both very good and very bad. On the integrated side, Suncor and Chevron have performed very, very well. As mentioned, Chevron is trading at the same level as when crude was over $100 while Suncor is actually out-performing the broader TSX since we initiated a position in early 2014. The servicers, however, have been significant drags on the portfolio. Trinidad has been particularly frustrating as its been a cheap stock that has only become cheaper. The cyclical recovery seems to be continually being pushed into the future and it hasn't helped that management has been making questionable investments. As one analyst put it to us: "...there is lots of asset value here but its not getting any respect/love from the [market]."  While the extended industry downturn has been frustrating, we have been seeing better tone from management and we think the shares can move meaningfully higher from here. Shawcor is a very high quality company and industry leader. The stock could see continued volatility in the short-term as 2018 is an 'air pocket' of project work, but 2019 and beyond look very promising on high levels of budgetary and bid work.

Amazon: An analyst we recently spoke to stated that "the laws of valuation don't apply to Amazon." While the stock prices of most companies are anchored to earnings or cash flow generation, this does not seem to be the current case with Amazon. We under-estimated the impact of changing consumer preferences on Kohl's, which has struggled with declining customer traffic despite numerous initiatives to reverse the trend. Interestingly, Kohls recently signed a partnership with Amazon that will carve out a section of its stores to offer Amazon's home devices like Echo, and allow returns of products purchased on Amazon's website. Given the valuation discount to the market, and that Kohls has a unique position versus other department stores with its off-mall store footprint, we think shares ultimately move higher. Due to how quickly consumers can change their minds, and how difficult that makes it on companies that sell to consumers, we have largely shied away from the consumer space, preferring to invest in companies whose customers are other businesses. The Amazon effect is another reason to continue doing so.

Looking Forward

We have added 5 new stocks to the portfolio over the last several months (TFII, SOY, KEYS, LCII and TSN) that have strong catalysts that we believe will propel shares higher for investors. These join the group of strong performers that have been making recent highs and have additional runway of opportunity. The FX headaches have begun to reverse and we expect stocks that have been overly-penalized by the market to recover.  We continue to use a 2-3 year time frame when selecting investments as this allows us to look beyond the 1-year outlook that analysts work off of.