Q1 2019 | Caldwell Balanced Fund Commentary

How quickly things can change! After severe drops in global asset prices in Q4 2018, markets recovered just as sharply in Q1 2019. Given the market’s performance to date, it seems that fears over global economic growth have eased. The Fed seems to have pulled back on plans for balance sheet reductions and interest rate hikes, China has responded to tariff risks with additional stimulus efforts and corporate earnings in Q4 turned out to be better than feared. Despite another round of ‘kicking the can down the road’, with respect to central bank policy, Canadian and U.S. market indices have rallied back and now sit close to previous highs. Companies start reporting Q1 earnings in mid-April which will give investors additional guide posts on the strength of demand, inflationary pressures, trade disruptions and capital allocation plans.

Taking it down to the portfolio level, our core investment principles have not changed: protect and grow our investors’ capital through discounted valuations, strong balance sheets, good management teams and attractive business environments. We did well in Q1 to have more exposure to the U.S. market as it once again out-paced Canadian returns. We also did well to have our largest weighting in Technology, which was the best-performing sector in the United States Health Care was the best performing sector in Canada, driven by Cannabis stocks which rallied back strongly after sharp declines in Q4.

The portfolio showed broad-based strength in Q1 with 78% of its holdings out-performing the TSX index return. Top performers were Keysight Technologies (KEYS-us: +40.5%), Delphi Technologies (DLPH-us:+34.5%) and IPG Photonics (IPGP-us:+34.0%).

Keysight, a leader in wireless testing technology, continues to build on strong momentum in 2018. The company is increasingly being recognized as one of the best ways to play the upcoming 5G cycle, which is still in its infancy and expected to see larger overall spend than the previous 4G cycle. KEYS also benefits from the increasing penetration of electric vehicles, also in the early stages of a long growth runway.

Delphi has rebounded from extremely low valuation levels that were driven by a perfect storm of negative, but temporary, factors. The sell-off seemed severe in the face of the company recording $9.8B of lifetime bookings in 2018 (for context, DLPH’s total revenue in 2018 was $5.1B). A new CEO that brings a solid reputation of operational excellence, easing trade tensions and Chinese stimulus plans have helped fuel the rebound.

Lastly, IPG Photonics, a fiber laser manufacturer, is also rebounding from a less pessimistic outlook on China. Macro concerns in Q4 shifted investor attention away from the long growth runway for IPGP driven by continued fiber laser adoption in manufacturing and other processes. IPGP’s growth potential, strong competitive advantages, and pristine balance sheet should drive continued share price increases going forward.

Two stocks were added to the portfolio in Q1: Middleby (MIDD-us) and 3M (MMM-us).

Middleby is a leading manufacturer of hot-side commercial cooking and food preparation equipment, industrial food processors and premium residential equipment. This is a high quality company with a long track record of consistent results. Middleby is known for strong customer relationships and innovation: close relationships drive an innovation funnel focused on helping customers achieve their goals. Today, that means finding solutions to address labour shortages and rising wages, reduce food waste, electricity and water costs, allow for menu flexibility, and reconfigure kitchens to facilitate takeout and delivery. We initiated a position into a depressed valuation as the company was coming off of a period of temporary softness in restaurant capital expenditure. We expect growth and margins to inflect positively going forward and with a revenue base of $2.7B, there is a significant growth runway given a $25B addressable market.

3M is a diversified industrials company that serves a broad set of end markets.  It, too, is a high quality company with a long track record of consistent results. When we think about a company’s ability to grow in value, competitive positioning is a key consideration. Much like Aesop’s Fables, where a bundle of sticks is indestructible but one stick alone can easily be broken, a company’s competitive advantage is stronger the more elements that are involved. 3Ms technology, manufacturing know-how, global capabilities and brand are powerful on their own but are that much more formidable when combined, especially while also leveraging intellectual property (“IP”) – 1/3 of 3Ms IP is in its manufacturing processes. The unique value proposition this business model creates for clients is evidenced by a powerful statistic: ~70% of 3Ms revenue is either designed in, specified or regulated at the end-use customer. We see significant runway for 3M to leverage this model into new growth areas and took the opportunity to initiate a position into fears of slowing Chinese and global growth.

Looking forward

We have talked about market volatility increasing in past notes and investors have certainly experienced this in recent months. While our investment principles are designed to protect and grow investors’ capital, we are not immune to the market’s volatility. As such, cash planning becomes critical. The reason we avoid companies with weak balance sheets is because they have a higher risk of being forced into actions that destroy shareholder value. Similarly, investors that know they need cash in the next year or two should probably avoid having that money invested in equity markets – you don’t want to be forced to sell stocks in the event of a depressed market. This is where working with an Investment Advisor is highly valuable.

We look forward to tracking the progress of the portfolio’s holdings and appreciate your continued support.

All data is as of March 31, 2019 unless otherwise indicated. The information contained herein provides general information about the Fund at a point in time. Investors are strongly encouraged to consult with a financial advisor and review the Simplified Prospectus and Fund Facts documents carefully prior to making investment decisions about the Fund. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Rates of returns, unless otherwise indicated, are the historical annual compounded returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns.  Mutual funds are not guaranteed; their values change frequently and past performance may not be repeated. Publication date: April 11, 2019.

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