May 15th, 2012
As highlighted in recent quarters, global central banks remain committed to providing liquidity in the form of lower interest rates as the post 2008/2009 recovery continues and the Euro region stabilizes. For example, the U.S. Federal Reserve has pledged to keep interest rates at current low levels until 2014.
As such, our bond strategy remains unchanged. We continue to hold a broadly diversified portfolio of bonds. Eventually, interest rates will rise, putting pressure on longer-term bonds so we continue to keep our average term relatively short.
The risk of financial repression also remains as long as interest rates, on a sustained basis, remain lower than inflation. We continue to manage this risk by avoiding longer-dated bond issues and keeping our average bond term short.
Our bond strategy is expected to continue to provide income support and diversification for our overall portfolios in the current rate environment.
In recent quarters, we discussed how equities were trading at historic discounts as macro issues (Euro region debt restructuring etc.) overshadowed positive corporate operating fundamentals. We suggested that equity valuations were not fully reflecting improving operating fundamentals.
That trend began to reverse during the first quarter of 2012 as North American equities turned in strong performance with Canada (TSX/S&P60) up approximately 3.5% and the U.S. (S&P500) up over 12%.
Despite Setbacks in 2012 and 2011, the S&P Has Rallied Sharply since March 2009
U.S. outperformance relative to Canada has further narrowed the valuation gap between companies in the two markets, a theme we identified in 2010. Specifically, in the fourth quarter of 2010, the U.S. market traded at a 2.6 times multiple discount to Canada based on projected earnings. That discount has now narrowed to 0.5 times as the U.S. trades at 12.6 times forward earnings compared to 13.1 times in Canada. In other words, investors have been realizing the attractiveness of the U.S. market relative to Canada and other global markets.
In context, even as U.S. markets have rebounded sharply, market valuations at recent March 2012 highs were still lower than at any 52-week market high going back to 1989.
Despite recently improving performance, we suggest that selective areas of the U.S. market still offer attractive value. That’s because U.S. equity performance continues to trail growth in corporate profits and GDP – just as it has for the last decade as shown in the chart below.
Profits, GDP, and Stock Price Over the Last Decade
The Coleford Model Portfolio
The Coleford Model portfolio performed well in the first quarter of 2012. We enjoyed strong performance from a variety of sectors operating around the globe. Our top performer during the quarter was Toyota (+31.3%) followed by Comcast (+26.6%), Microsoft (+24.2%), Eaton (+14.5%), United Technologies and IBM (both +13.5%). In terms of themes, global industrials and technology performed well.
The Model experienced weaker performance during quarter from BCE, TransCanada, Novartis and CN Rail. With the exception of Novartis, these companies performed well in 2011 and we remain comfortable with ownership. Novartis, a Swiss-based pharmaceutical company, continues to demonstrate good fundamentals that, in our view, are not fully reflected in the market.
Thomson Reuters – A Work in Progress
During the quarter, the Coleford Equity Model portfolio expanded its position in Thomson Reuters. This company has strong fundamentals, but has disappointed the market since its merger with Reuters in 2008. Shares have traded well below historic earnings’ multiples and the company recently hired a new CEO. On the plus side, approximately 86% of its revenues are recurring and approximately 45% of revenues are generated outside North America. Most important to us, it has proven to be an efficient manager of capital, regularly rewarding shareholders with dividend increases as evidenced in the chart below. The shares are yielding approximately 4.4% and we believe they offer attractive long-term value.
Thomson – 18 Consecutive Annual Dividend Increases
North American equity markets, particularly the U.S., performed well in the first quarter as valuations started to reflect recent strong operating fundamentals. Despite this progress, we recognize that as the U.S. and Euro region work through their respective economic recovery phases, risk remains. We are positive on our overall portfolio as global economic activity advances, corporate indicators remain positive and our model holdings are well positioned for this new economic era.