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A View From Here January 2010

January 31, 2010 • Print This Article

Welcome to a New Decade!

Believe it or not, the period between January 1st 2000 and December 31st 2009 wrapped up the worst decade in almost 200 years of recorded stock market history. Except for the TSX S&P Index, stocks on the New York Stock Exchange have lost an average of 0.50% a year.

For our accounts, the decade proved to be quite fruitful despite major setbacks in 2002-2003 and 2008-2009. I believe this was the case because we are investors rather than index players, traders, structured product investors or any other thing that makes you wonder...”would I have been better off in a GIC?”

In this month's unusually long A View from Here, we take a look back at each year and the investments that we held in our accounts. Of particular note is some of the following observations; firstly, a surprising amount of the company's we owned were taken over; most successful investments were purchased at periods of apathy or adversity; except for 2009, our best performance years occurred when markets are relatively stoic; Nothing can prepare you for, nor can you avoid market downturns which are avenues of opportunity; steering clear of themes such as technology (for the most part) in the early part of the decade and natural resources in the latter part have helped enhance overall investment returns; holding a relatively small and portfolio of companies has worked to our benefit; and lastly, positions enhanced as the story reveals itself over the term of the investment is important to building wealth.

A Look back on the Millennium...

2000 - Its hard not to think of the year 2000 as described in the New York Times as "The great historical Edsel of all time and all the Y2K gear hardware stores wouldn't take back." But with Y2K out of the way, investors rushed on-line to trade their way to financial freedom as we feared missing out on sure-fire investments such as 'Ask Jeeves'. This no doubt fuelled Nasdaq's meteoric rise before falling 45% and wiping out $8 trillion of investors wealth by year end.

Having said this, it was a good year for our performance with the exception of a portfolio of emerging Bluetooth technology companies that ultimately fell harder than the Nasdaq, never recovered, and sold for a loss. When the technology did finally emerge, it was completely different than had been anticipated. Fortunately, most of our investment focus was on the exact opposite end of the range where we believed value existed.

As such held investments in Canadian base metal companies such as Rio Algom and Cominco as well as holding a position in TD Bank, Suncor, Cara Foods (who operated Harveys, Swiss Chalet and 2nd Cup) and Four Seasons Hotels. In less than a year, 3 of those companies would be taken over at significantly higher prices, nullify the losses in Bluetooth. Four Seasons would be taken over at a small profit 5 years later. If there is any lesson from that year, it is the incredible downside that can occur to theme based investing.

2001 - Fear of recession from the Nasdaq collapse would linger in 2001 as investors pick up pieces from the fallen technology viewpoint and begin to focus on natural resources and demand from China. This theme would ultimately gain momentum and keep the Canadian stock markets (which is heavily weighted to natural resources) profitable for the decade.

However, if there is one defining moment for that year, it is clearly 9/11. The unity of nations around that event is something I have never seen before. Help came by way of the US Federal Reserve and the other nations who followed, lowering interest rates and keeping the stock markets from collapsing.

Our investments are rewarded in 2001 as Rio Algom, Cominco and Cara Foods are taken over. We also closed our investment in TD and Suncor. As such, 2001 was shaping out to be quite a strong year of performance and it also provided us the entry point of Flint Energy Services which we would continue to an investment in and ultimately sold in 2006.

2002 - Got off to a strong start as the boost from a post 9/11 euphoria to live our lives to the fullest gave way to two sobering realities; one, we really are in a recession as both government and consumer spending dissipated and two; the anxiety of a potential war and its consequences weighted heavily on peoples minds. I believe the sell off which started halfway through 2002 was also linked to another broken investment dream called Enron.

The performance of our portfolio's would have a strong start in 2002, but there was a dramatic change in market sentiment that gathered steam in the second half. As such, we suffered our worst performance year that I can remember to that point. Most accounts would use weakness to add to fallen positions. This would have a significant impact in the proceeding years as we added most notably to FirstService (which we have owned since 1993) and also established a investment commitments in the Intertan (Canadian operations of RadioShack), Sodisco-Howden Group (a distributor of hardware supplies) and chemical maker, Acetex.

Although hard to see at years end, these investment commitments would pave the way to strong performance the next two years, as the Dow Jones Industrial average was down 17%, the Nasdaq shed 23%, the TSX lower by 14% and the S&P 500 Index off 23%. The Consensus called for the markets to suffer their 3rd consecutive decline for 2003. Overall, 2002 was a very difficult year with double digit declines for most accounts, but we managed to plant seeds that would ultimately.

Interesting Quote that reflects the times "The most common cause of low prices is pessimism - sometimes pervasive, sometimes specific to a company or an industry. We want to do business in such an environment, not because we like pessimism, but because we like the prices it produces. It is optimism that is the enemy of the rational buyer." - Warren Buffett

2003 - Shock and Awe defined the world in 2003 as the US and its allies went to war with Iraq. Interestingly, Canada did not support its largest trading partner in the war. For our investments, the second half of 2003 would begin to bear fruit and by years end, we would see high single digit returns for most accounts. It is also the year that we would establish a position in Methanex Corp, a global chemical company that we hold till this day. The maximum annual RRSP limit had just been increased to $13,500 (now $21,000 for 2009). It is also the year of the SARS pandemic and the world would rally behind a beaten Toronto with a free concert for headlined by the Rolling Stones.

2004 - Starts a two and a half year run of plateauing stock markets, but perhaps the strongest period of the decade for our investment holdings. It is also the year of the Tsunami which is one of the worlds worst natural disasters which would kill over 200,000 people in southeast Asia.

As investors, 2004 would be a stellar year. Our performance benefits from arbitrage investments primarily in oil and gas as companies begin to consolidate into royalty and investment trusts. Our core positions continue to build strength and by years end, many accounts are seeing high double digit returns. Not only did we witness strength in existing positions, but investments such as Intertan, Acetex and Sodicso-Howden (which we would further benefit from an investment in its acquirer) were taken over at premium valuations to our original purchase price. We would also begin to establish a position in Pet Valu (a Pet products retailer) and Softchoice (a distributor of software and hardware products). Pet Valu would prove to be a long and hard fought investment battle and we would build a significant position before taken over in 2009 and continue to hold a significant position in Softchoice till this day.

2005 - The big news in 2005 would be hurricane Katrina that would ravish the southeastern US and while in Canada, the government put the Halloween kibosh on investment and royalty trusts breaking yet another investment theme.

For us, 2005 was an eventful year highlighted by continued strength in core positions, further success in arbitrage investments and Flint Energy's stellar rise to prices viewed possible at the onset of the investment in 2001. FirstService breaks out to all-time highs in June and we commit to an investment in Dynatec Corp and Stella Jones, both of which we would sell at significant profit, only to watch it go much higher over the next couple of years. We would also start to build a position in Nortel Preferred Shares with a view to capitalize on improving industry fundamentals and the belief ongoing industry consolidation among its peers could provide us with significant returns coupled with its monthly dividend payments. By 2008, we would be proven wrong.

2006 - The Dow Jones Industrial average breaks 11,000 for the first time since June 7, 2001. In Canada, Stephen Harper wins a minority government election while the Avian flu (aka Bird flu) strikes fear of another pandemic. Another middle-eastern war begins and ends fairly quickly as Israel invades Lebanon in the summer all the while we are all standing in line at Best Buy for Nintendo Wii's. Saddam Hussein and two of his senior aides are sentenced to death by hanging a year after he was captured.

Our investment portfolios continued the success of the previous year as we closed out our position in Flint Energy in the first half at prices 50% higher than originally anticipated and over 3x our average cost. Further, other core investment holdings continued to provide solid gains to round out the best performance year to date. So I bought a car.

2007 - Unforeseeable at the time, 2007 was to me a year of change as subtle shifts in bond pricing early in the year would foreshadow the beginning of the greatest sell off of world equity markets 18 months later. It seemed like the world was living well, maybe too well. Wall street had yet to implode, so private parties with individuals spending $150 on food and $10,000 on wine were still loud, proud an in abundance. We moved our practice to another investment dealer who promised prosperity for all and we watched American Idol every Tuesday night.

For our investment accounts, we established positions in Evertz Technologies and GLV and continued strength and conviction in our Pet Valu and Softchoice investments resulting in a strong improvement in their share prices. Both Evertz and GLV created tremendous profit as we closed out GLV, but continue to hold Evertz to this day. FirstService paid out a $5.00 preferred share dividend and its stock price would see its peak...for now. We began to establish positions in the Sterling Shoes Income Fund and Nova Chemicals which would not work out well at all the following year. However, we did make a commitment to a very successful investment in The Cash Store which operates pay-day loans to the public, a technology patent company called Mosaid Technologies (which we still own) and prefab home builder, Viceroy Homes.

The year was going incredibly strong and we were on the road to having our best performance to date, until the value of our positions started to consolidate in November. Despite the setback in valuations into December, we still managed a very strong performance year but with a very uneasy feeling at years end. Interestingly, in 2007, the TSX Index managed a 7% return, but only on the strength of only seven companies in the index. Something was in the air.

2008 - The news highlight of 2008 had to do with finance. Not since the crash of 1987 has the investment industry made such headlines. Not even the election of the first Afro-American in the white house who inherited 2 wars and a financial crisis at its peak to contend with could shake the fear of financial Armageddon. The fall of 2008 is something I will tell my grandchildren about.

Early in my career I met with a veteran investment advisor who told me that a bear market comes when you start to see your investment holdings mysteriously going down in price despite strong earnings, outlook and all the major index's are still moving higher. Unfortunately he said, you won't be able to make it out till after the fact. Looking back on that period, it is how I could best describe what happened to our investments during but prior to September's historic sell off. As our holdings were clearly lagging all investment indexes and continued to slide despite relatively strong earnings. However, we are fundamentalists, and just because prices are going down, does not mean we sell our investments. Would you sell your own business under similar circumstances? Client concerns were beginning to proliferate, but by the summers end, all seemed quiet...maybe to quiet.

The market sell-off which began in September, ushered in comparisons to the fall of Rome and of course everybody's favorite; The Great Depression. We were all in panic mode. It was difficult to make sense of something we had and still have no idea about...the balance sheets of financial institutions. One by one, they fell as companies with long standing histories such as Bear Stearns, Lehman Brothers and Citigroup faced extinction. While it was difficult to hold on to our sanity as investment positions were reduced in value by over 50%.

Warren Buffet is quoted as saying that you don't know whose naked until the tide goes out, and what could be more fitting the litany Ponzi schemes that followed the collapse as names like Allan Stanford and of course Bernard Madoff (names none of us I am sure never heard before these events) became poster boys for the greed and corruption on Wall Street. In fact so many more Ponzi schemes would pile up over the next couple of years that you would need wings to stay above it.

It was shaping up like 2009 was going to be a challenge especially with our position in Nortel Preferred prematurely suspending their distributions before going into CCAA. I came to work each day during that period wondering what form bad would take. We cancelled our family vacation plans that December.

Interesting Quote that reflects the times: "Just before a panic all is well-unusually more than well. Then the panic strikes, chaos ensues, and a dramatic status upheaval commences. People who were top of the financial order plummet to the bottom. People whose opinion was most valued are now ridiculed. Others who were on the sidelines race onto the field of play. The guy out in the wilderness who had been saying for the past four years that the good times were an illusion and a sham is wheeled in to take a bow and then hustled off stage, so that everyone else can regroup, and the whole process can start over again. And so it does, but with enough of the details changed that up close the new madness looks entirely different from any madness that has every before happened." - Michael Lewis

2009- Looking back on 2009, I would best describe it as a year of great opportunities. But it did not come cheap. It required steep mountain climbs, soul searching and the perseverance in the belief in ones value system to rise above adversity. But as we did, our investment holdings were rewarded with investment gains that we have not seen before. While the stock market rebounded incredibly from its March lows, our investment holdings increased at a substantially higher rate. Early in the year we chose to close out our position in The Sterling Shoes Income Fund following a series of inconsistent earnings releases and our position in Nova Chemicals was taken over in a successful bid for the company at a fraction of our original investment.

However, those who had the resolve to add to existing positions and/or use the funds from the sales to increase stakes in our core positions were rewarded with tremendous increases in their month end statements starting in March. As pointed out in last months View From Here, many accounts are now within 15% - 30% of their all time highs. Who would have thought that in the fall of 2008 or the winter of 2009?

Of particular note are Five holdings; Softchoice which increased 7-fold from its lows by year end, Pet Valu, which received and accepted the lowest take-over premium that I have ever held an investment in, The Cash Store which paid special dividends as well as more than doubling in price, FirstService, Methanex and Mosaid. Those who enhanced positions in these names throughout the fall of 2008 and early 2009 received the benefits of tremendous return.

In July we moved back to Research Capital Corporation and I will try not to look back in anger. This year, we took a short family vacation, I still own my car and we won the baseball championship... a first for me in 18 years. 2009 was a year of unbelievable highs and lows.

Time to move Forward

Although it has been an interesting look back on the decade, it is time to move forward and I have never been as excited about the future as I am now. For those who have held their accounts with me for over past decade, we have managed to establish a track record of success few have been able to achieve. It is an incredibly challenging but rewarding task which has resulted in the assets that we help manage increase more than four-fold during this period. 2010 will start of the fourth decade that I have helped some of you manage your investments. Experience of running this practice has established deeper roots into the investment process that is based on prudence and a better understanding of what makes a great investment.

Despite any setbacks, our success has well exceeded our disappointments. A mentor (and a very good friend) once told me that I am in the business of managing disappointment; disappointment when we sell too early (Stella Jones & Dynatec) and disappointment when things go badly (Bluetooth, Nortel, Sterling & Nova). But as the infamous Hank 'Ace' Greenberg once said; "when you soar with the eagles, you don't poop like a canary"

All Good Things,

Adam Hennick

Filed under: Uncategorized

The opinions, estimates and projections contained herein are those of the author as of the date hereof and are subject to change without notice and may not reflect those of Mackie Research Capital Corporation ("MRCC"). The information and opinions contained herein have been compiled and derived from sources believed to be reliable, but no representation or warranty, expressed or implied, is made as to their accuracy or completeness. Neither the author nor MRCC accepts liability whatsoever for any loss arising from any use of this report or its contents. Information may be available to MRCC which is not reflected herein. This report is not to be construed as an offer to sell or a solicitation for an offer to buy any securities. Member-Canadian Investor Protection Fund / member-fonds canadien de protection des épargnants.

Mackie Research Capital Corporation (MRCC) makes no representations whatsoever about any other website which you may access through this one. When you access a non-MRCC website please understand that it is independent from MRCC and that MRCC has no control over the content on that website. The content, accuracy, opinions expressed, and other links provided by these resources are not investigated, verified, monitored, or endorsed by MRCC.

 

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