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A View From Here Summer 2011

July 28, 2011 • Print This Article

"When investors in general are too risk-tolerant, security prices can embody more risk than they do return. When investors are too risk-averse, prices can offer more return than risk." - Howard Marks

Economic Anxiety...is always there

Looking at the above quote, do you feel that investors are too risk-tolerant these days? I believe that they are not. It is fascinating how many feel that things are once again on the cusp of meltdown. For my 2 cents, I believe that this fine line is always prevalent, except when things are too well on Bay and Wall Street. Outside of the period between December 1999 and March 2000, and perhaps spring-summer of 2007, there haven't been many times where I can recall the joyous view that things are great and only getting better. And then it happened...we hit a wall, and it all started to come apart; rapidly.

Looking back, it is interesting to note that when things begin to weaken, it is usually due to a catalyst that exposes a break in the system. In 2000, it was the massive sell off of the high tech stocks. In 1989 it was junk bonds, in 2002 it was geopolitical concerns and in 2008 it was housing. Prior to these events, euphoria and good cheer are mainstays of outlook. Then things start to fall apart and along with it comes a whole host of individuals that we've never really heard of before (Ivan Boesky, Bernard Madoff) that become the poster boys for greed and corruption of the times, as if we were all drunk at the party for too long. And then they slowly fade into obscurity, so the entrepreneur's can create their next bubble and the whole process begins again.

Bear vs. Bull Markets

Let's use recent events to highlight this process:

Bear Markets * Begin when a few thoughtful investors recognize that despite the prevailing bullishness, things won't always be rosy - fall 2007. * This is followed by a period when most investors recognize things are deteriorating: 2008 * The 3rd stage is when everyone's convinced things can only get worse: Fall 2008- Spring 2009

Then the process reverses when, a few forward-looking people begin to believe things will get better (Spring 2009).

Then when most investors realize improvement is actually taking place (2010-2011) and then when everyone concludes things will get better forever. (???)

It is important to think of this process much like a pendulum with the mid-point being neutral. Things are rarely neutral (and no money is made there), but when the pendulum springs forward in a powerful move, investors become quite risk tolerant and vice-versa. Bear markets do not last as long as bull markets which take the better part of a decade to present itself, and then when panic sets in, the bear market begins with the pendulum swings backward, and as in 2008-2009 takes on a very dramatic push.

Are we in a euphoric state, or are the events of just a few years ago, so fresh in our minds? I would argue the latter.

If Only...

When the pendulum swings against the markets, the dramatic devaluing of our portfolio shocks us. This prompts the thought...”if only we sold everything just a few months earlier”. But it is important to know that nobody has a successful track record making those bold calls and it is a different mentality anyway - one more akin to trading stocks, which has been 'a losers game' for as long as I've been helping clients manage their portfolios.

Peter Lynch once said, "More money is lost anticipating the changes in the overall stock market than any other way of investing." Through personal experience, I wholeheartedly agree with that statement. We are always concerned about the market. We must accept it as part of our lives and focus on what really matters: the valuation of our investments and why it should be worth more tomorrow. The rest is noise and market panics tend to arrive out of a number of storm warnings that are sent out by market pundits...it's almost impossible to pick the one that will arrive and perhaps most importantly, when. Another famous quote is "The market can go against you longer than you can stay solvent."

When I was a kid, I remember how bad things were said to be. But I don't remember food lines and the great depression. We continued living, eating and doing. Billy Joel summed it up best with this line from one of my favorite songs: "They say that these are not the best of times, but they're the only times I've ever known." (Summer, Highland Falls - 1975).

Finding our own Value

One of the best ways to avoid specific damage to portfolio is to stray away from what is a popular investment theme. It is when they are in the public's viewpoint that risk tolerance begins to take hold and the desire for ownership of a 'can't lose' becomes part of the investment fabric. For example, we are currently staying away from Gold. The price has been increasing for some time and while it may continue to do so for any years, we feel that we can find unrecognized value in other pockets to focus on. One more specific investment we also have avoided is Research In Motion. Being value-based, RIM hits all the parameters, which suggest that we should take a position. It is cheap on earnings, has a lot of cash and no debt, continues to show growth, but it is so popular, that we hope it works out for those who dare to tread, but have found that over time, we are better off looking in another place where the crowd has clearly avoided its trappings.

When looking back on the periods of consolidation three times in my career come to mind; 1989-1990, 2002-2003 and of course the grand-daddy of them all - 2008-2009. There are two traits that standout; one, they last only 12-18 months from start to finish, meaning that your not really sure what is happening until your well into it, and importantly, present the lowest risk opportunity for investors to pick up excellent business's for valuations inconceivable only months prior. Further, when a economic and therefore stock market panic sets in, it has proven to be only a matter of months before we, as investors, begin to reap the benefits ... especially if we know our investments well.

There are three examples from the 2008 fall out that I can point to:

First, we owned shares of a company called Mosaid, which we began to purchase in July 2007 in the $16 range. Despite strong growth of earnings, having a significant cash balance of 40% of its share price and an excellent dividend, the sellers drove the share price to the $7 range by February 2009 which at that price had $5.50 per share of cash, a $1.00 per share dividend and earnings of $2.00 per share. Many of us participated in adding to that position and when we sold it, in February of 2010, north of $22, the company had just raised $30 million in a secondary share offering and it was sold out. Interestingly, nothing had really changed in the business...Just perception.

Softchoice was another case. The misfortune of financing $100 million of acquisitions between October 2007 and January 2008 with maturities Between September and December 2008, when nobody was refinancing anything cannot be understated. This drove the share price down to $1 for fear that they would never receive financing and would ultimately default. We had many conversations with management during this period as they scratched their heads in bewilderment and when annual earnings were released, they had earned $0.73 per share (1.2x earnings - never seen that before). Despite being able to refinance (against the odds I suspect), the share price lingered as the markets continued their slide, but by the summer of 2009, had climbed back to the $8.00 range. Nothing had changed in that company as well except now they had integrated 3 major acquisitions that were beginning to add value to earnings.

Interestingly, Softchoice now has $36 million of cash and earnings have continued to grow despite the fact that its share price remains in a state of apathy. This can't stay for long (unless our analysis is wrong) and either the share price will begin to reflect its true value, or a strategic buyer will make an offer for the company like they have done so many times before with our holdings (Intertan, Pet Valu, Viceroy Homes, Nova).

Lastly, FirstService is another long term holding for us. Despite our close nature to this company, we have been successful at navigating its waters. Having reached over $40 in 2007, the company's share price fell to as low as $11 by February 2009 due to the fact their increased exposure to the commercial real estate sector (they hold the majority stake in Colliers Int'l - the worlds 2nd largest real estate brokerage). How many people could one convince to purchase that kind of business during a period of panic? Interestingly, FirstService was the best performer of its peers who saw their share prices sink to less than 10% of their highs, just over a year prior. Now with the hindsight of the events, FirstService traded down to its lowest valuation ever despite having a strong balance sheet and a long history of outperformance. Time moves quickly and if we know our investments well, then we can take the approach that we can buy them without the overall view that the stock market in general might go down.

For my 2 cents, I believe we are in a time much like the period after the 1987 crash when I entered the investment industry whereby, the colossal events of that period reined supreme in everyone's mind as they waiting for the other shoe to drop. The concerns of the world's debt crisis, the weak economy in the US and housing prices are the same concerns that have lingered for over 3 years. It is surprise not consensus that is going to create dramatic changes. If the debt ceiling, or Greece or US housing is going to create problems going forward, wouldn't one suspect that these factors have been priced in from the headlines and fear that they create? If you heard that a particular part of town turned out to be built on quicksand, would the value of the properties reflect that concern? And how long would it take before that concern would dissipate from its valuation?

Our Portfolio is holding well

Every month, Afsi and I print off the performance numbers of your accounts. We look to see the 3, 6, 12 and 18-month numbers and how we have performed relative to market index's and our own expectations. Our 12 month numbers are still excellent and exceed pretty much any yardstick one can put at it despite consolidation of the performance over the past 3 months. We are proud of the job we do on your behalf and feel comfortable stating that the returns we achieve on your behalf, few have been able to achieve.

That's a bold statement, but our numbers speak for themselves.

There are many proposed changes that we are working on from fee structure to portfolio adjustment as we begin to recommend the sale of a long standing position (at a loss - ouch) to adding new company's which we believe will bring income and stability to our holdings.

We are also welcoming new accounts and have received some referrals some of our clients recently. We believe that we offer the best long-term solution for individuals and would submit that if you know of anyone who is looking to increase the quality of their investment advice, that they consider our service. It is our firm belief that most investment advice remains questionable and that good advisors are out there...you just got to find them.

Enjoy this beautiful summer and as always,

All Good Things,


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.

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