SECOND QUARTER 2006 – RETROSPECTIVE

What a difference a quarter can make!

The Second Quarter of 2006 saw more than one-half the gains earned in the First Quarter disappear.

The TSX Total Return Index finished the quarter in negative territory, declining 4% and removing nearly one-half the gains made in the first quarter. Information Technology was down a whopping 22% in the quarter lead by Nortel and Cognos, each down around 31%! Health Care (-9%), Financials (-7%) and Industrials (-6%) also under-performed the Index. Only three groups reported positive performance in the quarter; Utilities (+1%), Materials (+1%) and Energy (+0.3%). Materials and Energy exhibited extreme price fluctuations during the quarter as the underlying commodities gyrated with every economic release. This was extremely evident on gold which collapsed $160 US from a high May 12 in a six week period. The Material sector was largely pulled onside right at the end of the period as Inco became in play with a bid from Phelps Dodge. The result of this bid was to excite market attention on the prospects for Teck Cominco, Falconbridge and other possible participants in the take-over follies.

There was not much to be thankful for in the Fixed Income markets either. The ScotiaCapital Universe Bond Index produced a negative return of 1%. Short-term money, as measured by the 91-day Treasury Bill compensated for the longer term bond market by recording a positive 1% return.

The stock markets had problems south of the border as well. The S&P 500 Index was down 1% in US currency and 6% when expressed in Canadian dollars. The Canadian dollar was particularly strong during the quarter as oil hit $75 US per barrel.

Globally, this was not a good quarter to be in the stock market as a Canadian investor. All fifteen of the largest world stock markets (Including US) reported negative capital returns according to their respective indexes expressed in Canadian currency.

REMAINING 2006 PROSPECTIVE

The market is coming our way!

Although not any cheaper than the beginning of 2006, equities are in fact more expensive overall than at January 1, but much better priced than March 31.

However, in volatility one can usually find opportunity. Before you get concerned that we mean to start aggressively trading trying to guess the momentary fluctuations of stock prices, let us assure you that our long-term commitment to value remains intact. When markets start to react so violently to daily economic releases, opportunities present themselves when the stocks of great companies get crushed with those of the not so great. In the coming months we expect to see several such incidences where it will be possible to upgrade the overall quality of our portfolios into companies with even greater financial strength and more limited downside risk.

Financial strength is becoming more important at this juncture. Concerns over the sustainability of economic growth are becoming more prevalent. In a large way, the market sell-off in the second quarter is related to these concerns, particularly the fear of the Federal Reserve “over shooting” in their attempt to slow economic activity to a level where inflationary forces can be brought under control. Thus far, it is not clear that the interest rate increases to date have achieved this objective. We have gone through a long period of economic expansion with rising commodity prices, low interest rates and little sign of inflation creeping into consumer prices or wages. Many companies (and consumers for that matter) have been able to hide under the cover of low interest rates and borrow to excess. Therefore, we want to be well positioned in firms with the financial wherewithal to handle a period of either higher interest rates, slower economic activity or both.

In our opinion, we do not expect the interest rate structure to move a lot higher. Whether a recession can be avoided is in question, although if one occurs it will hopefully be short in duration and intensity.

As stated in last quarter’s outlook, we remain cautiously optimistic. Our stance is to continue to focus on the long term, taking advantage opportunities as they are presented.

Have a wonderful summer.

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