FIRST QUARTER 2006 – RETROSPECTIVE AND PROSPECTIVE

The First Quarter of 2006 continued the optimism evident in the market in 2005.

The TSX Total Return finished the quarter in strong positive territory with a return of 8%. Looking at the details, there were some profound shifts in leadership. Materials (+15%) and Energy (+10%) continued to do well, but excellent returns were also recorded by Industrials (+10%), Information Technology (+10%) and Health Care (+8%). Only Utilities (-9%), Telecom Services (-1%) and Consumer Staples (-1%), three of the ten major industrial groups, posted negative returns in the quarter. Income Trusts, now integrating with the TSX Index, managed a total return of 7% (CIBC W M Total Return).

Fixed Income did not fair as well as Equities. The S&P/TSX Composite Bond Index produced a negative total return of -0.5% in the quarter in reaction to rising interest rates.

Due to the resource nature of the market, equity returns of the the more heavily consumer oriented US market did not keep pace with the Canadian market returns. The S&P 500 Index had a total return of just over 4%, measured in US currency. The Canadian dollar lost a modest bit of ground to the US dollar in the quarter resulting in a very small currency gain on US investments.

Other world markets as measured by the MSCI EAFE (Europe, Australasia, Far East) Index recorded a total return of 10% in the quarter, when measured in Canadian dollars.

Commodities fueled the equity markets in the first quarter. The volatility of the Canadian market appeared to be sensitive on a daily basis to fluctuations in oil prices. NYME Oil futures went from below $60US per barrel to over $67US, but tested the extremes several times. Gold was also gaining popularity, perhaps as a hedge against the gyrations of the US dollar as London Spot Gold prices increased form $524US to $588US over the last three months. Other metals also posted spectacular gains as you might surmise from the gain in the TSX Materials sub-index. Copper (from $2.08US to $2.51US per lb.), Aluminum ($1.04 to $1.14), Nickel ($6.07 to $6.96) and Zinc ($0.87 to $1.22) are but a few examples.

Mergers and Acquisitions, particularly large ones, were in evidence. Dofasco’s threatening acquirer was itself threatened with a take-over. The Hudson’s Bay Company became an American entity. Barrick Gold completed its acquisition of Placer Dome. At the end of the quarter, Sears US sweetened its offer for Sears Canada. It is getting more difficult to find consumer related exposure in Canada.

In Canada and the US, considerable focus on the beleaguered North American automobile sector continues as Delphi works its way towards some form of solvency, only a prelude to what the major brands may face. These concerns strike at the heartland of Ontario and only serve to cast more attention to Alberta’s petro-riches.

REMAINING 2006 PROSPECTIVE

Cautious optimism remains our theme.

Equities do not appear any cheaper than they were at the beginning of the year. In fact, the equity market is even more expensive. Our never ending search for value continues, but the pickings are slim.

We believe that the secular forces which have driven the market thus far remain intact for the long-term, but, for the immediate future volatility will cause market imbalances as economic direction remains unclear. It is our expectation that this volatility will present a few opportunities over the coming months. Global growth continues to drive the demand for basic materials where little capital has been allocated to capacity for some time. Already, smaller companies are forming to exploit old mine sites long abandoned by the major companies that high-graded the mines leaving then when prices were no longer economic. For their sake, the higher price environment better continue. Infrastructure projects slowly being announced in areas from road expansion (Highway 407), to new office complexes and transportation systems.

Interest rates have continued to increase at the short end leading to concerns as to the stability of the housing market with strong attention being paid to consumer debt. There is some inconclusive evidence that the consumer is beginning to lower purchases due to the burgeoning consumer debt levels.

Surely high commodity and energy prices must be having some effect on consumer spending habits. It is our opinion that the need to raise rates much further is quickly dissipating. The question remains as to whether or not a recession can be avoided before business spending picks up. In the meanwhile, we project that the market will continue to fluctuate around current levels until earnings catch up to current valuation levels or a more negative view comes to fore.

Overall, our long-term outlook remains quite positive for the Canadian market which will benefit from the higher material and energy environment. The demand for capital should support the financial sector. We suspect that the Canadian dollar will resume its appreciation relative to the US dollar. Hence, we will remain to be very selective in our quest to add US exposure.

Current market conditions allow us the opportunity to occasionally upgrade the quality of holdings in the portfolio. We will continue to be very selective in our endevour to invest in circumstances where the downside risk is constrained.

Enjoy a wonderful spring season.

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