Mackenzie Ivy Team
- U.S. markets experienced some volatility for the first time after a record-breaking run of subdued volatility. The current bull market is the second longest in history at 107 months and is third in amplitude at a 306.5% total gain from the March 9, 2009 low to January 26th when the most recent high was made. Valuations plummeted all the way to the 95 percentile (meaning only 5 years out of 100 would be expected to be more expensive) sparking buy-the-dip calls. It has been profitable to buy the dips on this record run but with valuations where they are when combined with immeasurable arrogance by monetary policy-makers and complacency by investors on pretty much everything we think it will be much more profitable on a long-term basis to remain very selective with market exposures. The mini melt-up we had in late January and early February exhibited the greatest amount of momentum ever on some measures. Was this the emotional peak for the market? Perhaps. Might not be the price peak but at this point it probably doesn’t matter much. So far the market has struggled to regain its strength.
- Economic data coming out of Europe has been generally strong over the past year, with solid GDP growth, and unemployment rates near multi-decade lows. There have been signs of some cooling off recently, and the ECB has kept the pedal pressed firmly on the floor. We don’t have a view on near-term economic performance in Europe, and it does not much inform our investment decisions one way or the other. We focus on finding great businesses (most of which have substantial parts of their profits outside of Europe), and value them in the context of a long-term assumption of economic growth, which includes expansions and recessions.
- Far East markets declined in local currency terms during Q1 2018, following the path of most other global markets. Q1 featured increased volatility in February and March, following a very strong January. Market participants grew more nervous about the prospects and impacts of rising interest rates in some countries (the US, for example), and roll-back of quantitative easing in others (Europe, UK). Later in the quarter, markets were hit with fears of a potential trade war between the US and China, and other trade-related protectionist actions.
- The MSCI World Index returned 1.2% over the first quarter of 2018 in CAD terms. Information Technology and Consumer Discretionary are the best performers, while Telecommunication Services, Energy and Consumer Staples were among the worst performers in the quarter. On a country basis, the index led by winners like Finland, Italy and Portugal, while Canada, Australia and Ireland were the worst performers.
Outlook & Strategy
What are the key opportunities you see?
- In the first quarter, volatility returned to the market after having been largely absent for years. Spurred by fears of inflation, the TSX, S&P 500 and MSCI World Index receded by 8.1%, 6.5% and 6.8%, respectively, over a period of 13 days. To be sure, this was a meaningful drop over a short period, but in the grand scheme it was but a blip on the radar, with valuations remaining broadly expensive. We were asked by several clients in the wake of this sell-off if it had led us into a buying spree, which it did not, however, on the margin we did add to select positions. Although our view that the market remains expensive is informed by our bottom-up observations of individual expected returns, it is also supported by the fact that the S&P 500 and MSCI World Indices have traded below their current price to sales levels 97% and 94% of the time going back to the early ‘90’s, while the Canadian market is slightly more constructive having traded lower 2/3 of the time (which is not to say it is cheap). While we continue to hold an elevated level of cash (~15%), we are constantly evaluating opportunities to deploy it. We are not necessarily waiting on a recession to accomplish this, rather a sufficient number of reasonably priced Ivy-type companies would suffice. In addition to a broad market sell-off, such opportunities could arise from isolated areas of disruption or superior growth that would justify higher near-term valuations. For instance, the impact of rising interest rates has weighed on pipeline, utility and telecom valuations, while our fundamental outlook for these sectors remains positive. During the quarter, this contributed to our decision to initiate new positions in Hydro One and Telus and to increase our position in Shaw in the Ivy Canadian strategy. In the Energy sector, the market’s apathy has seen many share prices retest the lows that were experienced in the 2014-2016 energy downturn, despite materially higher cash flows driven by increased production and higher oil prices. As a result, we were adding to our positions in low-cost oil producers with strong balance sheets, such as Spartan Energy and Raging River.
- In the U.S. market, performance in late January and early February’s drawdown was a little unusual with consumer staples companies catching all of the down but we see the likes of P&G now trading at very attractive levels even considering what is a recognized tough environment. We believe that very well financed stable companies like P&G, Pepsi, Colgate, Johnson and Johnson, Costco and Henry Schein combined with some attractive valuations for companies like Omnicom, Oracle, and Grainger will stand us in good stead when the market does turns.
- There has been a lot of focus on technology stocks in the past year, and not without reason, as technology continues to change how many industries operate. Technology as a sector is quite under-represented in the European markets – it is one of the smallest sectors in the region, while it is one of the largest globally. Our exposure to the sector is limited to small positions in Halma and EVS Broadcast Equipment in Ivy European Equity. However, there is a difference between technology “stocks” and how technology itself impacts companies of all kinds, either positively or negatively. Ivy European and Ivy International are shareholders in a UK business that is the national leader in its industry, receives 75% of its orders online, and delivers its products directly to customers nationwide in thirty minutes or less (a feat even Amazon is unable to match). While this may sound like a high-flying new tech firm, with a valuation to match, it is actually Domino’s Pizza Group (a “consumer discretionary” stock). Its use of technology, along with several other advantages, reinforces its success and helps sustain its high growth and profitability. Domino’s is an illustration not only of how a great business can capitalize on technological change, but also of how the lines between sectors can be somewhat artificial, and why we prefer a bottom-up approach to investing.
- We have repeated for some time that high quality stocks are, in our view, expensive. We still believe this is the case, but the degree of overvaluation has come down, and pockets of opportunity have begun to emerge. Some stocks on our watch list that were previously far out of investable range from a price perspective are now considerably closer. We remain disciplined, so cash levels are still elevated, but we are hopeful that we will see some opportunities during the year, particularly if recent levels of volatility persist.
What are key risks that need to be managed?
- We’ve had a lot of records broken on the way up and fundamental conditions are very worrying in our view. Is a simplistic view that extremes and records on the way up will be matched on the way down valid? Will people start to question whether debt-financed (buy-backs, tax cuts, lifestyles, [fill in the blank]) are really such a good idea? Will business models that seemed so promising end up being not so much? Tough to say. What is the cost of being wrong if it does? A lot when it’s happening. But if you manage your capital well on the way down opportunities will be presented by the fear of loss rather than the fear of missing out or the fear of losing your job for not keeping pace. We believe this will happen and we are ready to act aggressively to purchase equities at good prices when it does.