Fund manager Irwin Michael expects that the road will be rocky but the North American stock market will post gains again this year.
"I would not be a bit surprised if it earns 10 to 15 per cent," said the president of I.A. Michael Investment Counsel Ltd. But he doesn't think it will be smooth for the markets. "I expect it to remain extremely volatile as evidenced by what happened last week," he said.
A number of factors make him optimistic about the stock market. For one thing, he thinks that mergers and acquisitions will continue to be a significant factor in markets around the world. "We expect much more M&A going into 2007, particularly for smaller companies and in particular in the United States because we still believe the Sarbanes-Oxley Act is a catalyst for many small companies to go private," he said.
Moreover, he said "we believe there is a lot of cash out there; a lot of cash looking for a home," as many investors have shied away from bonds and money markets because of the low interest rates.
His optimism about the markets also arises out of a view that the North American economy will slow but still grow by 1.5 to 2.5 per cent this year.
Mr. Michael sees both the Canadian and U.S. stock markets doing well but said he is finding more bargains south of the border. "I think the U.S. market is one of the cheapest, if not the cheapest, in the world," he said.
He runs a number of funds, including the long-established ABC Fundamental Value Fund. The $850-million fund gained 19.13 per cent in last year, continuing a streak that saw it post a return of 19.04 per cent annualized over the past three years, 17.54 per cent over five years, and 18.51 per cent over 15 years.
Mr. Michael's three stock picks tend to bear out his contrarian orientation. They are not as well known as some other companies; their shares are trading below book value, below net asset value, and what he considers is their replacement cost. Furthermore, all three either pay a dividend or provide a yield.
Norbord Inc. (NBD-TSX), which primarily produces oriented strandboard (OSB), is a Canadian firm but about 70 per cent of its assets are in the United States.
"It is, we believe, the highest quality, best managed, lowest cost OSB producer in North America," Mr. Michael said. He said that he "would not be a bit surprised within the next 12 to 18 months" to see Norbord, which is part of the Brookfield Asset Management Corp. portfolio, sold.
Furthermore, there is concern about U.S. housing starts but he thinks Norbord, being the lowest cost producer, "can withstand low prices."
He says the shares, which closed at $9.26 on the Toronto Stock Exchange, have a net asset value between $11.50 and $12.50. They yield 4.45 per cent.
Mr. Michael reviews income trusts on the same standards as shares.
"While we would not buy many of the income trusts, we are finding about a dozen or so" that meet the deep value investing criteria, he said. One of those is TerraVest Income Fund (TI.UN-TSX), which has invested in a diversified group of income-producing companies that make, among other things, wellhead processing equipment and sleeping bags.
Mr. Michael said he would not be surprised if the current distribution of 11.5 cents a month were cut; indeed, he would prefer TerraVest did that and used the money saved to buy back units.
The attraction with TerraVest is the quality of its management, the fact that the units are trading at a discount to the NAV and are fundamentally cheap. The units ended yesterday's session at $6.20. Hong Kong-based Seaspan Corp. (SSW-NYSE) owns a fleet of 17 container ships, which it has leased out to customers on a long-term fixed-rate basis, Mr. Michael said. And it contracted to add another 24 ships over the next three years. He bought some shares at the time of the summer, 2005, initial public offering at $21 (U.S.) and then added to the position in a financing at $21.50 last November. The shares now stand at $23.33.
He believes that the replacement cost of the ships probably works out at $30 a share. The shares yield 7.1 per cent. He is impressed with the management. And he said that corporations are finding it cheaper to lease rather than buy ships, which is a plus for Seaspan.
By the numbers
Annualized gains of ABC Fundamental Value Fund
19.13% last year
19.04% over three years
17.54% over five years
ABC Fundamental Value
Top holdings (as of Dec. 29, 2006)
Hudbay Minerals Inc.
Nexen Inc.
Norbord Inc.
UNUM Provident Corp.
Pioneer Natural Resources Co.
Legacy Hotels REIT
Seaspan Corp.
Talisman Energy Inc.
LionOre Mining International Ltd.
Morguard Corp.
SOURCE: COMPANY