Value Library
The following is an
excerpt from the ABC Perspective - January 2000 - Pg. 4-5
A Reality Check for Year 2000
The late
autumn stock market surge continued into December and has met
up with the traditional Santa Claus rally. What is most
interesting is that share price firmness has continued in the
face of all the stock market pessimists who worried about an
impending Y2K collapse. Clearly, by late summer or fall the
markets had discounted all Y2K paranoia, interest rate,
inflation and economic concerns and ascended to higher levels
simply through supply and demand.
While we remain
generally optimistic, as evidenced by our portfolios' reduced
cash portions, the very narrow market advance particularly
concerns us. A select few stocks are leading the markets
upward. Once again Bell Canada and Northern Telecom, now
comprising over 24% of the TSE 300 Index, have powered the
general market move. The TSE index performance has been led by
anything related to high technology, telecommunications or
Internet, whereas most other sectors such as financial
services and resources have languished.
It is interesting to
note that while the TSE 300 advanced approximately 31.7% for
1999, if we exclude Bell Canada and Northern Telecom, the
remaining 298 stocks appreciated 8.63%. Clearly, the TSE index
remains very narrowly focussed and is sending the wrong
message to investors who are benchmarking their performance to
this standard. It is important to bear in mind that while the
TSE 300 benefited substantially from the extraordinary 1999
performance of Bell and Northern Telecom, any decline in their
over weighted values could have a correspondingly substantial
negative effect on the future course of the TSE 300.
We continue to champion
out-of-favour, small and medium capitalization value stocks.
Although we do not dispute the economic importance of high
technology, telecommunications or e-commerce, many of the
public companies associated with these sectors are
outrageously expensive. For instance many stocks are trading
at well over 100 times P/E ratios and have huge multiples of
sales and price-to-book values.
As one well-known
analyst commented on a recent conference call when asked about
the hot sectors, he estimated that there is over $1 trillion
of Internet stock market value without any visible profits.
Clearly over-exuberant investors are discounting earnings well
into the future. In fact, when queried further, the same
analyst declared that the NASDAQ or U.S. over the counter
market is discounting earnings not for Y2K, but rather Y3K.
Whether the analyst was facetious or not is irrelevant. The
fact is that excessive investor speculation in the technology
and Internet sector could lead to a substantial reactive
snapback of share prices. Presently this wild speculation,
akin to the 17th century Dutch Tulip Bulb Mania,
continues unabated with inexperienced investors increasingly
raising their investment antes as their speculative bravado
grows.
At the risk of sounding
like sour grapes, we are concerned about this speculation and
have abided by our fundamental value philosophy. We believe
that the present excessively spread between small and medium
capitalization companies versus the red-hot technology sector
will eventually narrow. As we enter year 2000 we expect
momentum to gradually shift back to the realization that
"value stocks" are indeed "dirt-cheap".
We are particularly
attracted to the natural resource and cyclical sectors, which
have become virtual investment pariahs. Especially cheap are
oil and gas, forestry, metals and mines which have
significantly under-performed the popular stock averages for
the past six months. Many companies trade at huge discounts to
net asset value with low P/E and cash flow multiples. Many are
ripe for takeover, mergers or reorganization.
Over the past month we
have taken advantage of the tax-loss-selling season. While we
have liquidated stale, under-performing losers such as
Destination Resorts, Future Shop and MMI Holdings, we have
added on price weakness Alliance Forest Products, TriLink
Resources, International Forest Products, Arbor Memorial
Services and Maxx Petroleum. We have initiated new positions
in Hudson Bay Company and Stantec Inc.
We are particularly
optimistic with regard to the Canadian dollar. We believe the
dollar should appreciate to at least 70 to 72 cents over the
next twelve months. Accordingly we have already purchased two
Canadian dollar forward contracts for year 2000 and have now
hedged half of our Canadian dollar currency exposure in our
ABC American-Value Fund.
The recently aborted
takeovers of FPI Limited and Surrey Metro Credit Union, while
unfortunate, have nonetheless highlighted these overlooked
stocks. We see both these holdings performing considerably
better in 2000 as other acquisitors or investment alternatives
become available to these two companies. The late December
unsolicited takeover bid of SMED International Inc. by Office
Specialty Inc. heartens our value philosophy. While we are
pleased with the proposed takeover, we believe the $19 cash
takeover price is too low. Assuming a deal is consummated, our
700,000 share holding, purchased less than six months ago,
will add over $14 million to our cash reserve to buy other
undervalued securities.
Overall, we remain
optimistic for year 2000 and expect our ABC value stocks could
become continued beneficiaries of takeovers, mergers or
reorganizations. While interest rates may trend higher
creating a risk to equities, we believe that a very firm North
American economy with at least a 4% growth rate and moderate
inflation of 2-3% will power cyclically-oriented common shares
to higher prices.
At this time, I would
like to wish everyone a healthy, happy and prosperous year
2000.
Irwin A. Michael, CFA
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