Value Library

The following is an excerpt from the ABC Perspective - January 2012 - Pg. 1

Progress

In all candour, 2011 was one of the toughest investment years in my entire professional career. Although the first three months of the year started off well, by early spring, concerns over the U.S. debt ceiling impasse followed by the expanding European sovereign debt/banking issues led to a late summer mini global stock market meltdown, which was succeeded by a modest recovery to year-end.

Interestingly, 2011 was a tale of two conflicting perspectives: fear versus fundamentals. Fear, which captivated investors, reflected the residual from the 2008-2009 financial trauma, the U.S. congressional impasse with regard to the federal government debt ceiling and the surging monetary and fiscal problems of Greece, Italy, et al. These mushrooming fears enervated investors and, as a result, little attention was paid to the slow but steady fundamental progress of the North American economies, improving corporate earnings and ameliorating balance sheets.

Part of the problem with regard to the slower than expected economic growth/recovery related to the deep concerns of corporate America and the propensity of companies to hoard cash – which at mid-2011 was estimated at over US$2 trillion in the United States alone – at the expense of employee rehirings and capital expenditures. However, despite the nagging macro economic concerns, corporate North America was, and still is, making progress. In fact, the recent Q3/2011 corporate earnings results in some 70% of the cases exceeded analysts’ expectations. Additionally, improving corporate fundamentals have led to dividend increases, common share buybacks, mergers, acquisitions and takeovers. Moreover, anemic interest rates of under one percent have translated into relatively low money market returns compared to very juicy, bulked-up corporate dividend yields. Also, the low interest rate environment is providing for comparatively cheap cost of capital with regard to corporate mergers, acquisitions and takeovers.

The point is that progress, no matter how measured, was made in 2011. It is our firm belief that the North American economies and corporate earnings results are improving. Furthermore, due to investor, consumer and company reticence, there is considerable pent up demand for goods and services and, by extension, 2012 could surprise us on the upside. True, European sovereign debt and banking issues linger, however, as long as the will remains, we believe Europe will muddle through. With regard to unemployment, we are optimistic that 2012 will be a year of slow but sure progress in employment gains. We sense that a selective number of individual company common shares are incredibly cheap. In fact, it should be noted that similar to past economic/investment cycles, it is in many cases cheaper to purchase a public company in the marketplace than to start off from scratch.

In summation, we are heartened by the steady 2011 economic and corporate progress. We envision that this improvement will continue and that an unexpectedly cheery 2012 could surprise corporations and investors sitting on significant cash hoards, awaiting tangible transformational catalysts to appear. It is our view that these catalysts are emerging but are, unfortunately, obscured by the current global macro anxiety and confusion. As a direct result, we remain very patient and quite optimistic for 2012.

Irwin A. Michael, CFA