No more cash for trash

"No more cash for trash," says Tom Trimble, CIBC Wood Gundy. This catchy theme tracking through private equity investing is explored below by CIBC Wood Gundy's investment expert, Tom Trimble:

It is hard to believe that it has been just over a year since the collapse of Lehman’s and the ensuing market maelstrom. At one point it appeared that the whole financial system was at risk, but the concerted effort of governments around the globe staved off disaster. While conditions have improved markedly, the sheer volume of conflicting information and opinion on what the future holds is staggering.

What we do know is that both the credit markets and the equity markets have roared back from a near death experience. Over the past month we have been conducting a number of annual reviews with clients that have their birthdays in the fall. Part of the meeting has been a discussion of the performance of the portfolios from a year-to-date, one year, and two year perspective. This coincides with the beginning of the meltdown in the U.S. and includes the worst days of 2008 and 2009. It has been encouraging that over this time period the “total” return has been only modestly negative, much better than most expected.

So what now? We would like to discuss several themes that are shaping our current thinking.

Bullish On Equity

As most of you are aware, at the height of the crisis we chose to move into corporate and high yield bonds as they offered the best risk-adjusted return at the time. If the number of bond issues that have come to the market since then is any indication, then credit markets have experienced a rapid thaw from the frozen conditions of March. The difference between Government of Canada bond yields and low grade bond yields has narrowed to almost pre-Lehman levels. At the same time the yield on cash assets have shrunk to almost zero.

While nobody wanted bonds in March, we now find that there is tremendous demand for any type of income product regardless of quality and yield. We are no longer buying much fixed income due to low interest rates and are thus more interested in equity that offers attractive yields and potential for capital appreciation. We feel that equity offers us the best risk adjusted return opportunity, especially the high quality companies that have lagged the market over the past six months. That being said we are very careful about what equity we wish to own. See “cash for trash” below.

In our last commentary we mentioned that we had created four CPMS branch portfolios. We have been meeting every Tuesday as a group to review the portfolio and to make any changes we deem necessary. Since we started on April 1^st we are happy to report that the CPMS portfolios have been excellent performers. Over the next few months we will be integrating the companies highlighted in these portfolios into our accounts. Stay tuned.

No More “Cash For Trash”

We have talked about this issue before, but it is worth repeating. In fact, CPMS has analyzed the characteristics of the best performing stocks over the past six months and it was clear the only positive attributes for these companies have been a low price to book ratio and high earnings expectations in the future. Once the governments stepped in and guaranteed the financial system, these companies were tossed a lifeline and their stocks moved up. This “hope trade” helped move these stocks through several technical barriers and many speculators/investors piled in for the ride. This ride has continued, especially with the commodity based stocks.

We feel that with the third quarter results being posted now, there will be a shift away from these higher risk stocks to the less risky, more consistent companies with steady growth in profits, and good balance sheets. It is our opinion that, in times like this, these are the companies that deserve a premium valuation. There may be a few extra innings on the “cash for trash” trade, but we are beginning to position our portfolios into the companies that offer steady profits, solid balance sheets and may not have moved with the market.

Currency, Commodities And Gold, Joined At The Hip

We are bullish on materials, energy, and agriculture over the long-term based on the age old supply/demand principle. Unfortunately, the U.S. governments’ ballooning deficit adds another dimension to this investment thesis. Since commodities are priced in $US, the movement in the dollar affects the price of commodities, but this does not necessarily improve energy, material, or agricultural companies bottom lines.

For example, if the $US declines by 10% and oil prices go up 8%, the net affect to a Canadian oil producer’s net income is actually negative as they have to convert their income into $CDN and most of their costs are in $CDN. Unfortunately most investors focus only on the price of oil and bid up oil shares as the price of oil goes higher without factoring in the effect of the currency. We don’t like investing in commodities that are inflated by short-term movement of the $US and would prefer to buy them when it is clear that demand is increasing faster than supply.

While we have seen some “green shoots” in the economy, we need to see sustainable demand in the developing world for the rally in commodities to continue based on supply and demand. At the moment, 40% of the China’s GDP is government stimulus spending. This kind of stimulus is not sustainable forever so we would like to see more growth coming from the consumer. If we see a correction in the $US and thus commodities we would add to our positions.

The World, It Be A Changing

Two years ago, all the talk was about the decoupling of the developed economies from developing economies. During the financial crisis this theory was put to the test and failed as all markets declined together. Now that we are in the recovery phase it is becoming abundantly clear that 2008 and 2009 were bumps in the road for these economies of China, India, Brazil, and Latin America.

Their balance sheets and banking systems are in solid shape. They have tremendous potential for consumer growth, they are great savers, and they did not see the asset bubbles from too much leverage that the OECD nations experienced.

If we look at the U.S. we see exploding public sector debt, a huge inventory of homes in foreclosure or about to be foreclosed, decreased consumption and increases savings by consumers, which would indicate a slow rate of recovery.

It is our opinion that we will gradually see a shift from the U.S. being a consuming nation to one that grows through exports. Meanwhile China, India, Brazil, Latin America, and Asia will generate less of their GDP growth through exports and more through domestic consumption. Growth in these economies will place demands on the supply of materials, energy, technology, agriculture, infrastructure and specialized services/industries.

Canada is well positioned to benefit from this economic shift through our commodities, however, our manufacturing sector will suffer with the continued decline of the $US. Our banks have done well recently, but will likely trade sideways for a while until there is visible proof that Canada’s economy is recovering with some strength.

CIBC Wood Gundy

Lisa Applegath Tom Trimble

Investment Advisor Investment Advisor

Contact: Fossati, Susy mailto:Susy.Fossati@cibc.com

Do these ideas get implemented?

To keep up to date, entrepreneurs do appreciate great idea people. I was sent this top 50 list of the best ideas people by an ideas man himself, Flavian Delima. To qualify, your ideas must get implemented and show results in companies. The top thinker on this prestigious list is CK Prahalad who used to co-author with Gary Hamel. Together, they introduced the idea of Core Competency to businesses which is one of the most enduring strategic concepts of the past 50 years.

I met both Hamel and Prahalad at a strategy conference in Chicago back in 1993 and was captivated. Hamel was by far the more showy of the two, and he can be credited with popularizing their ideas. Prahalad was more difficult to understand as he spoke in complex terms but obviously the deeper thinker of the pair.

They stopped working together and – like The Beatles – I have found their later work not to have had the same depth of theory combined with fiery rhetoric to get your ideas jumping from the text into your business. Maybe they will stage a reunion?

Jacoline Loewen, author and partner in private equity firm.

The interview with Prahalad is terrific and well worth a listen.

Remain calm when rejected for finance

Remain calm when rejected by people with finance. Listen to their comments and ask for more feedback. You can rework it and then come back or go to a new source of capital and try yoru plan again.

Canadian Business has a useful podcast on attaining financing for small and medium businesses. Read more.

Your business will benefit from you goofing off

If you want your business to grow, you need to work all the time, right? Not according to one the most interesting entrepreneurs who started and ultimately sold Flickr. Read more.

Caterina Fake, who, with her husband Stewart Butterfield, founded Flickr, knows a thing or two about bliztkreig work schedules. But she points out that late nights are seldom very useful in the grand scheme of things. Hard work? Overrated:

When we were building Flickr, we worked very hard. We worked all waking hours, we didn't stop. My Hunch cofounder Chris Dixon and I were talking about how hard we worked on our first startups, his being Site Advisor, acquired by McAfee--14-18 hours a day. We agreed that a lot of what we then considered "working hard" was actually "freaking out". Freaking out included panicking, working on things just to be working on something, not knowing what we were doing, fearing failure, worrying about things we needn't have worried about, thinking about fund raising rather than product building, building too many features, getting distracted by competitors, being at the office since just being there seemed productive even if it wasn't--and other time-consuming activities. This time around we have eliminated a lot of freaking out time. We seem to be working less hard this time, even making it home in time for dinner.

Much more important than working hard is knowing how to find the right thing to work on. Paying attention to what is going on in the world. Seeing patterns. Seeing things as they are rather than how you want them to be. Being able to read what people want. Putting yourself in the right place where information is flowing freely and interesting new juxtapositions can be seen. But you can save yourself a lot of time by working on the right thing. Working hard, even, if that's what you like to do.

Why you shouldn't miss the Profit Small Business Show October 15th

Get entrepreneurial lessons from those who have crossed the chasm and made it. Profit magazine supports and encourages SMEs here in Canada and is putting on a terrific event.

http://events.unisfair.com/index.jsp?eid=465&seid=28

Profit has given Canadian companies a powerful forum to be showcased and attract opportunities.

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