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Gal^Stad
Investments Inc.

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Year in Review

2018 in Perspective,
from the January 2019 issue

What a difference a year makes. In 2017, American equity markets rallied to new highs nearly every month as investors brimmed with optimism. Volatility was as quiet as a sleeping baby. Corporate M&A activity was in full swing and buybacks were all the rage.

Bitcoin and cryptocurrencies took the world by storm and presented the investing public with a tantalizing get-rich-quick scheme. Canadians eagerly awaited the legalization of marijuana and couldn’t pile on the debt fast enough as house prices soared and frantic bidding wars dominated large urban centres like Vancouver and Toronto.

Fast-forward to 2018, and volatility returned with a vengeance, dragging stock exchanges around the globe into bear-market territory. While buybacks are still in vogue, the pace of M&A deals has subsided. Cryptocurrencies imploded — even the pioneer, Bitcoin, lost over 80 percent of its value.

The Canadian housing sector stalled as higher interest rates, new taxes and tighter lending rules took hold. Cannabis was finally legalized after much toing-and-froing, but after a spectacular run, the old adage “buy on the rumour, sell on the news” left pot investors a little leaner — and with a case of the munchies.

In North America, indexes notched their worst performance in a decade despite solid economic growth and a new trade deal. The Dow and S&P 500 were down 5.6 and 6.2 percent respectively, while the Russell 2000 dropped 11.9 percent.

The declines felt worse because markets had been doing well until September. The high-flying FAANGs (Facebook, Apple, Amazon, Netflix and Google) were not immune, falling more than 20 percent and leading the Nasdaq into a bear market. US equities recorded their worst December since the Great Depression, and investor sentiment hit a level of pessimism not seen in a decade.

After surpassing 16,000 for the first time in 2017, Canada’s TSX Composite index finished down by 11.6 percent in 2018, erasing three years of gains, and it is now lower than its peak in 2008. The three main arenas — financials, materials and oil & gas — were all negative, and the TSX Venture Exchange lost over a third of its value.

The loonie skidded lower, from 80 cents US at the start of the year to 73 cents by the end of December.

Farther afield, exchanges did even worse than in North America. The biggest loser was Turkey, which swooned by 43.6 percent. The country suffered from rampant inflation and a currency crisis. Though the situation appears to have stabilized, there’s still a complex set of domestic and regional economic/political challenges to be traversed.

Greece was hammered 37.8 percent. Austria was thumped 29.3 percent versus a spectacular run in 2017, and Belgium, Germany and Italy all entered bear markets.

In Asia, heavyweights China, India and Japan decreased 21, 8.8 and 15 percent respectively. The fortunes of China and India appear to be diverging. China’s economic liberalization has stalled, and the country is struggling with significant debt, challenging demographics and a deteriorating trade relationship with the US.

Meanwhile, India’s laissez-faire economic reforms under Modi appear to be having the desired effect, and the nation has strong demographic trends going for it. India’s GDP growth rate handily surpassed that of China for the first nine months of 2018.

“Was anywhere positive?” you ask. Why, yes: little Qatar was the only developed or emerging market covered by MSCI to break the pattern, up an impressive 25.5 percent. Silver and bronze medals for “best performance” went to Brazil and Russia, which achieved losses in the low single digits. Hardly worth climbing onto the podium for.

Commodities didn’t have a great year either. America’s oil benchmark, West Texas Intermediate (WTI), lost roughly a quarter of its value during 2018. In the fourth quarter, oil moved into bear territory in less than five weeks and skidded to its longest losing streak on record, posting 11 consecutive days of decline.

Europe’s Brent benchmark met a similar fate. In Canada, Western Select was a total basket case; the discount to WTI was the largest ever. In the face of the sell-off, OPEC and Russia decided to curtail some production for 2019, as did — surprise, surprise — Alberta. Will the Permian eat everyone else’s lunch again?

Though North American natural gas showed signs of life in November, it flagged in December and ended the year roughly where it started. Unfortunately for Canada, the AECO gas hub in Alberta remains at a discount to its American peers amid — you guessed it — pipeline capacity constraints.

In the world of metals, gold was off less than three percent thanks to a late-year rally. Investors have once again turned to the precious metal in nervous times. Silver and copper didn’t fare so well; they were off by low double digits. Winners in the commodities space included uranium, wheat and poultry, which appreciated in the double digits.

Here at Contra the Heard, the results reflected the broader environment. The President’s Portfolio clocked in at –11.9 percent, making 2018 the fourth-worst year in its history. Still, the ten-year annualized return is 21.3 percent. We can live with that.

Of the myriad positions held during the year, only six ended in the plus column. Highlights included the partial sale of ATS Automation for a 215 percent gain, and the sale of First United for a gain of 157 percent. Lowlights included Cathedral Energy, Flex, General Electric and Obsidian, all of which fell by more than half. Yikes!

With the exception of the horrible 2008 that followed the feeble 2007, the PP has always bounced back the next year with a return of better than 47 percent. As the disclaimer says, “Past returns . . .” You know the drill.

The VPP was off by a mild 1.5 percent. Leading the way was the partial sale of Century Aluminum for a gain of 523 percent in just over two years, and the entire sale of ATS for a gain of 227 percent. Guess? also returned over 23 percent, plus a handsome dividend, during a year when most retailers took a shellacking.

Unfortunately, Bellatrix and Carbo Ceramics fell by more than half. The portfolio is up 125.2 percent since inception in 2010, which annualizes to 9.5 percent.

Though we took our licks, the drawdown yielded some picks with what we consider excellent potential. Benj doubled up on Cathedral and acquired Black Diamond Group and Stuart Olson.

Within the VPP, Ben and Phil repurchased Diana Shipping, increased their exposure to Major Drilling and TransAlta and added Hibbett Sports, SIFY Technologies and Gold Resource Corp. With the entry of Ensco into the VPP last March, it was an active year on the buy side.

Although benchmarks have retreated significantly, valuations remain historically high. As the savings rate in Canada hit a multi-decade low of 0.8 percent in late 2018, debt levels were elevated globally across all economic actors: consumers, corporations and governments. Investors should be mindful that leverage is the enemy of stability, and high valuations tend to regress to the mean.

The current US economic expansion is one of the longest-lived on record, and the yield curve is flirting with inversion for many countries — one of the more reliable recession indicators out there.

There are also fears regarding US–China trade relations, Brexit and such emerging issues as the ongoing situations in Turkey and Argentina. Taken together, it suggests investors should proceed with caution. Still, it’s worth remembering that there are opportunities out there. Here in Contra’s little world, we continue to seek less levered securities in beaten-up fields, while we monitor the financial health of existing positions.

Behind the scenes at Team Contra, change is minor. Phil has returned to Victoria, B. C., after seven years in Toronto and is the company’s West Coast representative. Meanwhile, Bill remains the outfit’s East Coast equivalent. The core of the operation resides — of course — in Toronto, where Ben, Benj, Lloyd and Mark continue to man their posts.

The Twitter feed (@ContratheHeard) will dutifully report; Benj’s personal account (@BenjContra) will chirp less than The Donald’s. We’re proud to say that, in our 25 years of doing Contra, the team has remained broadly intact. From the perspective of the Benjamins, that speaks loudly.


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