Commentary

Once again, a disappointing month and an even worse quarter for capital markets, and particularly our funds, as macro events trumped any semblance of sanity. What was already a tough year, especially for mid to small cap, just got worse as our policy makers and politicians bumbled their way into ineptitude, starting with a budget impasse in the U.S. and to a Euro crisis by the end of September. As such, this correction has called into question the global economy and the bull market we have been experiencing since February 2009.
With vivid memories of the financial crisis of 2008, once again investors have panicked. In the 30 years of being in this business, the speed and recklessness of this market astounds me. Rational thought does not exist when one panics and some commentators are once again talking about the end of the world as we know it.
We do not view the global economy to be as vulnerable to a recession as four years ago, and we continue to believe there will be no global recession this year or early next. As we have said previously, we anticipate sluggish global growth of 2.5% to 3.5% over the next year. We do believe that rational heads will prevail and many of the macro problems will be addressed. As to being solved, that is for another time. We believe investors are way too bearish and being overly swayed by macro variables. Fundamentals drive stocks and right now there are way too many cheap stocks.

The current earnings yield of 6%+ versus the long- bond yield is much larger than average and now with operation Twist in place, the spread of 4.5% provides support to the equity markets. Outside of the recent drop of metal prices commodity prices continue to hold well above recessionary levels.
Although analysts have slightly lowered earnings expectations, the damage to stocks has more than offset any cuts to forecast. Obviously, macro events have weighed heavily on the risk trade. Both energy and materials have been particularly hard hit. As liquidity concerns heightened, the mid-to-small cap sector has experienced abnormally large declines. Traditional defensive areas have held up well and one can argue that this group is now the most expensive part of the market. As an example, Enbridge Inc. now trades at 22 times earnings versus the S&P/TSX at 12.5 times. As investors continue to seek yield at any cost, one has to ask if things are getting carried away. With savings rates at 0.5% and 10-year rates below 2%, we suggest that it is time to put some risk into your portfolios.

Once macro events dissipate, we believe the market could stage at least a 15% rally. This is similar to what we experienced post the Russian crisis in 1998.
In closing, I am not so naïve as to believe everything is OK. In fact, until we see bold moves by central bankers and policy makers, the volatility is likely to continue. We believe at some point policy makers will make bold moves, but hopefully it will be proactive rather than reactive.

The Fund
For the month, the Canadian Hedge Fund registered a loss of 11.7% versus the S&P/TSX (-8.97%), S & P (-7.18%). At the end of the quarter we had a 35% cash weighting, and it is our intent to deploy half of the cash back into the market. We are likely to add to positions in senior oils and international oils. We do believe that mergers and acquisitions will begin to accelerate and that China will begin to deploy its large treasury bond positions into hard assets, both in the purchases of materials as well as corporations.
We will continue to avoid the insurers and although the banks will be market performers, we prefer to focus on the beaten down areas of the market.

Frank Mersch