Animal spirits - a cautionary tale?

Greg Dean's picture

Wow! What a change in sentiment we have seen over the last 12 months around stocks. At this time last year, we were inverting the colours of our Bloomberg terminals for companies on our watch list, so that when stocks were down they showed in GREEN! Then, the popular debate was whether the U.S. and rest of world were entering a recession and whether China would devalue its currency. Today, everyone seems to be focused on President Trump and whether his administration will be able to deliver the “tremendous” growth they have been promising through tax cuts, infrastructure spending (wall building?) and deregulation in the financial sector. The term “animal spirits” has re-emerged for the first time since the financial crisis.

At Cambridge, we have entered 2017 about as conservatively positioned across our funds as we have at any point in our careers. As a firm, we are holding about 20% of our clients’ assets in cash and have dramatically reduced positions in U.S. financials after their near-historic rally. (See the Texas Capital Bancshares case study below.)  We also took some profits and de-risked positions in industrials and other stocks that we feel may be pricing in overly rosy assumptions about the economy.

Below is a brief performance summary of various asset classes.

1 year performance as at February 28, 2017:

  • Cambridge Growth Companies Corporate Class F: +38.8%*
  • Cambridge Canadian Dividend Fund Class F: +17.6%*
  • Cambridge Asset Allocation Corporate Class F: +11.6%*
  • S&P/TSX Composite Index: +23.2%
  • S&P 500 Index TR (CAD): +22.4%
  • MSCI World Index GR (CAD): +19.2%

Sources: Morningstar and Bloomberg
*Fund performance is net of embedded fees. 

Now please take a deep breath and repeat the following with me:

“We did very well with our investments last year and additional caution is now warranted. I may need to lower my return expectations in the short term.”

First and foremost, our goal as a firm has always been to protect client capital. We only invest your money if we are confident that the risk/reward opportunity is skewed in your favour. The simple fact is today we aren’t seeing as many of those opportunities. It’s important that our clients’ expectations are focused on the LONG TERM, especially some of our newer clients who may be looking at our past performance and extrapolating it into the future. We do look forward to many years of strong returns, but we have been doing this long enough to know that stocks don’t go up in a straight line. Corrections are healthy and usually come when you least expect them and/or are riding high from looking at how well you’ve done. Given the rate at which clients have trusted us with new money, we felt it was important we make clear our own return expectations for the near future. Our goal is to keep what we earned last year for our clients. Hopefully, the market will provide us with some nice opportunities (it has never failed to do so). But with markets at all-time highs, we aren’t expecting to see as many as we did over the last few years. It is likely that the best opportunities will become available after a period of negative returns. Our hope is that you will trust us even more at that time. If you think you may not, then our funds may not be the right investment for you.

Thanks for your continued partnership.

Texas Capital Bancshares example
Here is an example to illustrate why the position size of Texas Capital Bancshares was trimmed – a regional bank with which we are deeply familiar.

Texas Capital Bancshares was founded in 1996 and went public in 2003. It is a classic deposit-taking bank that has organically compounded earnings at 11% a year for 10 years (including the period through the financial collapse). It has been one of our holdings since Cambridge Growth Companies Fund was launched in mid-2014. According to our fundamental research, the risk/reward opportunity became very interesting when the market started to worry about its exposure to the Texas economy – predominantly the oil and gas sector during last fall and winter. At that time, I made it a top five holding (oil and gas were < 10% of its loan book) when it got to book value. Today, with two-year interest rates having moved up from the bottom (July 2016) and at their highest since the financial crisis, and more importantly with inflation expectations picking up, the stock is now 2.3x book value and has gone from 10x earnings to 22x earnings!! In our opinion it is still a great company; however, it is more risky than it was a year ago. Therefore, we have reduced the position considerably.

The historical annual compounded total rates of return for Series F units of Cambridge Growth Companies Corporate Class are: 1 year 38.8% and SI 16.2% and since inception of July 29, 2014. The historical annual compounded total rates of return for Series F units of Cambridge Canadian Dividend Fund are: 1 year 17.6%, 3 year 13.2%, 5 year 11.5%, 10 year 7.4, SI 8.6%, since inception of June 14, 2006.  The historical annual compounded total rates of return for Series F units of Cambridge Asset Allocation Corporate Class are: 1 year 11.6%, 3 year 7.2%, 5 year 9.0%, SI 7.3%, since inception of December 31, 2007.

Disclaimer:
This commentary is provided as a general source of information and should not be considered personal investment advice or an offer or solicitation to buy or sell securities. Every effort has been made to ensure that the material contained in this commentary is accurate at the time of publication. However, CI Investments Inc. cannot guarantee its accuracy or completeness and accepts no responsibility for any loss arising from any use of or reliance on the information contained herein. All charts and illustrations in this guide are for illustrative purposes only; they are not intended to predict or project investment results. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in share or unit value and reinvestment of all dividends or distributions and does not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. This report may contain forward-looking statements about CI funds, future performance, strategies or prospects, and possible future fund action. These statements reflect the portfolio managers’ current beliefs and are based on information currently available to them. Forward-looking statements are not guarantees of future performance. We caution you not to place undue reliance on these statements as a number of factors could cause actual events or results to differ materially from those expressed in any forward-looking statement, including economic, political and market changes and other developments.

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