July 2021 Commentary

At Kingwest, we take the long view. It is central to who we are and how we deliver market leading performance. This long-term perspective has been ingrained in our culture since our firm was founded nearly 40 years ago, and the firm continues to be run in the same way. That means thinking about the implications of every decision — from investments, risk management and team building — in terms of years and decades rather than just months or quarters. We are built to last.

We manage money for some of Canada’s leading investors, and patiently deploy that capital in investments that we believe can safely generate very attractive returns across market and economic cycles. In doing so, we have delivered better than market investment returns for our clients for decades.

Our disciplined approach set the stage for a terrific year. All our managed portfolios today stand at record levels. Since the start of the year, our Canadian Equity portfolio rose 18.5% and the US portfolio jumped 22.6% (in U.S. Dollars). This is well ahead of the 17.3% rise in the Canadian market and 15.2% in the US.

Propelled by adapting

Part of taking the long view is recognizing that the world changes and that we must adapt to the circumstances to continue to perform well. A lot of the things that create value in the long term can be unpopular in the short term. Given the market’s obsession with the near term, wonderful profitable opportunities abound when taking a longer view.

While we describe our investment process in virtually the same way throughout our history, we have had to adapt it continuously as finance has evolved. In the early 1980’s computer systems were far less ubiquitous than they are now. They provided the opportunity to screen for companies that were statistically cheap ahead of the market and they would provide excellent returns. That is rare today. Every day trader has at his or her fingertips computer programs that are as sophisticated for screening as the biggest institutions. And so, the opportunity for this simple technique has been competed away.

Today the simple statistical screening for cheap stocks is much less beneficial. The last number of ideas that our newest portfolio manager Anthony Visano has put forth all started with the same phrase — unintentionally I might add, “This company screens badly but … “.

Opportunities come when you can find a company that others have shunned because the recent results are either nothing to write home about — Sobeys for example — or are downright scary, as was the case of the very high debt levels of GFL Environmental when we first bought them. But a deeper understanding of the developments in the company’s affairs and looking out a few years showed that these were transitory issues, and each company was poised for positive change. And in both cases, it has proven to be the case. Both stocks have gained over 50% since we bought them, and they continue to have bright prospects, Sobeys with its market leading food delivery system and GFL with recent acquisitions expanding its business.

So today even more than in the past the best investing is based on a real understanding of the business. What it has now, how it makes money, and whether it has the legs to continue to earn attractive returns in the future. When those characteristics exist, the investment will likely prove very rewarding.

A perceived drawback, or difficulty with long-term holding of securities is that some people think because there is not a lot of trading activity the portfolio is being ignored. Nothing could be farther from the truth. It takes as much or more work to maintain a position as we have to remain confident that that business is continuing to create value. That compounding value creation is what drives share price performance.

The art of knowing when not to act — referred to as masterly inactivity — was the topic of address to our clients in June by Professor Stephen Foerster of the Ivey School of Business, Western University.

Investors pay a steep price for ignoring masterly inactivity. People frequently overreact to dramatic and unexpected news, and this negatively impacts their portfolios. Following a large drop in the stock market, many people tend to liquidate stocks and move into cash.  This may sound like a prudent maneuver. Perversely, it is not.

Being in the market for the best days of the year is critical. The chart below illustrates the dramatic difference in returns of being fully invested for 24 years as opposed to missing out on 10-60 best days of the S&P/TSX market. Missing just the ten best days reduces the return by over two thirds. Forty, fifty and sixty best days absent, all yielded negative returns.

 

$10,000 invested from January 1, 1986 to December 31, 2020

Average annualized returns in the S&P/TSX Composite Index

Source: Refinitiv Index total return from January 1, 1986 to December 31, 2020

A panicked response of selling stocks did not play out well. The chart below shows what happened in the subsequent 10 days after the worst one-day return in the market.

 

Worst days and subsequent 10 trading days

S&P 500: 1962 – 2021

    Source: Steven Foerster, Western University: Presentation to Kingwest & Company June 17, 2021

Over the last sixty years the market drops in the worst days ranged from -20% to -7%. Selling would lock-in these losses.

Doing nothing, masterly inactivity, worked out far better. In 7 of the 10 cases, the market was up, in one case the market was flat, and in only two cases did the market continue declining. In both, the market corrected shortly after the 10 trading days (the green bars show the cumulative returns on the subsequent 10 trading days). Overall, the average short-term rebound, the blue bars, was 2.2%. So, related to extreme negative events, on average, masterly inactivity paid off.

It is one thing to get out of the market after a severe downturn; it is another thing to know when to get back in. The average annualized return without dividends on the S&P 500 since 1962 was 7.61% (with dividends, the annual total return was around 10%).

 

Missing out on the best days

Source: Steven Foerster, Western University: Presentation to Kingwest & Company June 17, 2021

If you missed just the 10 best trading days, the average annual return drops around 1.5% — and that is just eliminating 10 days out of 14,809! If you exclude the 30 best days drops the return to 4.33%, and finally excluding the best 50 days drops the return to 2.86%. You would have given up over 60% of the returns if you had been out of the market just those few days each year.

We are showing all of this to highlight one point — attempting to outsmart the market by jumping in and out is a very risky endeavour.

The message is clear. A longer-term view pays off handsomely in investing.

Stock prices in general reflect the economic reality of their underlying businesses. The North American economy has been a substantial wealth creator for over 70 years and there appears no reason to presume this will not continue as innovation is moving the economy forward at an astonishing rate. As the economy continues to grow, share prices will grow to reflect it. Stock returns over the long term should continue to pay off handsomely.

We continue to be positive on the investment outlook. There will no doubt be setbacks along the way, as there have always been, but the outlook is wonderful. The companies we are invested in are continually creating value and their share prices still do not reflect it.  Due to these factors today, the portfolio contains plenty of opportunity and we are constantly on the lookout for new opportunities with these same attributes. The best is yet to come.