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The value view
Value managers concerned

Value managers come in many shapes and sizes. Some are more price focussed and are often drawn to cheap but troubled companies. While a notably larger camp, the GARP managers, conduct an ongoing search for the less typical combination of quality and price. This week is a summary of the opinions and views of what I feel are some of Canada's most skilled money managers.

Irwin Michael (ABC Funds)

Balanced portfolios managed by Irwin Michael are heavily weighted to stocks while his equity portfolios are now about fully invested - a marked change from the roughly 15 percent cash allocation in June. While he's obviously bullish on stocks, he admits, "fundamentally undervalued stocks are tougher and tougher to uncover today".

This is evidenced by his continued focus on the small cap segment - which has a much larger number of names from which to choose and tends to be overlooked by most institutions - and a sizeable 40 percent weighting in special situation stocks in his U.S. equity portfolio. On a macro level, he sees the U.S. Federal Reserve continuing its stimulative stance, since measures taken so far have not yet had the expected impact.

Kim Shannon (Sionna Investment Management - CI Funds)

Kim Shannon, manager of CI Canadian Investment fund, is shocked that the leaders of the last bull market are many of the same groups at the top of the past year's run up in prices. This leads into her concern for overall market valuations - which she considers to be at very high levels. In short, she doesn't think such valuation levels are sustainable.

Shannon subscribes to the belief that the shorter-term market direction is largely a function of human psychology since people ultimately determine stock prices. She attributes much of the past year's rise in market prices to a general bullish sentiment of what the economy has in store. It's fair to say that she thinks the optimism has been overdone judging by current valuations, which is causing some difficulty in identifying new opportunities.

Vito Maida (Patient Capital Management)

Intensive bottom up analysis forms the core of Vito Maida's investment process, as president and co-founder of Patient Capital Management (PCM). His third quarter newsletter, however, cites a number of macro concerns in an effort to highlight the disconnect between these issues and the strong optimism built into today's share prices.

Besides a sluggish job market, an abundance of excess capacity, and mounting consumer debt, Maida draws out attention to the illusionary growth in corporate profitability.

Despite the fact that operating income (ever present in quarterly earnings reports) have been rising sharply, he cites a September 15, 2003 Fortune magazine article which confirms that corporate income reported to the IRS has been rather flat. Maida notes that another article - from the October 20th issue of Business Week - notes that net income reported by the S&P 500 firms has doubled since the end of the recession while operating cash flow has risen less than 4 percent.

Maida's sentiment is nicely summarized in the following excerpt from his Q3 newsletter:

"The average share price for the companies that PCM monitors carefully is more than 200 percent above our targeted buy price. We strongly believe that these very high valuation levels coupled with the economic risks discussed above present substantial risks for equity markets."

It's fair to say that Maida is perhaps the most pessimistic of this group.

Gerry Coleman (CI Harbour Group)

Coleman cannot comprehend the market's rebound given that the technology names leading the pack are many of the same names behind the bubble at its peak just three short years ago. Coleman notes that many big tech players are likely to see modest single-digit growth rates in the future, but their share prices have much more optimistic built-in expectations. (Note: This was the message of a recent article in this space entitled Tech Stock Update.)

Coleman opines that these inflated prices will end up meeting the same fate as the last bubble, but admits that the timing of the realization that "price matters" is anyone's guess.

Summary

It's important to note that value managers, by nature tend to be more sceptical and less tolerant of high prices. It's also important to remind readers that I happen to have a personal bias in favour of value managers because I'm something of a skeptic, in case you hadn't noticed.

That having been said, ignoring the cautionary tone of these top-notch money managers would be a mistake for advisors and clients. Valuations do matter if examined properly, and provide a floor of sorts that allows you to judge downside risk and return potential.

Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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