September 2014

The Monthly


With this commentary, we plan to communicate with you every month about our thoughts on the markets, some snap-shots of metrics, a section on behavioural investing and finally an update on some of the people at MacNicol & Associates Asset Management Inc. (MAAM). I hope you enjoy this information, and it allows you to better understand what we see going on in the market place.


“I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.” – Warren Buffet


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Market Commentary: Korea


The global economy is continually evolving and changing; the world, as we know it, is ‘shrinking’, as new technologies have allowed for a level of global connectivity to prosper which was previously inconceivable only a short time ago. Foreign markets are increasingly accessible for both businesses and consumers alike, and, as such, have begun to present significant opportunity for prudent investors. China was an early example of the benefits of international investing, as the Chinese growth story coincided nicely with the explosion of the internet and the nascence of globalized investing. Chinese GDP has expanded five-fold over the past 10 years alone, and many investors have benefitted. That being said, the Chinese economy is beginning to show ‘growing pains’, which has led many investors to search for the next big story in international investing. It is such prospects of significant opportunity that cause us to expand our investment horizons into several foreign nations, all of which exhibit positive economic prospects and growth stories. We have done so with India, and have also recently added another country to our repertoire: Korea. The South Korean market piqued our interest while we were attending the Value Investor’s Congress in Las Vegas of last spring, and through further research, we have become considerably excited with the prospective growth opportunity of the market.




Although typically known as the host country to Samsung and for their tumultuous neighbours to the north, South Korea also boasts a disciplined and productive economy. The country is 15th in the world in GDP, has run a budget surplus for 9 of the past 10 years, exhibits a debt-to-GDP ratio of just 34%, is currently running a trade surplus, and has a sovereign debt rating of A+ by S&P. As political and economic stability are two of the main catalysts for economic growth and corporate investment, these statistics work to lay a strong foundation for the future growth.




However, despite their strong economic foundation, the Korean stock market remains extremely attractive in terms of valuation metrics, which led to the market being named ‘the most attractive stock market in the world’ by Citibank. For reference, Canada’s market achieved a rank of 9th on the list, while the U.S. market was ranked 10th.  Korea has been dubbed somewhat of a ‘value investor’s haven’ due to its attractive valuation metrics; many profitable companies trade at 0.5x book value, or less, and at price-to-earnings ratios in the low single digits. Some companies even trade lower than their net cash levels, despite the fact that they are profitable. Returns on equity are also high among Korean corporations.




The attractiveness of the market can perhaps be best exhibited by one of its biggest advocates: legendary value investor Warren Buffet. In 2006, Mr. Buffet put together a $100 million portfolio of 20 Korean companies, stating that, “if I were to start all over again today, I would start with 100% of my money invested in Korea”.  Buffet continues to hold a large position in POSCO, the third largest steel-maker in the world.




Due to the fact that the Korean market is already established, however, the Korean investment thesis differs significantly than that of the Chinese growth story. Whereas the Chinese growth story focused on the country’s journey from emerging market to economic powerhouse, the Korean investment thesis focuses on the positive impact of the globalization and western influence on the stock market. As stated previously, the Korean market trades at extremely attractive levels. This has typically been due to low levels of English reporting, strict shareholder laws, complicated organizational structures, and difficult hurdles for North American investors. Although some of these hurdles remain, the progression towards an open, westernized market is evident. Recent legislation has increased the power of minority shareholders and also increased visibility; upcoming legislation plans to reduce the dividend tax rate, in order to spur investment, as well as plans to tax excess corporate cash, in order to incentivize capital investment. These additional changes to regulation have opened the country to western activist investors, who are eager to help these Korean companies achieve their full potential. We recognize the strong potential in this market; however, we are hesitant to dive into individual stocks in a foreign country until we have properly experienced the process. In order to get our foot in the door, we have begun buying the iShares South Korean ETF, in order to gain experience in the market. Future opportunities in Korea will be assessed and analyzed on an ongoing basis.

Market Commentary: North America


In contrast to the detail concerning the Korean market, we thought it may be of interest for us to include a contrasting overview of the North American markets, and also include an overview of our current sentiment.


In terms of valuation, the S&P 500 is currently trading at a Price-to-Earnings level of 20 times. This is slightly above the long-term average of ~18 times earnings, but has not yet reached levels where an immediate crash is warranted. The price-to-book value of the S&P 500 is currently 2.8, which, again, is slightly above the long-term average of 2.8. The levels of these valuation metrics suggest that the market has slightly gotten ahead of itself; however, there is also no reason to panic. The Dividend Discount model, which is another aspect of analysis we utilize, currently places the market at approximately 12% overvalued. Since the bottom of the stock market, GDP growth in the United States has remained range-bound between 1-2%, however, in contrast, the stock market has practically tripled. When considering this fact, it makes sense to come to the conclusion that the stock market is at least partially ahead of itself.


There are, however, justifiable reasons as to why the North American markets, and specifically the United States markets, have been out-performing. One reason is persistently low interest rates, which allow cheap access to money and cultivate investment. As recently indicated by Federal Reserve Chair Janet Yellen, low rates are here to stay for at least the next few years, therefore, this force is unlikely to reverse in the near-term and exert downward pressure on the markets. Corporate earnings have also strengthened recently, as the most recent report indicated that S&P 500 companies are making $101.52 per share.  This figure represented a growth of 8%, which was the best reading we have seen in this regard in some time. On the job front, the most recent report of initial jobless claims in the U.S. was 280,000, which was far below the estimates of 305,000,  the jobs lost from the financial crisis has finally been regained, and the overall poverty rate has dropped for the first time since 2006 due to the increase to full-time jobs. The most pivotal moment of the year will be the upcoming release of Q3 U.S. GDP, which will provide further context for the surprisingly strong Q2 figure. Many believe that the strength of this figure was due to the shifting of Q1 activity, which had been delayed due to poor weather, as well as a strong contribution from inventory investment, which won’t necessarily be repeated.


The strength of the U.S. economy is clearest when contrasted to the current global situation; when it comes down to it, investible reserves will flow where the strength is, and the U.S. economy is the only one which currently shows any signs of life. The European Central Bank’s President Mario Draghi recently increased their monetary easing initiative by $1 trillion due to European weakness; Italy is back in recession, Germany’s economic growth has stalled, and France is on the brink of a recession as well. In addition, despite waves of easing, Japan’s economy continues to sputter. To make matters worse, China has also recently injected monetary liquidity into their market, in an effort to support their economy. The amount of money currently being pushed into the system will likely support economies in the short-term, however, as the German finance minister stated “Monetary easing only buys time.” As long as these countries have to continually pump their markets full of liquidity, they cannot be relied upon for strong, meaningful growth. In contrast, the U.S. is one of the few developed countries who have a near-term plan to eliminate quantitative easing and raise interest rates; the Fed is currently on track to exit their bond-buying program by October. Because of this, international investors have been rushing into U.S. assets, which can be characterized by the fact that the USD has risen 8% against the euro and 4% versus the yen over the past four months.


In conclusion, we continue to navigate forward with cautious optimism. In the near term, with the amount of liquidity in the global economy, and signals of strength in the U.S. economy, we see no reason for imminent collapse; however, there are definite causes for concern, as well as long-term issues that must be resolved. Although disaster is unlikely in the near-term, a sizeable pull-back is not, as we have not experienced a correction of 10% or more in the past three years. Typically, corrections of this size happen at least once a year.


Behavioural Investing Segment


In order to continue our discussion of Behavioural Investing, we would like to detail an important concept: Overconfidence. This may well be one of the most difficult aspects of Behavioural Investing to detect, as well as manage, due to the importance of confidence and vindication to successful investing. There is a fine line between confidence and overconfidence, and when properly understood, they are actually supplementary.


There have been numerous studies on overconfidence, many of which have found very interesting results, which tend to explain the idea of overconfidence better than any dictionary definition. Below are some examples.


When asked during a survey:

  • 19% of people believe they belong to the richest 1% of U.S. households.
  • 82% of people say they are in the top 30% of safe drivers.
  • 80% of students think they will finish in the top half of the class.


These results show that we, as human beings, tend to over-estimate our own merits and abilities. Much like anything else, although a certain level of confidence is beneficial, too much is often detrimental. Below are a few examples as to how an excessive level of confidence can be detrimental.


  • When asked during a survey to make a prediction at a 98% confidence level, participants were only right 60-70% of the time. Those who were given more information often quoted themselves as having an increased level of confidence, but were, in reality, wrong more often.


This example exhibits the fact that people tend to become increasing confident with more information, and more often than not, the new information has worsened their judgement. This has significant applications to the art of investing. As stated previously, confidence in this business is a must. An investor must be able to remain committed to their idea, and display confidence in their analysis and process through both bull and bear markets. The key pillar of confident investing, however, is belief in your own individual process and analysis, or the ability to focus on your strengths. On the other hand, overconfidence tends to cause an investor to stray from their strengths, as they subscribe to the belief that their competencies stretch farther than they do in reality.  A study by two University of California, Davis professors found that those money managers wo were the most confident in their abilities tended to trade more and perform less. Other symptoms of overconfidence that they observe were excessive leverage or trading, and a lack of diversification. In addition, one Princeton study showed that overconfident managers often utilized sloppy analysis, as they placed too much emphasis on market and sector level information, and tended to lose track of firm-specific data. This has been noted as a major contributory factor to the 2000 internet stock bubble.


The best way to guard against overconfidence is maintaining a margin of safety, remaining cognizant of your individual strengths, and maintaining a qualified team which complements these strengths. Maintaining a margin of safety in stock analysis adjusts for overconfidence, as it allows a ‘cushion’ for optimistic projections. Remaining conscious of your individual strengths allows you to remain humble and focused, as well as forces communication and cooperation with a team. A strong team is able to fill in the gaps of each other’s analysis and skill-set, and the more diverse the background of the team, the less likely overconfidence will be an issue.




We are happy to report that on August 23 Jay Bryant and his wife Jenn welcomed their second child, Georgia Beverly weighing 8. 13 pounds.  She joins her older brother Jack who has just begun full day Kindergarten this fall.  Jay is looking forward to his 20th High School Reunion at the end of the month.  Jenn is enjoying her maternity leave and plans to return to work full time in February.


As well, Naima welcomed her second son, Amir Nalayeh weighing 8.9 pounds on September 11.  Naima says that, “being a Mom for the second time around has been great so far.  Seeing my eldest son Yusuf interact with his younger brother Amir has been very rewarding for my husband and me.   All in all, Amir has completed our family.  We are so overjoyed and are excited to see him and Yusuf grow together.“  Naima will be on maternity leave for the next few months and we all look forward to her return as she is missed around here.



David A. MacNicol, B.Eng.Sci., CIM, FCSI, President, Portfolio Manager

MacNicol & Associates Asset Management Inc.

September 2014