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Sprung Investment Management Commentary - 2nd Quarter, 2018

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Trade tensions intensified in the second quarter of 2018. The US aggressively enacted more encompassing tariffs that were soon countered by their disgruntled trading partners. Investors reacted by retreating from the markets as fears of a trade war escalated. It is becoming increasingly evident that the US in no longer going to accept what it views as asymmetrical trade and military alliances as the status quo. This state of affairs has enormous implications for the US and its trading partners. Market participants must be prepared for a period of enhanced volatility as negotiations continue between the effected parties.

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Sprung Investment Management Commentary - 2nd Quarter, 2018

  1. 1. SECOND QUARTER 2018 RETROSPECTIVE AND PROSPECTIVE Trade Machinations 10 King Street East, Suite 801 Toronto ON M5C 1C3
  2. 2. 10 King Street East, Suite 801, Toronto ON M5C 1C3| Phone: 416.607.6642 | www. SprungInvestment. com | P a g e | 2 Sprung Investment Management our focus is to create investment portfolios for our clients that enable them to achieve their unique, long-term investment goals. In this endeavour, we strive to act with the utmost integrity, utilising all of our analytical skills, knowledge and intuitions. PRIVATE CLIENT FOCUS Sprung Investment Management is an independent discretionary investment management firm that serves the investment needs of high net worth private clients including business owners and entrepreneurs, professionals, family trusts, estates, and private charitable foundations. OUR PEOPLE At Sprung Investment Management, the investment team collectively has over 120 years of diversified investment experience. All of our principals hold the Chartered Financial Analyst designation and as such adhere to the CFA Institute Code of Ethics. Each has made a commitment to continuing education. RISK PERSPECTIVE We understand that our clients have worked hard to get where they are and we appreciate that they don’t want to lose it. As the chosen stewards of their investment assets, our risk management approach is to preserve their capital by purchasing under-valued securities, with a margin of safety that we expect will deliver income and capital appreciation over the long term. PERFORMANCE Sprung Investment Management has a track record of low volatility of returns since company inception in June 2005. This has served our clients well over this relatively difficult investment period that includes the bear market of 2007- 2008. Our performance numbers are available by request. CLIENT SERVICE At Sprung Investment Management, satisfying our client’s financial needs is our top priority. Each and every client is special and receives individual attention and customized investment advice based on his/her specific objectives and risk tolerance. Our principals are always available to speak directly to clients. INVESTMENT STYLE In building equity portfolios, individual security selection is based on “bottom up” research that is value- driven and often contrarian to current popular thinking. We assess quality and continuity of return on equity, current price relative to intrinsic value, economic value added and quality of management. Although our typical investment horizon is two to five years, we constantly evaluate our current holdings against new opportunities that may offer better value. Our view is that a strong sell discipline is a critical component to long-term investment success. Our investment approach on the fixed income side is to conduct rigorous credit analysis in the context of future economic and interest rate expectations.
  3. 3. 10 King Street East, Suite 801, Toronto ON M5C 1C3| Phone: 416.607.6642 | www. SprungInvestment. com | P a g e | 3 SECOND QUARTER 2018 RETROSPECTIVE AND PROSPECTIVE Trade Machinations “What protectionism teaches us, is to do ourselves in time of peace what enemies seek to do to us in time of war.” Henry George “In the business world, the rear-view mirror is always clearer than the windshield.” Warren Buffett Trade tensions intensified in the second quarter of 2018. The US aggressively enacted more encompassing tariffs that were soon countered by their disgruntled trading partners. Investors reacted by retreating from the markets as fears of a trade war escalated. It is becoming increasingly evident that the US in no longer going to accept what it views as asymmetrical trade and military alliances as the status quo. This state of affairs has enormous implications for the US and its trading partners. Market participants must be prepared for a period of enhanced volatility as negotiations continue between the effected parties. In Canada, the S&P/TSX Total Return Index advanced 6.8% in the quarter led largely by the Energy sector (up 15.8%) as investors reacted to greater tensions in the Middle East. The US market advanced 3.4% as measured by the US dollar denominated S&P 500 Total Return Index in the second quarter as share buybacks alleviated much of the negative pressure stemming from retail selling. It is of note that smaller capitalized stocks outperformed larger companies by a wide margin. The S&P SmallCap 600 gained 9% in the quarter. Chinese and other Emerging markets were mostly negative. The Canadian dollar lost another 2.1% to its US counterpart. Canadian Dollar US Dollar Q1 Q2 Q3 Q4 YTD Q1 Q2 Q3 Q4 YTD Toronto Stock Exchange -4.5% 6.8% 1.9% S&P 500 1.7% 5.4% 7.2% -0.8% 3.4% 2.6% MSCI EAFE* 0.0% -0.3% -0.3% -2.4% -2.2% -4.5% 91 Day T-Bill 0.3% 0.3% 0.6% CUBI** 0.1% 0.5% 0.6% CDN/US dollar -2.7% -2.1% -4.7% * Europe, Asia and Far East Index ** Canadian Universe Bond Index Until recently, markets shrugged off political and geopolitical developments. Even the potential of
  4. 4. 10 King Street East, Suite 801, Toronto ON M5C 1C3| Phone: 416.607.6642 | www. SprungInvestment. com | P a g e | 4 increasing barriers to trade failed to disrupt the positive market momentum. Market participants generally seemed to perceive that the sabre rattling emanating from the US was a negotiating ploy that would soon give way to “common sense” as new trade agreements would fall into place, maintaining the status quo with few modifications. The current world trading system evolved in the post war period. The US took on a leadership role as it had the largest economy in the world and it needed to foster alliances during the cold war that followed WWII. During this period the US covered most of the costs in establishing these alliances and everyone benefited from the growth in economic trade that was precipitated. The US is now taking the stance that the cold war has ended and global economies have grown to the point that other countries should bear more of the costs implicit in these alliances. Furthermore, as trade has grown some inequities have developed in terms of the flow of trade, the protection of intellectual property rights and non-tariff barriers that have frustrated “fair” trade. As the quarter progressed, the rhetoric emanating from the US became more vitriolic. The US enacted more encompassing tariffs on goods from foreign sources. Other countries have responded in kind. The real possibility of an out and out trade war has roiled global markets as investors begin to perceive the damage these tariffs may cause to corporate earnings. The global synchronized recovery also appears to be stumbling as the momentum in the Chinese and European economies exhibit signs of slowing down. Tariffs and counter-tariffs are going to put the brakes on even harder, leading to higher interest rates as investors demand greater compensation for greater risk. In the midst of all this trade chaos, the Federal Reserve continues to pursue a policy of tightening the money supply through rising interest rates. This policy is progressing even in the face of rising deficits in the US as the recent tax cuts take effect and government spending increases. Presumably, the US is going to want to finance these deficits. Attracting capital from their major trading partners that they have just enraged may prove difficult. Despite these factors, the US market managed to post positive returns in the quarter on the back of strong employment numbers and economic growth. However, it is interesting to note that mutual funds in the US experienced US$52.9 billion in net outflows in the quarter; US$23.7 billion in June alone. Perhaps the US$433.6 billion in share buybacks more than compensated for the exodus. US firms are sitting on over US$2 trillion in cash. At this juncture, buybacks, mergers and acquisition activity and dividends appear to be taking precedence over capital expenditures. Canadian investors have been focused on the NAFTA negotiations during this period of escalating tariffs. The US has made it clear that the world is changing and access to their market cannot be taken for granted. The best outcome would be a world of more open trading with fewer barriers but that may be hard to achieve with Canada where inter-provincial barriers are so ingrained. Investors must concentrate on fundamentals during this period where volatility and uncertainty will continue to vex markets.
  5. 5. 10 King Street East, Suite 801, Toronto ON M5C 1C3| Phone: 416.607.6642 | www. SprungInvestment. com | P a g e | 5 SECOND QUARTER 2018 FIXED INCOME COMMENTARY "Every man lives by exchanging." ~ Adam Smith The Federal Reserve continued on its path of cautiously raising interest rates, hiking the trend setting Fed Funds target by a 0.25% to 2% in June. The Bank of Canada did not move at all during the quarter despite Governor Poloz noting the improving economic climate. Leaving rates unchanged in Canada thus allowing the Canadian dollar to weaken will offset to some degree the protectionist tariff measures in the US. The shape of the yield curve (described by the difference between the yields of two year bonds and thirty year bonds) has flattened decisively over the quarter, continuing the trend in the first quarter. This difference was at year-end 0.6%, 0.5% at the end of the first quarter and is now down to 0.3% at the end of June. Normally, rising short term interest rates against longer term yields is considered a harbinger of an economic slowdown or recession. This is due to central banks raising short-term interest rates to "cool" down an overheating economy thereby throttling back current economic growth. Market participants would then expect lower rates in the future. In the current environment while the economy is growing at a moderate pace, the rate increases have less to do with an attempt to slow growth, but more to do with an attempt to drain liquidity from the economy following the immense amount of stimulus that had been pumped into the world financial markets subsequent to 2008 / 9 . This process must be managed carefully due to the fact that a vigorous or speedy withdrawal of liquidity could drive economies into a recession once again. It is hoped that liquidity levels will be brought back to more normal levels so that the distortive effects of excessive "easy money" are corrected. The total return performance of the bond market as measured by the FTSE TMX Canada Universe Bond Index for the second quarter was a modest increase of 0.5% bringing the year-to-date return to 0.6%. 91- day Treasury bills returned 0.3% and 0.6% over the same periods. The benchmark ten-year Government of Canada bond yield increased by 0.09% over the course of the quarter three months of the year to end with a 2.17% yield. Over the course of the same period the Canadian dollar depreciated further by 1.7 cents from 77.6 cents US to 75.9 cents US.
  6. 6. 10 King Street East, Suite 801, Toronto ON M5C 1C3| Phone: 416.607.6642 | www. SprungInvestment. com | P a g e | 6 Our Team Michael Sprung, CFA: Chief Investment Officer msprung@sprunginvestment.com • Chief Investment Officer • More than 30 years experience in Canadian Investment industry, overseeing portfolios up to $2.5B • Senior level positions with YMG Capital Management, Goodman & Company, Ontario Teachers’ Pension Fund, Ontario Hydro and Cassels Blaikie & Co. • Frequent contributor to BNN-TV, Globe & Mail, National Post and Money Sense Fred Palik, CFA: Vice President, Fixed Income fpalik@sprunginvestment.com • Extensive experience in fixed income management in a variety of senior positions, primarily in the insurance and hospital sectors. • Member of the Toronto CFA Society and the CFA Institute. Lois O’Sullivan, CFA: Vice President loiso@sprunginvestment.com More that 25 years experience in investment management. • Co-founder of Sprucegrove Investment Management, specializing in international markets. • Senior level roles at Confed Investment Counselling and Confederation Life Insurance Company. • Fellow of the Life Office Management Institute (FLMI), the Toronto CFA Society and the CFA Institute. Joie P. Watts, CFA, FSCI: Vice President & Portfolio Manager jpwatts@sprunginvestment.com • Over 30 years of progressive experience in the securities and investment industry. • Senior level roles at Burns Fry Limited, Merrill Lynch Canada and Nesbitt Thomson. • Managing Director of Instinet Canada Limited for over 10 years • CEO of Shorcan ATS Limited, a specialized marketplace for equity dealers trading as principal. Robert D. Champion, MSEd: Vice President, Client Services rchampion@sprunginvestment.com • Joined Sprung Investments Management in 2012 after several years with Successful Investor Wealth Management. • Prior to that, he had a fifteen-year career in OEM industrial sales. • Manager with investment-publishing division of MPL Communications in the 1980s and early 1990s. MPL publish Investor’s Digest and Investment Reporter. Stay connected with Sprung Investment Management: Twitter https://twitter.com/SprungInvest Twitter handle @SprungInvest Facebook http://www.facebook.com/SprungInvestment Linkedin http://www.linkedin.com/company/1699967 Google+ https://plus.google.com/+Sprunginvestment/ See Michael on BNN Bloomberg Market Call http://www.sprunginvestment.com/videos/

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