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January 2008 Newsletter
Tuesday, January 01, 2008
MARKETS AT A GLANCE: QUARTERLY UPDATE
All of us here at Van Arbor would like to wish you a joyous New Year. May 2008 be a year filled with happiness, health and peace.
The Bank of Canada surprisingly cut interest rates by a quarter point in December after raising rates by the same amount in July. The reversal in action and stance revealed how rapid the effect of the strong Loonie is having on the Canadian economy. Outgoing Bank Governor David Dodge was surprised how fast the currency's appreciation cooled inflation, thus allowing room to cut rates. The manufacturing, industrial and financial sectors welcomed the relief as they battle US credit problems and slowing export demand. The door now is open for further cuts into 2008 as inflation cools and economic growth moderates. The Loonie continues to trade around par and should do so as long as Canada cuts interest rates in tandem with the US. The domestic economy continues to operate above capacity with a tight job market; thus, some moderation of growth would be welcomed by the central bank.
The US economy remains in a state of uncertainty with mixed signals from the credit market, jobs market and the consumer. The facts to date show a weak housing market, a resilient job market, increasing demand for exports and rising inflation. It is no wonder US equity markets remain volatile and will probably remain that way for the next couple of months. The weakness of the dollar has really helped offset the slowdown in the housing sector with a significant pickup in export demand offsetting the drag from housing, which helps explain last quarter's strong GDP number. The Federal Reserve continues to cut rates and will most likely continue to do so well into 2008. The main question mark remains the consumer as inflation, especially from food and energy, cuts into individual's incomes. A shift in consumption to savings seems evident given that housing prices continue to fall. The consumer so far has been supported by a tight labour market coupled with rising incomes. Look for a slow first quarter in 2008 with selective opportunities developing once interest cuts start to kick into the economy.
Inflation continues to be the number one risk to the Euro Zone economy, which subsequently is fueling the rise of the Euro versus the US dollar. The European Central Bank (ECB) remains hawkish on interest rates and has clearly taken a stand in preventing inflation from creeping higher. Food and energy prices coupled with historically low unemployment are fuelling expectations of wage inflation risk spiraling higher. The ECB clearly is making a verbal stance in order to dampen inflation expectations; however, it seems that holding rates steady rather than raising them is on the future agenda. The Euro remains at record high levels as the US continues to cut rates and foreign governments add more Euros to their currency reserves. Exporters are so far holding up in the face of foreign price competition. Industrial production rebounded last month as export demand from the Middle East and Asia is compensating weaker US demand. Any indication that inflation is easing from cheaper import prices would help open the door to lower rates in the near future.
CANADIAN ADVANTAGE FUND
The Canadian Advantage Fund rebounded nicely last month, rising 5.4% while the S&P TSX Index ended the month up 1.3%. This resulted in a 4% outperformance led by our holdings in the energy, telecommunications and industrial sectors. The strongest gains came from Petro-Canada, Canadian Western Bank, Westjet and Stantec whom all saw double digit gains. Oil remained above $90 a barrel, which helped lift the Canadian dollar back above par. 2007 proved to be a volatile year as investors digested rapid oil and currency appreciation as well as US credit concerns. Nevertheless, we ended the year with a 6.6% gain and start 2008 with a well positioned portfolio that should take advantage of the selective opportunities that have presented themselves from recent volatility. We sold shares of TD Bank (TD:TSX) in December and established a position in Shoppers Drug Mart (SC:TSX).
US ADVANTAGE FUND
The US Advantage Fund ended the month down 2.1% while the S&P 500 Index fell 0.9%. This month continued last month's theme with weakness from the consumer discretionary and financial sectors. 2007 ended up to be a roller coaster of volatility as equity markets were unable to come to a consensus on the direction of the economy. It has become evident that housing and financial companies will need time to sort out difficulties from the sub prime credit woes. It also has become evident that 2008 will see some corporate earnings weaken while others continue to grown and benefit from dollar weakness. Therefore, equity selection will be paramount to any gains in 2008. The Federal Reserve appears ready to cut rates further and may do so well into the year. The main question mark will be if the economy is in a soft landing or in a housing led recession. Expectations are currently quite low, so any developments contrary to this may create good opportunities in this emotionally driven market. 
EURO ADVANTAGE FUND
The Euro Advantage Fund fell 3.4% last month while the S&P Euro Index was down 2.2%. Currency fluctuations contributed 1.6% to the decline. Utilities continue to perform well in current conditions while financials remain the weak link. Industrials seem to be coping with a strong Euro currency; however, the market continues to apply selling pressure as there remains uncertainty on how earnings will be effected. 2007 ended rather poorly after getting off to a great start, which eventually sucumbed to negative sentiment out of the US. So far the European domestic economy and emerging markets have helped current corporate earnings and thus should help compensate for any possible US slowdown. The outlook for 2008 is for economic growth remaining moderate while possible interest rate cuts may provide relief to exporters. Once the credit mess in the US begins to sort itself out, look for that cloud of uncertainty to dissipate from Euro equity markets. 
Van Arbor Asset Management is an independent Asset Management company dedicated to creating wealth using a disciplined, proprietary investment strategy with an emphasis on preserving capital while generating superior long-term returns.
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