March 2013

by Bruce Campbell

History doesn’t repeat but often rhymes, and that seems to be the case this year again.  For the last 3 years, we have seen strong markets for the first quarter of the year, with weakness in Q2 and part of Q3 before the uptrend resumes in the final quarter of the year.  This becomes a self-fulfilling prophecy, as investors try to “game” the selloff and jump out ahead of the typical “Sell in May” period. 

The indicators that we follow have shown some signs of weakening over the last few weeks.  As a result of these indicators, in late March we moved to a neutral positioning.  When in a neutral positioning, we remove any individual positions that have broken down fundamentally or technically and we do not replace those positions, thereby raising cash in the portfolio.

The core of the investment process that we use to identify individual companies looks for accelerating earnings growth.  The S&P/TSX continues to be defined by the haves and have not’s.  From a top down perspective, Industrials, Consumer Discretionary, Consumer Staples and Financials are seeing the largest sector earnings growth forecasts, while energy and materials are experiencing slowing earnings growth rates.  By using a disciplined process we continue to discover individual companies included in every major sector that are experiencing accelerated earnings growth rates.   At the end of March our three largest sector exposures were Energy, Materials and Consumer Discretionary. 

The overall portfolio continues to show characteristics of high earnings per share growth with attractive valuations.  The portfolio attributes are:

Recall that in the last commentary, we noted that some of the longer term indicators that we follow were starting to make significant changes that historically lead to our investment process being favoured by the markets.  We first saw this happening in late 2012 and we continue to see these changes at the end of the 1st quarter.These tend to be longer term trends that last from 12-24 months in duration. 

At StoneCastle we are committed to a disciplined and time tested investment strategy based on accelerating earnings growth, analyst’s revisions, relative strength and valuations.  History shows that these metrics are the best way to identify stocks that are most likely to outperform the market.  The key to success with our methodology is patience and discipline.