2020 Quarter 2

Investment Update for Q2 of 2020

Whereas the first quarter of 2020 was devastating to global markets, the theme of the 2nd quarter has been recovery, even though the underlying economic situation has actually deteriorated in that time. Most clients will have recouped almost all of their losses on the year and are now sitting just below the break even point YTD. The recovery though is still very precarious as there remains a great deal of uncertainty and the fallout from COVID 19 is still ongoing. As cases continue to rise in the US and other hot spots around the world, we are a long way from being through this crisis.

Most of the recovery in markets can be attributed to companies which either benefit, or at least are not hindered by the virus. The Technology and Biotechnology sectors have really driven markets over the last 3 months, much as Technology has been the driving factor for the past 10years. Investors are hyper focused on businesses with growth right now and they are less inclined to care about the prices they are paying. A good example would be the insane price appreciation of Tesla Inc., which just recently supplanted Toyota as the world’s most valuable car company, despite making only about 100,000 cars in the quarter compared to Toyota’s 2.7 million cars inQ2. Growth trumps size or profitability in today’s stock market. In addition with Tesla you have a celebrity manager who transcends business as he offers a technological solution to our climate change problems. On top of that, Tesla’s are cool! This has created a perfect storm for Tesla shares as they’ve more than doubled in value this year. The company trades at about 8 times their annual revenues and since they have only had minimal profits to date, it’s quite difficult to value them based on earnings. Many small retail investors have jumped onto the Tesla bandwagon and that’s helping to push up the price of the stock. We don’t own Tesla, not because I don’t think it’s a great business with a lot of potential, but because the prices people are paying right now already prices in a huge amount of that potential already. If the growth disappoints for any reason, the people buying shares today will be very disappointed.

When we look at an investment, we’re always looking to avoid losing money first and foremost. We do this by buying companies with a large margin of safety built into the price. By doing this, we can afford to be really wrong with our forecast of future earnings, and we will still make money. With Tesla trading at 8 times sales, there is no margin of safety here, and that’s why we won’t buy it. We may be wrong about Tesla’s growth potential, but that’s a mistake our client scan live with. What they can’t live with is permanently losing money because we overpaid for a growth company that didn’t turn out as well as we thought.

Speaking of retail investors, Q2 has been the heyday of retail investors. Amateurs have thrived during the quarter while professional investors are getting criticized left and right. As many of you already know, I am an avid follower of Warren Buffett, and the Oracle of Omaha has had a rough couple of years of performance. Now everyone has been jumping on the bash Buffett Bandwagon, even Barstool Sports Owner-turned-Day-Trader Dave Portnoy.https://www.marketwatch.com/story/warren-buffett-is-an-idiot-says-investor-who-claimsdaytrading-is-the-easiest-game-ive-ever-played-2020-06-09 . In all seriousness, I think that a lot of what is going on in the markets right now is unsustainable. Buffett has been widely criticized for dumping Berkshire’s positions in the major US airlines, only to have the airlines’ stocks rally20% or more since March. Amateur investors have piled into the airlines trying to play there bound and it’s worked so far. The airlines have significant challenges going forward however and even though their share prices have risen, that doesn’t mean the outlook for their business has gotten any better. I would be very leery about investing in airlines right now given the uncertainty for demand for air travel as well as the large debt being added to Airlines’ balance sheets right now. I think Buffett was right to sell his positions.

Another example of the insanity out there is the stock price performance of Hertz Global Holdings Inc. Hertz filed for Chapter 11 bankruptcy protection in April, and their stock has shot UP in value since then. It went so high that Hertz was considering issuing new shares to try and defray their debt obligations in their bankruptcy proceeding. That was eventually nixed by the SEC, but the very fact that there is willing buyers out there to buy stock which by Hertz’s own admission is virtually worthless shows the madness out there in markets right now. Despite the short term success of retail investors on picks like these, I think there will be a reckoning at some point. As Warren Buffett says, “It’s only when the tide goes out do you find out who’s been swimming naked.” Investing in worthless car rental companies or extremely challenged airlines is not a recipe for long term success in investments.

What is a recipe for long term success then? Well we continue to like our technology positions in Alibaba and Tencent. There continues to be a great deal of geopolitical tension between China and the US and Canada. This is likely not going away anytime soon. Fortunately this has very little impact on Alibaba or Tencent’s business. Most of their revenues come from China domestically or from the Asia Pacific region. Very little revenue comes from North America, so they are not really impacted by tariffs. Politicians are inherently unpredictable, but we like the management of both companies, and we believe they are a force for good in the world (as evidenced by their large donations to COVID 19 relief). So even though we may not like the actions that politicians in China and the US are taking to stoke tensions between them, we think that long term these companies will deliver a ton of value to shareholders.

We also continue to like our energy businesses. In the 2nd quarter we added a position in Canadian Natural Resources (CNQ), which is a large Canadian energy company. CNQ is of the highest quality when it comes to Canadian energy and their strong balance sheet and low production costs are what enticed us to invest. Energy prices have been extremely volatile as everyone knows but they have stabilized and returned to an equilibrium price just as I had predicted in our last quarterly update. The WTI price of oil is currently sitting around $40 US.CNQ can break even on their production at around $31 WTI price, so they are profitable even at these relatively lower levels. Our other energy position, Whitecap Resources (WCP), is profitable at these prices counting their hedged production for 2020, but they will need to see WTI prices in the low to mid 40s in order to be sustainable long term. I expect there to continue to be volatility in the price as long as COVID 19 is lingering, but the situation in oil markets is a lot less dire then it was even two months ago. We’re starting to see bankruptcies of shale producers in the US and this is a trend which will be very positive for both CNQ and WCP. There is the growing potential for an overshoot on supply reductions and we could even see price spikes if demand comes back stronger than expected. This is still a remote possibility, but it was almost unthinkable even a month ago. Overall I think there’s a lot more upside potential then down side in these two companies and we’ve already seen them rally tremendously in the past three months

One change we did make in the second quarter was to reduce some of our positions in long term fixed income and replace those with additions to other short term or alternative investment options. This was done for primarily one reason. Long term fixed income is extremely susceptible to interest rate rises and higher inflation. Even long term Government of Canada bonds (which are sometimes called “risk-free”) could lose 20-30% of their market value based on a 2% rise in interest rates. This seems unlikely in the short term but governments around the world are taking on tremendous debt and printing lots of money to deal with the economic challenges caused by COVID 19. This has historically led to higher inflation and I think this inevitably will be the result, though I have no idea when it will happen. In order to lessen the risk, we’ve reduced our holdings of long term government bonds. I think this is a significant problem for many Canadian investors, particularly those who are retired, so if you have any questions about this, either for yourself or for a friend or relative, I would strongly encourage you to reach out to us.

Should you have any questions or concerns about your portfolio or about the topics discussed in this letter, please feel free to reach out to your Endeavour Wealth Management Investment Advisor.

- Craig White, BA, LL.B., CIM®

Craig White is an Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Craig White an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.