Monthly Commentaries

Splitting Signal from Noise – March, 2012

March marked the end of the best quarter for U.S. markets since 1998. The S&P 500 was up 12.5% and the TSX was up 4.5% for the quarter with the MSCI up 9%. With such strong equity market returns, it was not surprising that government bond markets were off about 5%, the largest drop in the treasury market since 2010. However, corporate bond markets fared better because markets equated stronger economic news as less risk in corporate bonds and accordingly yield spreads narrowed, producing a return of 0% for the corporate bond market as a whole. Despite the strong performance of equity markets, the pessimism about European and American economic prospects continued. This month, we wanted to touch on the difference between noise and trend. Each day we are inundated with news about what the markets are doing with reporters talking breathlessly about the proximate cause for the move in major market averages. The day-to-day movement often masks the actual underlying trend for a particular stock. That is why it is crucially important not to be swept up in the noise of the daily news flow and remain focused on the long-term prospects of the corporation.

Let's take a simple example of a stock that is trading at ten dollars and based on Toron's research group's detailed analysis we believe that the stock will likely go up ten percent (one dollar) during the year consisting of two percent from dividends and eight percent from price appreciation resulting from higher free cash flows. That means twenty cents will arrive in four dividend payments of five cents per quarter, and eighty cents will accrue over the year or about a third of one cent per trading day. For an actively traded stock, the bid offer can be two cents, so one week's gain may not even cover the bid-offer spread. When you add on the movement generated by people buying and selling, many for non-economic reasons, the trend in value is all but swallowed up by the noise.

Markets will inevitably gyrate back and forth but for a patient investor, the growth in the underlying value of the company is what will ultimately generate the performance, not the day-to-day noise. The investor knows that the cash flows are growing and that dividends are being paid. Those factors should be the ultimate focus, not day-to-day price movements. Arthur Heinmaa, CFA Managing Partner