Manager commentary - December 31, 2018

IA Clarington Focused U.S. Equity Class struggled through a difficult fourth quarter with Series A of the Fund returning -23.6%, as U.S. equities posted a sharp decline. Instead of the “Santa Claus rally” investors were expecting, the S&P 500 Index had its worst ever December and saw its biggest quarterly decline since 2011. There was nowhere safe to hide during the quarter as recession fears and global trade woes took everything down. Tax-loss selling only intensified the sell-off. Exposure to cycle-sensitive sectors detracted from Fund returns. The portfolio’s energy and materials positions were the hardest hit. Encana Corp. (ECA), EOG Resources Inc. (EOG) and Forterra Inc. (FRTA) were the Fund’s biggest individual detractors from returns. Concrete pipe manufacturer FRTA had a modestly weak quarter and unexpectedly missed earnings estimates due to unfavourable weather. The market punished the stock and further tax-loss selling took FRTA down 46%. We believe the market overreacted and the decline was exaggerated. The stock has recovered +30% since the December low. High-quality producers ECA and EOG suffered on weak oil prices. Negative market reaction to an acquisition and the deep discount in Canadian crude oil added to pressure on ECA stock. We believe the worst is behind us for the energy sector. We expect WTI oil prices to turn with OPEC cuts and Canadian oil to see a stronger recovery with Canadian pipelines coming on stream, increased rail shipping and mandatory production cuts. ECA has recovered +30% and EOG +11% from their December lows.

We initiated positions in Owens Corning (OC) and Royal Caribbean Cruises Ltd. (RCL) during the quarter. We stepped in when OC stock became significantly oversold on weaker-than-expected roofing shingle sales due to below-normal storm activity in the U.S. and increased costs from higher oil prices. OC's valuation is currently at multi-year lows. We expect OC to benefit from lower raw material costs and normal storm activity in 2019. Recession fears have pushed RCL’s valuation to multi-year lows. RCL should benefit from lower fuel prices and new IMO diesel emission standards in 2020 should see its fuel costs decline even lower than recent levels. Booking demand for 2019 is solid and we believe the cruise line sector is still well positioned for several years of secular growth.

The markets appear to be turning a corner with the new year but there is still uncertainty and fears of a recession. Escalating protectionism and trade wars could stall the economy. With the economic cycle in its tenth year, there is considerable discussion about the risk of recession. The market is certainly priced for it. We are still of the view that a recession in the near term is unlikely. Signals that we are nearing the end of this cycle are just not there. Consumer confidence is still high, employment is rising, wages are higher, unemployment claims are at their lowest in almost 50 years, and while inflation is rising, it is still relatively low. Rising rates have many scared, but the U.S. Federal Reserve’s stance appears to be softening and lending rates have come down.

The Fund is concentrated and fully invested to position for continued economic growth in the U.S. – not “shoot the lights out” growth, but steady, plodding growth. At this stage in the cycle the market should shift in favour of value stocks and economically sensitive sectors. We have good exposure to high-quality companies leveraged to the economy and rising rates. We have solid exposure to deeply discounted materials, industrials, financials and consumer goods companies with investments in Whirlpool Corp., Caterpillar Inc., Owens Corning, Royal Caribbean and Martinrea International Inc. We have exposure to U.S. financials through investments in Allstate Corp., MBIA Inc. and Assured Guaranty Ltd.

Some of the best value opportunities have emerged in the financials, commodities, industrials and consumer sectors. Corporate earnings were strong in 2018, but many companies guided lower because of increasing manufacturing costs and recession fears. Input costs are rising, yet stock prices of companies in those sectors haven’t participated and continue to trade at unrealistic lows because the market is pricing them for a recession. Multiples are contracting in the face of solid earnings. If you don’t believe a recession is imminent – and all indicators suggest it is not – this disconnect creates a very attractive opportunity.

Fund and benchmark performance as at December 31, 20181 year3 yearSince inception (Jun. 2014)
IA Clarington Focused U.S. Equity Class - Series A-26.7%-3.6%1.0%
S&P 500 Index4.2%8.8%13.7%


Learn more about IA Clarington Focused U.S. Equity Class

The performance data comparison presented is intended to illustrate the Fund’s historical performance as compared with historical performance of widely quoted market indices. There are various important differences that may exist between the Fund and the stated indices that may affect the performance of each. The S&P 500 Index includes 500 leading companies in leading industries of the U.S. economy and is widely regarded as the best single gauge of the U.S. equities market. The Fund’s market capitalization and sector exposure may differ from that of the benchmark. The Fund’s currency risk exposure may be different than that of the benchmark. The Fund may hold cash while the benchmark does not. It is not possible to invest directly in market indices. The performance comparison is for illustrative purposes only and does not imply future performance.