I
the NVESTMENT
Quarterly Market Commentary
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In this issue
Putting it all together
- Stimulus, China, & the
Economy
pg 1
A look at New Value
- Bio & Info Technology
pg 4
Media Watch
Pacifica Partners appears on
BNN and writes for the Finan-
cial Post. Interviews and com-
mentaries are available on our
website and now via Twitter.
pacificapartners.com
COMPASS
Summer 2009
Putting it all Together
Stimulus, China, & the
Economy
W hat a difference a few months
can make. As markets regained
their confidence that the global econ-
omy was not going to land us in a re-
peat of The Great Depression, markets
ushered in a rally that has offset the
freefall that marked the beginning of
2009. Recall that only a few short
months ago there were fears that the
US government was going to have to
effectively nationalize much of the US
banking system and Europe would be
sure to follow.
The choice confronting investors now is
to decide whether the markets have
moved too far, too fast. That is, are
they pricing in the kind of economic re-
covery that has tradi-
tionally followed a re- “We recognized ...
cession?
equity markets could
Most times, after a re- experience a reflexive
cession loses its grip,
the economy tends to bounce... due to ex-
bounce back sharply – treme pessimism”
the so-called ―V-
shaped‖ recovery. Although the current
optimism is not totally unwarranted,
there are signs emerging that last quar-
ter’s stock market surge might be a little
ahead of itself. We have been hearing
the term “greenshoots” on a daily ba-
sis (possibly one of the most overused
words in history).
This term came about from Fed Chair-
man Bernanke’s comments that there
are signs that some economic green-
shoots were appearing. This was fol-
lowed by a series of economic data re-
Summary:
Key Economic Indicators are still show-
ing signs of weakness, suggesting the
possibility of a market that is ahead-of-
itself.
Stimulus Packages made headlines ear-
lier this year but are doing little to restart
the economy in a meaningful way.
China & US Consumers are the key
to understanding the greater picture of
what has happened to-date.
leases that showed things were “less bad”. To
that, we say that at some point, markets need to
be reinforced with the idea that things are not
only less bad, but actually sequentially improv-
ing. Remember, the markets have already
priced in that things are getting less bad – that
we are not all going to collectively fall off the
proverbial cliff.
We had recognized in our
last quarter’s Investment
Compass that the equity
markets could experience a
reflexive bounce off their
spring lows due to extreme
pessimism of the over-
extended selloff . But as with many corrections,
the speed of which this rebound occurred may
not be completely justified based on fundamen-
tals of the economy.
From our perspective, the quality of this market
rally has been suspect but welcome nonethe-
less. We began to deploy our cash reserves into
the markets in late February with the belief that
the markets were overly pessimistic and just as
excessive optimism has made us retrench in the
past, the sea of pessimism and media stories
emphasizing panic/fear made us optimistic.
Sure enough, the rally ensued.
Continued on page 2
pg 2

Continued from page 1

As we have mentioned in the past, unemployment can be a
To understand why the market may be trailing indicator when looking at stock market recoveries.
ahead of itself, we turn to the most recent economic Therefore, we also turn our attention to another key meas-
ure to put the current economic situation in context. This
data that seems to suggest the economy may have stabi-
measure, industrial capacity utilization, suggests that the
lized but has not yet reached a recovery stage. Of particular
level of capacity that is sitting idle (at manufacturing plants,
concern is that US unemployment is at levels not seen since
for example) is at levels well beyond the lows seen during
the deep recession of the early 80s, and is showing little evi-
any recession since the mid 1960’s. At this point in time,
dence of subsiding. But of greater concern is that earlier
only about 65% of US industrial capacity is in use.
signals that were considered to
demonstrate that the bad news
was at least slowing down are
now showing the possibility of
persisting. One such measure,
non-farm payrolls, an employ-
ment statistic used to measure
the total number of private-sector
paid US workers, dropped at Payrolls dropped at a faster
increasing rates from last fall
through to February and had pace.— Unemployment higher
begun to show signs of slowing. than in the 1980s
However, in July we once again
saw acceleration in the number
of unemployed.

But what does this all mean? The US con-
sumer fuels two-thirds of the American economy and about
one-fifth of economic activity globally. Therefore, a record
number of unemployed Americans imply a significant drop in
potential global consumption and production. Of added im-
portance, and as we wrote in our June 2nd Financial Post
Column, ―The US Consumer: Engine of the Global Econ-
omy Gears Down‖, US personal savings rates are climbing
to levels not seen in the last two decades. This tells us that
those Americans fortunate enough to be working are not
consuming goods and services at anywhere near the same
appetite that spurred the last period of economic expansion.
Unused industrial capacity
is well beyond levels seen in any
recession since the 1960’s
To balance this fairly bleak backdrop, we have to remember
that much of this economic decline stems from last fall’s col-
lapse of US investment house Lehman Brothers. When
Lehman collapsed, world trade and financial markets froze.
As the markets have continued their
“The market steady progress towards functioning
again, a snapback in economic indi-
may have al- cators should be expected. How-
ready priced in ever, the rate of decrease in indus-
the economic trial production is not showing
meaningful signs of improvement.
recovery” The chart to the left displays the
rate of change in United States In-
dustrial Production and demon-
strates no signs of improvement.
Notably, the utilization rates after
both the 1990 and 2001 recessions
never fully recovered back to their
pre recession highs and even then
took close to four years to inch up-
wards to peak business-cycle lev-
els. This suggests the possibility of
a slower recovery than many are
anticipating.
Helping global confidence are ac-
tions by governments around the
world who have committed enor-

Continued on page 3
pg 3
Continued from page 2
mous levels of fiscal and monetary stimulus. For example,
the US has injected fiscal stimulus of about 5.5% of its
GDP totaling $787 billion and China has committed about
18% of its GDP totaling $586 billion. China has also forced
its banks to open the monetary spigot by mandating loans
be made quickly. This has resulted in a very fast pick up in
China’s economic growth. For the economic recovery to
continue, the US consumer is going to have to become
confident enough to begin spending again. Longer term,
the rising savings
rate of US con-
sumers is good for
the US economy –
but at this point in
time, a little extra
spending could go
a long way to help
cement the global
econom y’s at-
tempts to rebound.
How are the global stimulus packages
and overextended markets related?
Well, with the unprecedented levels of global stimulus we
saw a surge in energy and base metals as the market an-
ticipated a restart of the Chinese industrial machine and
eager US consumers who were supposedly poised to begin
spending again. These expectations resulted in oil prices
climbing from $50 to $70/barrel. This price increase oc-
curred despite the fact that inventories in the US and
Europe were and are at capacity. Extra storage capacity is
being found by the leasing of train cars and tanker ships
that are being used for storage instead of transport pur-
poses. In short, the
For the economic re- market may have
covery to continue, the already priced in
the economic re-
US consumer is going covery. Where cau-
to have to become con- tion is warranted is if
the economic recov-
fident enough to begin ery doesn’t match up
spending again. to the market’s ex-
pectations.
To see where the Chinese stimulus ef-
forts have gone we note that with the excessive
liquidity in the Chinese markets, real estate prices are be-
ing bid up to text-book bubble levels. Gu Yunchang, secre-
tary-general of the China Real Estate Association is quoted
as stating, ―While people have a strong perception of ex-
cessive liquidity and further price growth, the possibility of a
[real estate] bubble is pretty big.‖ (China Daily, 2009-07-03) The
evidence is not purely anecdotal – the People’s Bank of
China also reported that new loans as a percentage of GDP
has actually exploded to 70%, whereas the previous high
over the last six years was under 30%.
China’s influence on commodity prices has not gone unno-
ticed. The big question with respect to China is just how
much of its commodity demand is for legitimate industrial
use and how much of it is simply China stockpiling com-
modities. At one point, Chinese harbors were full of ships
waiting to unload their cargo but could not as Chinese
docks were overflowing with inventory. While this could
have been due to inefficiencies in Chinese infrastructure
and transportation bot-
tlenecks, it bears All the talk about
watching.
“Greenshoots”,
The US stimulus pack- “things are less bad”,
age differs in that or comparisons to the
much of it still has not
“Great Depression”
made its way into the
are fairly irrelevant
economy. Current pro-
jections are that about
50% of it will have been spent by mid 2010. About 30-40%
of the government cheques that were sent to US house-
holds have gone into debt reduction or savings. Late last
month, the White House was saying that they underesti-
mated the state of the economy and many in Congress
were of the opinion that perhaps an additional stimulus
package might be needed. Any talk of an additional stimu-
lus would not be welcome by the bond market – where in-
terest rates would be hurled upwards – negating the bene-
fits of additional stimulus.
It is now of our opinion that all the talk about ―green-
shoots,” “things are less bad”, or comparisons to the
At this
“Great Depression” are fairly irrelevant.
point, investors should be more con-
cerned with whether or not markets have already
priced in corporate earnings that are expected to rebound
with the economy. Companies have done a very good job of
reducing costs and adjusting their levels of inventory. Sus-
tainable demand will depend on a return of confidence.
Compared to last fall when the world was in a liquidation
mode, we have come a long way. Going forward, we will be
able to answer the question with more certainty of whether
last quarter’s exuberant market rally should instead
have been a more humble sigh-of-relief rather than
a roaring-applause.
pg 4

A look at the New Value—

Bio & Info technology

O ur most recent interview on Business News Net-

work took place on July 10, 2009. Key points of
the interview included our stance that energy and
material stocks appeared to be over-bought and thus
resulted in our reduction in oil stock weights in the
spring. The catalyst for this reduction arose from
over-priced oil, at $70/barrel, which appeared to be
out of line with global supply and demand indicators.

Market segments that we are finding intriguing oppor-

tunities in are both the Health Care/Biotechnology
and Technology sectors. While it is true that the Bio-
technology sector is not traditionally considered a
defensive sector, we reminded our interviewer that
the sector has been forgotten about by most inves-
tors for much of the last decade. That tends to create
opportunity.

In general, we are attracted to companies with sound

balance sheets and/or the ability to continue to pay
solid dividends that rise over time. These companies
nored company despite their strong financial position. Four days after
should continue to provide positive and consistent
our interview Intel reported second quarter earnings which soundly
performance despite a slow-growth economic envi-
beat estimates—sending Intel shares higher by 8%. The surge in Intel
ronment. What has further peaked our interest in the
subsequently triggered a strong market wide rally on optimism
biotechnology sector is that over the last year and
that perhaps corporate profits might be better than expected.
half the biotech segment has managed to perform
very well relative to the broad S&P 500 market index
(relative strength).
Companies discussed in our interview
Within the information technology space, our prefer-
ence has been within the semi-conductor segment.
Again, we are attracted to strong balance sheets,
high level of cash generation, and large dividends.
These attributes were not associated with this sector
a decade ago, thus causing us to refer to this sector
as ―the new value‖. One of the semi conductor pro-
ducers that we liked and mentioned in our interview Our full interview is available
was chip maker, Intel (INTC). With its nearly 80% online on our Investment-Waves Blog at
market share, we felt that Intel was a relatively ig- www.pacificapartners.com

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