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Canada’s JC Clark Licks Wounds and Accepts Bull Market; Buys HP


Date: Thursday, February 10, 2011
Author: Matt Walcoff, Bloomberg

JC Clark Ltd., a Toronto-based hedge fund manager that got burned by its forecast that stocks would tumble last year, has reversed course and taken its most-bullish position since the depths of the 2008-09 bear market.

Co-founder Colin F. Stewart says he’s convinced that U.S. stimulus policies will boost stocks for at least this year, before markets suffer the consequences of excessive government debt. The C$175 million ($177 million) JCCLark Preservation Trust, which was voted best directional hedge fund at the 2008 and 2009 Canadian Investment Awards, has the widest ratio of shares owned to shares sold short in almost two years, he said.

The fund bought stock in electronics maker Hewlett-Packard Co., panelboard producer Norbord Inc. and Consolidated Thompson Iron Mines Ltd. since reversing its view last last year. In mid-2010 the fund was more focused on shortselling -- or borrowing shares and selling them with the intention of profiting from price declines by buying them back later.

“The long-term structural issues are still very much the same,” Stewart, who took over as sole manager of the fund after the retirement of founder John C. Clark on Feb. 1, said in an interview at the fund’s Toronto office. “Those risks are significant, and at some point in time, the significant budget deficit, the situation in Europe with sovereign debt, those issues will start to be an area of focus for the equity market down the road. Now I’m of the view that may be a couple of years down the road.”

Bearish

Last June, JC Clark adopted its most-bearish portfolio since before the Lehman Brothers Holdings Inc. crash of 2008, with Stewart forecasting that government-debt concerns might drive equity benchmarks down 25 percent. The Preservation Trust, which has returned 13 percent a year since its inception in 1999, lost 7.3 percent last year while the Standard & Poor’s 500 Index and S&P/Toronto Stock Exchange Composite Index had total returns of 15 percent and 18 percent respectively.

“What I had not anticipated was that the Federal Reserve is very determined in the U.S. to do whatever they have to do to improve the unemployment situation in the U.S. and inject enough liquidity into to the system to stimulate economic growth,” said Stewart, who co-founded JC Clark in 1999.

The U.S. central bank announced a $600 billion asset- purchase program in November and has kept interest rates at record lows.

Stewart, 35, said he still believes the growing U.S. national debt will lead to higher interest rates and bond yields, making stocks more expensive per dollar of profit and less attractive to investors than fixed income.

Signal to Sell

The S&P/TSX and S&P 500 should gain 5 percent to 10 percent this year, before suffering a drop of as much as 20 percent sometime during the next few years, he said. An increase of “a few hundred basis points” in bond yields will be a signal to sell equities. A basis point is 0.01 percentage point.

The fund’s net long exposure has increased to about 40 percent from 15 percent to 20 percent in mid 2010, he said. Net long exposure is calculated by subtracting the percentage of a fund’s equity capital invested in short sales from the percentage used for long positions, according to the Alternative Investment Management Association.

“We’ve shifted to being short-term more bullish, but we still see longer-term structural risks,” Stewart said. “The question is how do we protect against these risks, and the answer is, we’re in larger, more liquid stocks today than we have been in the past. We can make changes quite quickly.”

Stewart, who also manages the C$55 million Canadian- oriented Focused Opportunity Fund, is buying stocks that are comparatively cheap compared to their profits, have healthy balance sheets or pay dividends. These companies tend to be in the technology, telecommunications or health-care sectors.

The Preservation Trust bought shares of HP, the world’s largest personal-computer maker, late last year. In December, HP’s share price fell to $7.89 per dollar of analysts’ average forecast profit, compared with $14.48 for the S&P 500.

Housing Bet

Stewart has also taken a bet on the housing industry, buying shares of Toronto-based Norbord and Toll Brothers Inc., the biggest builder of luxury homes in the U.S. After the subprime-mortgage crisis led to a 79 percent plunge in housing starts in the late 2000s, home-builders are only building half of the homes necessary to match population growth, he said.

“There is a significant demand-supply imbalance,” Stewart said. “It may take some time for that to be worked through, but when it does, any company that had to become more efficient through the downturn, when you get a rebound in demand, we think you’re going to see a lot of that revenue improvement flow to the bottom line.”

Because of its concerns about the U.S. national debt -- which the International Monetary Fund sees surpassing gross domestic product next year -- about 65 percent of the equity shares the Preservation Trust owns are Canadian.

The hedge fund invested in Consolidated Thompson, the iron producer being bought by Cliffs Natural Resources Inc., to take advantage of supply disruptions from last month’s floods in Australia. Another company may seek to outbid Cliffs, Stewart said.

JC Clark has reduced holdings of or sold short companies in the industrial, retail and consumer-discretionary industries, with Stewart citing surges in share prices since August.

Last month, the Preservation Trust shorted shares of Cintas Corp., the largest U.S. supplier of uniforms.

“It’s a business whose key market, the manufacturing sector, is in a secular decline,” Stewart said. “Manufacturing jobs are leaving the U.S. and going overseas. That’s a trend we think is going to continue.”

To contact the reporter on this story: Matt Walcoff in Toronto at mwalcoff1@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net