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October 31, 2011: Equities rebound in October

The price of West Texas Intermediate (WTI) oil rose 17.5% in October driving an 11.0% increase in the S&P/TSX Composite Energy sub-index, a strong contributor to the S&P/TSX Composite Index’s 5.4% rise in October. The Selective Asset Long Biased Equity Hedge Fund was up 1.8% in October.

U.S. stocks rose significantly in October as investors bought “compelling” valued stocks. We believe that stock prices rose in October as investors started to anticipate that “QE3” in the U.S. will soon arrive. The Bank of England led the way on quantitative easing in October when they announced their plan to buy $115 billion (US) of bonds. In addition a number of U.S. Federal Reserve Board officials started to talk about another round of quantitative easing involving the purchase of large quantities of mortgage backed securities to drive mortgage interest rates lower.

Fred Hickey editor of The High-Tech Strategist offered a frank view of Europe’s challenges on November 6th “The European socialist-leaning, cradle-to-grave welfare states – decades in the making –with their overly-regulated economies, overstuffed bureaucracies filled with overpaid public union employees, high taxes and ridiculous labor rules; is non-productive and non-competitive with the recent new world order brought on by globalization. For years the deficits and debts have piled up, but now they’ve grown so large they can no longer be funded.”

In the August commentary we noted “Italy remains the key to the European debt crisis. Italy is the third largest sovereign debtor in the world: $2.5 trillion Cdn$, 120% of GDP. Italy’s funding requirement this year is larger than the total amount of Greek debt outstanding.”

On October 21st the yield on 10-year Italian government bonds hit 6.04% surpassing the 6.03% level set on July 18th. On November 7th the yield had risen further to 6.55%. David Rosenberg of Gluskin Sheff noted “the yield on Italian bonds and the spread off of (German) bonds are both now getting perilously close to the levels that drove Greece, Ireland and Portugal into bailout mode.”

The 50% “haircut” that Greek bondholders have been forced to accept in round 2 of the Greek bailout does not “technically” qualify as a default. As a result investors who bought bond insurance (Credit Default Swaps) to protect themselves from the risk of default on Greek bonds have been short changed. Holders of Italian bond insurance fear the same treatment which is another cause of the rising yields on Italian bonds. Holders of all sovereign debt are now rethinking their exposures given that sovereign debt default can no longer be reliably hedged.

The Greek/Euro debt crisis has reduced consumer and business confidence in Europe causing German and French economic activity to slow. This is significant as Europe is China’s largest export market. The growth rate of China’s exports to Europe fell from 22% year over year growth in August to less than 10% in September.

From a seasonality perspective gold performs best from November to February. As well the uncertainty in Europe is expected to push the price of gold up before year-end. The growth oriented portfolios are expected to benefit due to the significant holdings of precious metal stocks.

In spite of all of the European gloom earnings growth in the U.S. and Canada for the Q3 reporting period has been about 3% better than expected. The trailing return on equity for the S&P 500 is 22% on a weighted basis and 15% for the S&P/TSX Composite on a weighted basis. Earnings growth of about 12% is forecasted for the next 12 months in-line with historically normal levels.

On October 25th the price of West Texas Intermediate (WTI) oil rose above $92.50 for the first time in 3-months confirming the upside breakout by equities in October. We believe the equity rally will continue into the New Year in spite of near-term Euro debt concerns and U.S. debt limit distractions.

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September 30, 2011: European debt uncertainty drags stocks lower

Equity markets declined in September due to Greek/European debt uncertainty and its potential negative impact on world economic growth.

The S&P/TSX Composite Index was down 9.0% in September while the Selective Asset Long-Biased Equity Hedge Fund was down 12.7%. This was the sixth consecutive month of decline for the S&P/TSX. Previous six month declines for the S&P/TSX ended in February 2009 (during the U.S. financial crisis) and in June 1982 (U.S. recession). Six months later the S&P /TSX Composite was up more than 43% in both cases.

The October 7th comment from Jan Loeys of JP Morgan’s Global Asset Allocation group provided an interesting Global perspective “Much of the fall in global equities this year took place… in early August, around the time of the chaos around the US debt ceiling, its downgrade from AAA, and the collapse in consumer and company confidence. This timing coincidence provides good evidence that uncertainty around fiscal and regulatory policies, in both the US and the Euro area, is the root cause of weaker economies and asset markets. This uncertainty, if not chaos, was not preordained, but is a self-inflicted (by politicians) wound.”

On September 19th the price of copper declined below the $3.85 lows set in mid-May and late-July, 2011. Copper subsequently ended the first week of October at $3.29, about 15% below the $3.85 “support level”. Copper’s price decline creates a caution flag as it is viewed as a proxy for the outlook for world economic growth.

“Operation Twist” was announced by the U.S. Federal Reserve Board (Fed) on September 21st. The Fed will sell $400 million of short-term bonds and buy longer-term bonds in an attempt to lower longer term interest rates and mortgage rates. At the time of the announcement Fed chairman Ben Bernanke spoke of “significant downside risks to the economic outlook, including strains in global financial markets.”

Bernanke previously warned of “significant downside risk” to economic growth on July 15th, 2008 in his semi-annual Monetary Policy Report to Congress just prior to the subsequent 6 month decline in economic growth and equity markets.

On October 6th the European Central Bank activated an emergency funding program for banks by offering 12 month loans to European banks. This program was required because lending to and between European banks had dried up due to the lack of transparency on each bank’s exposure to Greek and other European sovereign debt. Greece’s government said it would miss 2011’s and 2012’s budget deficit targets even after allowing for the 30,000 public sector jobs that are to be cut by December.

The IMF said that European banks need 100 to 200 billion Euros of extra capital due to potential losses on Greek debt. On October 6th Deutsche Bank took a write-off of 250 million Euros ($335 million U.S.) on its Greek debt. In light of this the IMF’s extra capital estimate appears far too low.

Vincent Delisle Scotia Capital’s portfolio strategist commented on October 7th “Following last month’s selloff and commodity shellacking the equity risk-reward outlook has gone from very attractive to outright compelling, in our view.”

The price earnings multiple for the S&P/TSX for 2012 is estimated at 11x based on 18% earnings growth. The price earnings multiple for the S&P 500 for 2012 is estimated at 10.5x based on 11.7% earnings growth.

On October 3rd the Institute for Supply Management’s manufacturing index was reported as 51.6 indicating the 26th straight month of economic expansion. On October 6th the International Council of Shopping Centers said that sales in September at U.S shopping centers rose 5.5% (better than economists had forecast).

On October 7th the U.S reported that nonfarm payrolls increased by 103,000 in September, above the consensus estimate of 60,000. Ned Davis Research commented about the strong employment numbers “we have not seen a peak in payrolls, a necessary ingredient to call a recession…as a result of these developments we are, reducing the probability that the (U.S.) economy is currently in recession to 25% from 40%.

This encouraging economic data reinforces our view that U.S economic growth while modest will continue to be positive well into 2012. We believe that equity markets will improve in the fourth quarter as investors acknowledge the “compelling” equity valuations and become more confident in a resolution of the European debt crisis and positive economic growth.

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September 9, 2011: Equity markets rebound from August 8th lows

Last month we noted �Due to global debt concerns most currencies appear vulnerable and gold appears to be an attractive alternative investment.Œ This proved correct as gold moved from $1,619 at the beginning of the month to a high of $1,898 on August 22nd and closed up 12.8% at $1,826 at the end of the August. The portfolio benefited from holding gold and silver stocks in August. The S&P/TSX Composite Index was down 1.4% in August while the Selective Asset Long Biased Equity Hedge Fund was down 6.7%.

Standard & Poors Corp. noted in May that almost three quarters of the sovereign debt ratings it had placed on negative Credit Watch led to down grades within an average of seven weeks. Standard & Poors put the U.S on Credit Watch in mid-July, and then downgraded the U.S. debt rating after the close on Friday August 5th. Standard & Poors unprecedented move reflected their frustration with the U.S. debt ceiling compromise that requires a committee of 12 politicians to target specific programs by November 23rd. The U.S. political infighting related to the U.S. debt ceiling contributed to the University of Michigan¡s consumer confidence index dropping to its lowest point in 3 years.

U.S. quantitative easing �QE2Œ was completed at the end of June, 2011. In an attempt to further stimulate the U.S. economy on August 9th the U.S. Federal Reserve Open Market Committee announced a �low interest rate for 2 yearsŒ policy noting that �downside risks to the economic outlook have increased™ Œeconomic conditions™ are likely to warrant exceptionally low levels for the federal fund rate at least through mid-2013.Œ

The Fed¡s low interest rate policy is expected to be supportive of rising gold prices as historically a negative real interest rate environment has been beneficial to gold. It appears that gold stocks may continue their strong performance as in early September the Market Vectors Gold Miners (GDX) broke above its previous $64.62 high set in early December, 2010. The NYSE Gold Bugs Index (HUI) also showed a similar positive technical pattern.

On Friday September 2nd the U.S. employment report for August showed zero growth in non-farm payrolls and a modest 17,000 increase in private-sector jobs.

In a further attempt to stimulate the U.S economy and lower long term interest rates the Fed is expected to announce in September a �TwistŒ operation. The Fed is expected to sell 2 year bonds and use the proceeds to buy 10 years bonds.

The Northern European countries of Holland, Germany and Finland are increasingly hesitant to lend to the debt laden Southern European countries that are reluctant to implement the severe austerity measures required to cut their budget deficits. Reflecting these concerns Greece¡s debt is trading at near default levels: 1 year yields are over 80% while 2 year yields are over 50%.

Italy remains the key to the European debt crisis. Italy is the third largest sovereign debtor in the world: $2.5 trillion Cdn$, 120% of GDP. Italy¡s funding requirement this year is larger than the total amount of Greek debt outstanding. Reflecting concerns about European debt in early September the Euro declined to a new 6 month closing low.

The decline in stock prices since May in part reflects concerns about the increased possibility of a U.S. recession. Guggenheim Partners L.L.C believes these fears are overblown as the Conference Board¡s Leading Economic Index (L.E.I) for the U.S. increased 0.5% in July, following a 0.3% increase in June and a 0.7% increase in May. Guggenheim notes that �no (U.S) recession has ever occurred without at least four consecutive negative monthsŒ (of L.E.I Index readings).

In addition the current steep yield curve implies that earnings will continue to grow to the first half of 2012. Guggenheim Partners also noted �The difference between 2-year and 10-year Treasury yields remains at historic highs. Going back to the 1970¡s, there has never been a recession that commenced with a positive spread between these two yields.Œ

In response to the Fed¡s August 9th announcement North American equity markets rebounded from the lows of the month set on August 8th. We expect stocks to continue to rise reflecting an improvement in economic growth in the second half of 2011.

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August 15, 2011: Fund outperformance driven by oil service and gold stocks

In spite of the gloomy headlines performance in the fund in July was encouraging lead by oil and gas service stocks and precious metal stocks. The S&P/TSX Composite Index was down 2.7% in July while the Selective Asset Long Biased Equity Hedge Fund was up 3.3%.

In May, 2010 a 3 year 110 billion Euro bailout for Greece was approved. Unfortunately this program was too optimistic about how quickly Greece would be able to return to the bond market for financing.

The second Greek bailout announced in the 3rd week of July, 2011 attempts to achieve rollovers/extensions of the Greek debt without causing bond rating agencies to describe Greece as having defaulted on its loans.

The latest Greek bailout consisted of 109 billion Euros from international lenders and up to 50 million Euros in private contributions from bond holders. Also much greater flexibility for the European Financial Stability Facility (EFSF) the Region¡s main rescue fund was announced. The EFSF has been given new powers to purchase bonds in the secondary market to stem contagionary stress in sovereign markets if sentiment worsens. This is important as Italy¡s debt is 2.5 times the combined debt exposure of Greece, Ireland and Portugal.

10 year Italian bond yields rose from 4.89% at the end of June/2011 to 6.00% at the beginning of August reflecting increased concern about European Sovereign debt. These concerns caused the French and German stock markets to trade to new 4 month lows in early August.

On July 29th the Q1 U.S. G.D.P. numbers were revised downward from 1.9% to a modest 0.4%. The downward revision occurred as the initial estimates of inventory build-up by companies were too high and outlays by consumers and the U.S. Federal government were also revised down.

On the same day the advance estimate Q2 U.S. G.D.P. growth was 1.3%. It was estimated that U.S. consumer spending shrank from 2.1% in Q1 to 0.1% in Q2 due to continuing high unemployment and rising food and energy prices. The Institute of Supply Management (ISM) Manufacturing Index¡s June reading of 50.9 was well below the 54.3 consensus estimate and the lowest level since July 2009.

The U.S. debt ceiling compromise reached in early August requires a committee of 12 politicians to target specific programs for $1.5 trillion of budget cuts by November 23rd. If no agreement is reached the debt ceiling is raised by $1.2 trillion in exchange for an automatic $1.2 trillion budget cut (over 9 years) to be divided equally between national security and no-defense discretionary programs.

We expect a continued rise in the price of gold into October/November in line with previous rallies in the second half of the year (2007, 2009, and 2010). Due to global debt concerns most currencies appear vulnerable and gold appears to be an attractive alternative investment.

In early August U.S. 10 year bond yields declined to 2.55% the lowest level in 8 months, reflecting the weak U.S. economic growth. In early August the S&P 500 Composite Index and the German DAX Index closed below their 200 day moving averages for the first time since September, 2010 and U.S. stocks were down for 7 consecutive days.

The selling appears to be over done. We expect stocks to rise reflecting an improvement in economic growth in the second half of 2011. As Ned Davis Research noted on August 3rd, �Despite the correction long-term uptrends remain intact.Œ

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July 11, 2011: Markets pullback in June

Concerns about slowing U.S economic growth, Greece¡s debt problems and inflation pushed markets lower until mid-June. The S&P/TSX Composite had declined 7.3% by June 17th then rallied almost 4% to close down 3.6% on the month. The Selective Asset Long Biased Equity Hedge fund was down 6.5%. In Canada the energy and materials sub-indices under-performed in June as oil and gold declined 3.4% and 2.6% respectively.

The decline in Sino Forest shares in June hurt the performance of the fund. On June 2nd, investment firm Muddy Waters published a report that Sino Forest had exaggerated its assets. Sino Forest shares declined over 70% in the following 2 days. As a result of uncertainty over Sino Forest¡s public disclosures and financial statements the shares were sold.

In May, 2010 a 3 year 110 billion Euro bailout for Greece was approved. Unfortunately this program was too optimistic about how quickly Greece would be able to return to the bond market for financing. The debate currently revolves around how to achieve rollovers/extensions of the Greek debt without causing bond rating agencies to describe Greece as having defaulted on its loans. As 33% of Greek youth under the age of 25 are unemployed social unrest will continue as Greek economic growth will struggle under the austerity measures. Sovereign debt concerns have reappeared in Italy, Spain and Portugal causing the Euro to decline.

The positive shape of the yield curve implies that earnings will continue to grow to the first half of 2012. U.S earnings estimates have been increased 4.3% in the past three months in contrast to the 0.5% reduction in U.S G.D.P growth estimates. Why focus on U.S G.D.P. growth estimates? RBC Capital markets estimates that a one percent change in U.S G.D.P. growth causes a 7.7% change in earnings for material stocks and a 5.6% change for consumer discretionary stocks.

Last month we noted �The equity markets¡ rotational pattern that began in February appears to need more time as the S&P 500 Composite Index closed below its 100 day moving average (1,318) in early June. This caused technical analysts to forecast near term weakness potentially to the 200 day moving average (1,248).Œ

The expected near term weakness occurred as the S&P 500 declined and bounced off it¡s rising 200 day moving average on June 16th (1258) and June 23rd (1263). The S&P 500 continued to advance into the first week of July. The S&P/TSX rally that began on June 18th also continued into the first week of July and it appears that a new intermediate equity uptrend is underway.

On July 6th J.P. Morgan¡s Global Asset Allocation Group stated we �increase(d) the beta of our equity portfolio by reversing our under weight in Cyclicals vs. Defensive sectors.Œ This shift to over weight the Cyclicals is significant and J.P Morgan¡s top commodity pick is copper �on the rebound in industrial activity in Japan and firmer final demand in the USŒ.

We believe that stocks will move higher into the New Year as stocks appear to be at an attractive 16% discount. The S&P 500 is trading at a forward P/E of 12x versus the 14.3x long-term average.

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June 14, 2011: Equity Markets¡ rotational correction continues

The S&P/TSX Composite Index declined 4% to its May 13th low then rallied to close down 1% on the month. The Selective Asset Long Biased Equity Hedge Fund was down 0.9% in May. European debt, weak U.S. job growth, declining U.S. home prices, continued weak U.S. home construction and high energy prices caused the market weakness.

The U.S. added 54,000 jobs in May (the smallest increase in eight months), well below the 165,000 forecast by economists. It was also well below 2011¡s average monthly gain of 102,000 jobs. Private sector employment rose by 83,000, offset by a 29,000 decline in government jobs as budget cuts continue.

U.S. G.D.P. rose 1.8% in the first quarter and the recent weak US economic news indicated that growth would likely continue at a modest pace. Cyclical stocks under-performed in May; energy, forest products and material stocks were laggards.

There was a similar U.S. economic growth slowdown last summer due to concerns about the Greek debt crisis. The U.S. Federal Reserve Board responded with �QE2Œ, the Fed¡s plan to buy $.6 Trillion of debt to stimulate the U.S. economy. We do not expect an extension of QE2.

While oil declined 10% in May (WTI: $102.70 close) it was virtually unchanged on a three-month basis. Meanwhile natural gas quietly rose 14% over the three-month period to close the month at $4.76. In early June natural gas hit $4.86 almost surpassing the late January 2011 high of $4.88. The previous high occurred two-years ago on August 2, 2010 at $5.01. A continuation in the rise of natural gas would be a significant positive for Canadian energy and energy service stocks.

The equity markets¡ rotational pattern that began in February appears to need more time as the S&P 500 Composite Index closed below its 100 day moving average (1,318) in early June. This caused technical analysts to forecast near term weakness potentially to the 200 day moving average (1,248).

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May 10, 2011: Commodity stocks weigh on S&P/TSX in April.

The S&P/TSX Composite Index was down 1.2% in April. In spite of the 5% increase in the price of oil and natural gas the S&P/TSX Energy Exploration and Production sub-index was down 3.8%. The Selective Asset Long Biased Equity Hedge Fund was down 1.8% in April due to the energy sector stocks. Other drags on the performance of the S&P/TSX Composite Index were: Banks down 1.6% and Information and Technology (heavy Research in Motion weight) down 10.5%.

Gold was up 9.4% in April, while copper and zinc were down 0.5% (to $4.18) and 6.2%, respectively. Copper¡s decline below the $4.25 technical analysis support level is of concern.

Defensive groups such as grocery stores (Staples), Utilities and Health Care moved up in April while energy and cyclical stocks (base metals and forest products) declined.

In the first week of May the Commodities Research Bureau (CRB) index dropped 9% due to the apparent reversal (to the upside) of the U.S dollar and concerns about slowing U.S., Chinese and European economic growth. W.T.I oil traded above $100 for the first time in 2 ê years in February, hit $114.83 on May 2nd, 2011 then dropped below $98 on May 6th.

The decline in commodities has affected many S&P/TSX stocks and 25% of S&P composite stocks are now 20% below their 52 week high, in contrast only 8% of S&P 500 stocks are below their 52 week high. The S&P/TSX Composite is below its 100 day moving average for the first since August, 2010.

Does the strength in defensive stocks signal the end of the equity bull market? We don¡t think so. Ned Davis Research¡s (NDR) May 9th, 2011 report entitled �Are we there yet?Œ notes that U.S �breadth remains strong, valuations are not extreme and (their strategist) Tim Hayes has NDR¡s asset allocation as overweight stocks.Œ

In the same report, NDR notes low volatility stocks have started to outperform. In addition NDR favors high sales growth stocks in the current environment (NDR believes overall S&P 500 sales momentum has peaked) and �the deceleration in earnings momentum is one of the reasons why we favor Growth over Value.Œ Stocks held in the portfolio have strong exposure to these favored characteristics.

We believe that the bull market is intact and that economic growth will reaccelerate in the second half of 2011 leading stock prices higher.

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April 8, 2011: Increased market volatility caused by international crises.

During March the S&P/TSX Composite Index declined 4.2% by mid month then rallied and closed virtually unchanged (down 14 basis points). Major U.S. equity indices have also recovered from the shallow correction in March and are back trading above their 50 day moving averages. The decline was caused by uncertainty due to the devastating Tohoku earth quake/tsunami (9.0 magnitude) near the northeast coast of Honshu, Japan. Anti-Gadhafi forces battling in Libya raised concerns about potential oil disruption. The Selective Asset Long Biased Equity Hedge Fund LP was down 2.1% in March.

There was a significant 17.2% ($16.70) price difference between West Texas Intermediate (WTI), $96.97 and Brent (North Sea) oil, $113.69 at the end of February. This spread narrowed significantly to 7.6% ($8.06) by the end of March as the WTI price of oil rose.
In spite of the 10% rise in WTI in March the S&P/TSX energy sub-index was down 1.8%. The decline in energy stocks caused the underperformance of the fund.

We believe the underperformance of energy stocks will quickly reverse as the price of oil is higher for near term delivery versus long term delivery prices (backwardation). Backwardation implies that near term supplies of oil will remain tight and the price of oil will remain high. Historically the majority of oil rallies have occurred under similar conditions.

Historically when the Brent price for oil is 40% above its 3 year moving average (as is the case now) U.S. home prices have declined. As a result we expect U.S. homebuilding to continue to face tough sledding and U.S. consumers to remain cautious.

In March U.S. employment growth of 216,000 new jobs was stronger than expected. This was the second consecutive month of strong job growth. The jobless rate fell from 8.9% to a two year low of 8.8%.

Since 2009 the U.S. Federal Reserve Board (Fed) has aggressively printed money leading to a tripling of the U.S. monetary base to $2.4 trillion. Of this it is estimated that over half ($1.3 trillion) is held by U.S. banks as excess reserves. Banks have bought bonds rather than lending the money.

Under QE2 the Fed has been the biggest buyer of bonds. What happens when QE2 ends in June? Will bond yields rise causing banks to sell bonds and buy stocks? This may already be occurring as the Dow Jones Industrial Index was up 6.4% in Q1/2011 the best Q1 percentage gain in 12 years.

The U.S. dollar has weakened because of U.S. deficit concerns ($1.5 trillion) and because European Central Bank would raised interest rates by §% to 1 §% for the first time in almost 3 years.

The recent U.S. dollar weakness has caused gold to move above $1,450 which was the top end of a 6 month sideways trading pattern. We believe further gains for gold and gold stocks lie ahead. Second quarter gains since 1950 in pre-election years at 6%+ have been over twice the typical 2.5%+ average Q2 increase seen over the past 20 years. While U.S. economic uncertainties continue we believe that world GDP growth of 3% in 2011 and rising profits will help stocks continue to move up well into 2012.

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March 11, 2011: Energy drives S&P/TSX up in February

The S&P/TSX Composite was up 4.3% in February driven by the strong performance of large cap and energy stocks. The Selective Asset Long-Biased Equity Hedge Fund was up 1.4%. Last month we noted that Brent oil had risen above US$ 100 for the first time in two years. There was concern that the protests in Egypt that led to the ousting of President Hosni Mubarek¡s regime could spread to other Middle East or North African oil-producing countries.

The protest did spread to other nearby regions. However, in contrast to the relatively quick upheavals that led to the change in leadership in Egypt and Tunisia, Libya appears to be entering a drawn-out civil war. The violent conflict in Libya pushed the price of West Texas Intermediate (�WTIŒ) oil above US$104 in the first week of March. U.S. gasoline prices are up 22% to US$3.29 per gallon versus US$2.70 last summer. The oil price rise is estimated to cost U.S. consumers US$80 billion per year more.

James M. Buchanan, a Nobel Laureate in Economics and Professor Emeritus at George Mason University, argued that deficit spending would evolve into a permanent disconnect between spending and revenue, precisely because it brings short-term economic gains.

In an effort to break the disconnect, the new Republican majority in the U.S. House of Representatives plans to cut US$59 billion in U.S. government spending in the second half of 2011. Economists forecast that this would lead to the loss of 650,000 government jobs and the indirect loss of an additional 325,000 jobs as fewer government workers buy less goods and services.

At the end of June the U.S. Federal Reserve Board is expected to complete its US$600 billion purchase of U.S. government bonds. July is the start of the new fiscal year for most U.S. states and significant cuts and layoffs are expected.

In spite of rising commodity prices, U.S. bond yields declined since the peak in early February as investors increased weights in �safe havenŒ assets. As long as U.S. 10-year bond yields stay above 3.25% (they were 3.47% in early March), investors will likely continue to favor equities.

The U.S. Institute for Supply Management¡s (�ISMŒ) Factory Activity Index rose in February to the highest level since May 2004. The ISM¡s employment sub-index showed hiring rising at the fastest rate since 1973 as new orders surged while the inventory index fell.

The rise in the oil price and state and local U.S. budget cuts will make it tougher for the economy to grow in the second half of 2011. Copper recently traded below US$4.20 per pound breaking an uptrend that started in June 2010 at US$2.72 per pound. As the price of copper is viewed as a leading economic indicator the equity markets may be moving to the long anticipated 5 to 10% correction.

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February 14, 2011: The Selective Asset Long Biased Equity Hedge Fund LP outperforms the S&P/TSX in January

The S&P/TSX Composite was up 0.8% in January led by the Health Care, Energy and Telecom services sectors. Portfolio holdings in mining stocks were significantly reduced in the second half of December this was beneficial as Metal and Mining stocks (including Golds) were significant laggards in January. The Selective Asset Long Biased Equity Hedge Fund LP was up 1.5% in January.

The S&P 500 Composite index rose 2.3% in January reflecting the strong fourth quarter S&P 500 earnings, up 28% year over year (better than expected) on a 7.7% year over year increase in sales.

In early February U.S. retailers reported January sales that were up 4.4%, ahead of expectations. January¡s strong sales followed the best holiday season¡s sales in 4 years. Consumer spending rose 4.4% in Q4/2010, the fastest rate of growth in 4 years. Strong hiring and the $112 billion U.S. payroll tax cut (half of which is expected to be spent at the mall) have driven the increase in spending.

The Institute for Supply Management (ISM) service sector index rose 2.3 points to 59.4 in January the best rise since August 2005. The new orders and jobs measures also hit multiyear highs. ISM¡s manufacturing index also showed similar strength in January.

The United Nations¡ Food and Agriculture Organization reported that world food prices rose to a record (20+ years) high in January, 2011. This will continue to cause rising inflation in Emerging Market countries where food makes up about 30% of the local Consumer Price Index. Last year¡s severe weather and low inventories are expected to cause grain prices to move higher into the summer until new crops are harvested.

Egyptian protests about the President Hosni Mubarek¡s regime caused the price of Brent oil to rise above $100 for the first time in over 2 years amid concerns that the Suez Canal could close. The security of the strategic Sumed pipeline that links the Red Sea with the Mediterranean was also a concern. The potential of the protests spreading to other Middle East or North African oil producers is an additional risk. Rising food prices are causing discomfort in Egypt and other emerging markets.

Diane Francis¡s Financial Post column of February 5th, 2011 describes �Egypt¡s crisis is more demographic than democratic and a sign of things to come in all countries. Youth unemployment is highest in Egypt and the rest of the Middle East and North Africa at 24% on average between 15 and 24 years of age.Œ

The rise in U.S. economic indicators and rising commodity prices caused U.S. 30 year bond yields to rise to 4.74% in early February setting new yield highs. The yield highs surpassed the mid-April 2010 highs and stretch back to yields last seen in October, 2007.

This rise in bond yields is significant because technical analyst Arthur Hill (stockcharts.com) cautioned of the end of 2010 that a �break above the 2008-2010 (yield) highs would reverse a 20+ year downtrend in long-term (interest) rates.Œ
Weights in metal and mining stocks which were reduced in December have been increased as copper has moved out of a short term trading range and moved above $4.50/pound.

The fund has a significant overweight in energy stocks. From a seasonal perspective, they typically advance from the end of January to mid May.

We had expected a 5 to 10% pullback, however it now appears that more of a �rotationalŒ rather than broad-based correction may be occurring.

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January 12, 2011: Strong performance continues with Enhanced Growth Model

The Selective Asset Long Biased Equity Hedge Fund LP was up 3.4%* in December 2010, and was up 8.5%* in 2010 (*un-audited).

In Canada the Financials, Energy and Materials subgroups accounted for 94% of the 14.5% gain in the S&P/TSX Composite in 2010. The S&P 500 Composite was up 90% in 2010 in Canadian dollar terms.

In late August we �increased the emphasis on a company¡s ability to service its debt as well as reduce its debt.Œ This change has contributed to the significant performance that has occurred since the end of August. From August 31st, 2010 to December 31st, 2010 the Selective Asset Long Biased Equity Hedge Fund LP was up 18.4%* outperforming the S&P/TSX Composite index which was up 12.8% (*un-audited).

2010 was a strong year for equity markets as earnings continued to rebound from their recessionary lows.

Strong 2011 forecast earnings growth of 26% for the S&P/TSX companies and 13% for S&P 500 companies is expected to drive stocks higher in 2011. We expect 2011 to be the year when rising earnings momentum distinguishes the performance leaders versus the laggards.

Concerns about rising inflation and the U.S. budget deficit at 10% of G.D.P. are expected to hold back bond prices in 2011. As a result investors should shift their focus from bond to equity funds in 2011.

Growth vs. Value

We favour growth stocks over value stocks at this stage in the market. The S&P/TSX Composite index has outperformed the S&P 500 Composite Index in 7 of the past 8 years due to the strong performance of resource sector stocks. The S&P/TSX is expected to outperform again in 2011 as its over 50% resource stock weight benefits from rising global economic growth and particularly from the strong energizing market economies.

Oil

Ray Hanson, Technical Analyst at RBC Capital Markets, believes that the price of oil will rise above $120 U.S. in 2011 as oil appears to have broken out (to the upside) from an 18 month trading range.

Copper

We noted in the October commentary that �technical analysts forecast that if the price of copper rises above $4.00/pound it could rise 50% to $6.00/pound in the next 12 to 18 months.Œ Copper has risen above $4.00/pound and because of strong demand and limited growth in supply for the next 2 years it appears that the price of copper will be significantly higher by the end of 2011.

Consumer Spending

The U.S. household debt servicing cost is the lowest it has been in 20 years. This may lead to an upside surprise in U.S. consumer spending in 2011. Small businesses in the U.S. may be the driver of increased hiring leading to further reductions in the U.S. unemployment rate.

Rising energy and raw material costs in 2011 may lead to a squeeze in consumer oriented profit margins. This occurred in 2007/2008 but natural resource companies (the providers of the raw materials) benefited at that time and are expected to benefit in 2011 providing further support of our view that the S&P/TSX should outperform.

In Summary™

Since mid-November US$20 billion has been withdrawn from U.S. bond mutual funds to pay for equity purchases. We expect flows from fixed income funds into equities to continue to drive demand for equities.

We see 2011 as a year of opportunity as we believe a new equity bull market is under way. A near term pull back of 5 to 10% would be viewed as an opportunity to increase resource stock holdings.

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