Finally, economic growth starts to accelerate, inflationary pressures start to rise and interest rates also start going higher. During this time better performance comes from the larger, cyclically-oriented industrial, energy, basic materials and ‘old’ technology’ sectors. While there is always some debate about whether the economy actually is picking up steam, those cyclical stock groups have clearly taken over the stock market leadership over the past few months. This is one reason why the Canadian stock market has been one of the strongest industrial markets so far in 2014 since it has a much larger bias towards those cyclical stock groups. This ‘normal rotation’ also explains why the Internet and Biotech sectors have had such poor recent performance. Economic numbers have started getting better again, the U.S. Federal Reserve has started making some references to ‘rising interest rates’ and there is much less discussion about potential deflation in the global economy. This all suggests we are moving to the ‘Mature Growth’ phase of the current cycle.

This was apparent in sector returns as Basic Materials and Energy were the clear winners in the first quarter in the Canadian market, rising 9.2% and 8.8%, respectively, in a market that had an overall first quarter gain of 5.2%. The gains for the Basic Materials sector were driven primarily by the gold stocks, which rose 15.7% in the first quarter despite a sharp 8.8% drop in March. Base metal stocks were still weak, however, as copper prices briefly traded below the key US$3.00 support level on worries about excessive copper inventories in China and rumours that copper has been used as collateral on some unprofitable loans. The mining sector has easily been the most volatile sector in the index for the past five years as the commodity sector has alternated between boom and bust. After the substantial gains for the commodity stocks over the 10-year period ended in 2011 (interrupted by a sharp drop during the financial crisis in 2008), mining stocks are back to their average index size. The chart below shows the weight of the global mining sector as a percentage of the total global stock market over the past 40 years. There were two periods of ‘commoditiy booms’; in the late 1970’s and again from 2001-08. The sharp drop from the ultimate peak in 2011 took the index back to its long-term average.  Volatile Mining back to 40 year average

If history repeats itself, then the sector could be in for a very long period of average performance. However, with growth in the emerging economies expected to outpace that of the developed markets for the next decade at least and with the costs of mining continuing to rise, we are more inclined to believe that the supply/demand balance still favours better times ahead for the mining group. The companies in this sector also seemed to have learned some important lessons from the ‘buying binge’ that they went through in the heydays before the financial crisis and now seem more focus on delivering ‘profitable growth’ as opposed to ‘expansion at any cost.’

In terms of the overall outlook for the stock market, a positive development is the substantial level of overall liquidity in the corporate sector, as shown in the recent release of 4th quarter flow of funds data in the U.S. In the nonfinancial corporate sector, balance sheets remain flush with cash, at US$1.6 trillion! That’s the highest level of cash as a share of GDP (9.6%) on record. Corporations have also been tapping the bond market while interest rates are at record lows and this has helped to build up cash balances even further. While policymakers want to see those funds directed toward business investment, the bulk of it has been going towards stock buybacks and dividend increases. This has helped boost earnings per share and dividend yields, and shareholders aren’t complaining. Combined buybacks and dividends in the nonfinancial sector totalled a near-record $880 billion in 2013. That’s shy of the buyback-binge days of 2007 but, at 5.2% of GDP, is still well above historical norms. With earnings and cash flow sturdy and balance sheets flush with cash, Corporate America is still in solid fiscal shape. The private sector is also in much better shape now too. Record equity prices, along with rising home prices, helped lift U.S. household net worth 14% in 2013, and it is now fully 18% above prerecession levels.

While Enablence Techologies (ENA) has been a disappointment in the portfolio over the past two years, the stock had a substantial price reversal in March as it announced a $1 million order from a Tier 1 mobile carrier, which is expected to aggregate to multiple-million with several customers, for its TOSA/ROSA devices (Transmit/Receive Optical Sub-Assembly). This is the first commercial order for the long awaited next generation devices ENA has been working on for several years.

We believe this marks the beginning of a wave of investment by carriers who need to protect their investment in 4G infrastructure. This same technology is being developed for data center markets and the company expects to have the former product in production in 2014. The data center market is expected to increase 10 fold to over $10B by 2018 (source: Ovum). The high throughput afforded by these devices will provide tremendous opportunities in both the telecom and datacom markets and ENA stands at the forefront. With carriers moving to 4G, there is a greater need for fiber backhaul and ENA has a unique solution to address this growing need. We understand this initial order has the potential to grow to $2-10M per year over for the next several years. Clearly with this announcement of commercial availability we would expect other tier 1 vendors will take notice. The stock is definitely one of the riskier, speculative positions in the portfolio but it also has the greatest potential to have a significant gain over the next two years as their product portfolio gets picked up and the markets gravitate to much higher bandwidths.

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