1. Volume 17 Issue 4 october 2012
cardinal
quarterly
Market Outlook
by Timothy E. Burt, cfa
W ith all the negative market psychology and talk of another
global recession coming soon, you would think that economic
fundamentals are poor, corporate profits are declining, and the stock
market is falling. But this is not the case. The stock market has risen
gradually and steadily throughout the year with only one correction so
far (in May). For the first nine months of the year, the best performing
stock market was Germany (DAX-30, up 22.3%), followed by the U.S.
(S&P 500, up 14.6%), Australia (ASX-200, up 8.1%), France (CAC-40,
up 6.2%), with Canada (S&P/TSX) and the United Kingdom (FTSE-100)
both up 3.0%. In fact, the S&P 500 is only off 6.7% as of October 5
from its record high set on October 9, 2007 at 1565.15. Unfortunately,
the S&P/TSX is still off 17.6% as of October 5 from its record high of
15,073.13 set on June 18, 2008.
Most of Europe is slipping into a recession due to severe fiscal
austerity measures designed to reduce large fiscal deficits, with the Inside This Issue
primary exceptions being the UK, Germany, and the Netherlands. China’s
economy is slowing, but still growing at 7.0% plus rates. Japan’s economy Cardinal Rules................ 2
has been stuck in a recession for years with no signs of ending soon.
Investment Q&A.............. 3
Fortunately, the American and Canadian economies are still recovering
from the 2009 recession even though GDP growth rates are near 2.0%. Cardinal Research........... 4
Job growth continues in both countries with the unemployment rates
at 7.4% in Canada and 7.8% in the U.S. Inflation rates have stayed low in Cardinal News................ 4
both countries with 1.2% in Canada and 1.7% in the U.S. The U.S. housing
market continues to improve each month with higher housing starts, new
home sales, and existing home sales. Home prices are even rising in most
markets from last year’s levels. Auto sales in North America have improved
continued on page 2...
400-1780 Wellington Avenue Winnipeg, Manitoba R3H 1B3 www.cardinal.ca

2. to near normal levels (near 15.0 million autos annually). spending cuts in the U.S. Right now the race is too close to call,
Recoveries in the housing and auto sectors have been a big reason but after November 6, we will know who will be President for the
for new job creation this year. Even the consumer is steadily paying next four years and what kind of Congress he will have to deal with.
down debt and taking advantage of record low mortgage rates to In our opinion, stocks are still cheap and a better investment than
refinance mortgages. bonds. Considering the level of interest rates and inflation rates,
With record low interest rates, consumers and businesses P/E-ratios are low and should be much higher. Most high quality
are able to borrow cheaply. Even though most corporations stocks still have dividend yields above 10-year government bond
are sitting on record cash balances, many are selling long-term yields. This situation rarely happens. While third quarter corporate
bonds to take advantage of the low rates. Eventually, these funds profit comparisons may be weaker than the first two quarters, we
will be used to finance capital expenditures, acquisitions, stock think analyst expectations are too low and thus, there should be
buy backs, and dividend increases. With consumer confidence more positive surprises than negative ones. This should set the
improving, so are retail sales. We strongly doubt that another stage for the stock market to move even higher in the last quarter
recession is just around the corner in Canada or in the U.S. While of the year. We believe investors are too pessimistic in their
GDP growth has been weak in both countries, both the Bank of outlook and will be disappointed if they remain heavily invested
Canada and the U.S. Federal Reserve Board seem determined to in cash or bonds. We believe the bond markets’ best days are
keep monetary stimulus in force for at least another year. Once behind it. While there could be a minor correction this October,
the major political uncertainty of the upcoming U.S. presidential we think November and December will be strong months for
election is over, there will be clarity concerning taxation and fiscal stocks and allow us to end the year on a positive note.
Cardinal the range of 8% to 12% in industries ranging from real estate
to oil field services.
Rules Currently, the 3-year Government of Canada Bond yield is
1.2% while the 10-year is just 1.8%. Common sense dictates that
Use Common Sense it is impossible for an investment offering 12% annual returns to
By Evan Mancer, cfa be guaranteed when the risk free rate is below 2%. Most investors
understand this, but it becomes easy to abandon common sense
P erhaps the most important investing rule at Cardinal
is to use common sense. We normally discuss this rule
in the context of making a common sense investment case
when a proposal comes along that sounds this perfect. We urge
extreme caution.
for the companies we own. Common sense however is equally When considering an investment that is too good to be true,
important when considering the structure of any new always consider the proposal from the other party’s point of view.
investment opportunities. Almost all of the “guaranteed” investments we come across have
the goal of raising cash. If the investment is truly guaranteed,
At Cardinal, we keep our structure as simple as possible.
why wouldn’t they go to the bank and borrow cash at 2%? Is the
We invest in large-cap equities and high-quality bonds that we
structure clear, and are the true risks and costs disclosed? Why is
can easily trade should any of our clients immediately require
the structure so complex and to whose benefit is the complexity?
their capital. Furthermore, our clients see exactly what they
own, and what fees they pay, through Cardinal and through Even worse, these types of investments normally require
the custodian. investors to lock up their money for up to five years with penalties
for withdrawing early. Lock-up periods may even be extended
With the current investing environment of historic low
without any consent by the investor. Promoters will claim that
interest yields, wishful investors have become susceptible to
there is no volatility, but this is simply because there is no public
investment proposals that make big promises, but may not make
market to provide daily pricing. Investors will find out at the end
sense. We have noticed an increasing number of companies that
of their lock-up period just how volatile the investment was!
have emerged offering “guaranteed” annual investment returns in
2 cardinal quarterly

3. Investment Q&A So then, will what is out of favour today be the next natural
gas? We are excited by the prospects for Canadian energy stocks,
With the past 5 years fairly flat, what could the next and for Canadian insurers. Media focusses on how dismal their
five years be like? prospects are. Slow growth in the U.S., Europe and China could
The past 5 years have been turbulent for the market and for cause energy prices to decline. Interest rates may stay at these
investors’ emotions. Prior to 2008, investors were riding high levels for the foreseeable future, meaning that insurance
on a growing economy with manageable inflation and low companies will be stuck with miserly returns on their portfolios.
interest rates. Companies were growing their revenues, earnings We believe that, unloved as they are, these sectors should show
and dividends and many investors were invested in the market, dramatic returns in the not too distant future. The market will
reaping the rewards of a bull market. Then in 2008, we again show how share prices beset by emotions must return to
experienced the “great recession” and a bear market where many levels determined by fundamentals.
of the major indices fell over 50%. Some stocks fell more than Henry Hudek, cfa
that and investors rushed to fixed income securities.
Central Banks state that interest rates will remain low.
Years later, stock prices and markets have not yet recovered
Why does Cardinal believe rates will rise?
to old highs. Worries about the European debt crisis and a
slowdown in China, are making investors hesitant to invest The Bank of Canada has reiterated that they will maintain
more in the market as headline news continues to affect their their target overnight rate at 1% where it has remained since
emotions. But how have our company’s business fundamentals September 2010. They have also stated that the timing and degree
fared over this period? of any withdrawal of monetary stimulus (by tightening their
monitory policy through an increase to the overnight rate) will be
Our Canadian companies have survived the recession well
carefully weighed against domestic and economic developments.
and have continued to grow their businesses. Balance sheets are
The U.S. Federal Reserve has been more forthcoming, stating
stronger than five years ago and revenues, earnings and cash
that it sees a likelihood of the U.S. Fed Funds rate staying at
flows have grown. More importantly, dividends have grown on
“exceptionally low levels” (basically zero) at least through the
average over 57% over the past five years, while share prices in
middle of 2015.
some cases are unchanged. These companies have become more
valuable, given their growth in earnings, cash flows and dividends, There is a misconception that long term interest rates will
which are all long-term drivers of share price returns. If our only increase when central banks begin to increase interest rates.
companies continue to grow their earnings, cash flows and For example, in 2010 the Bank of Canada increased its target for
dividends over the next five years (and we expect that they will), the overnight rate 50 basis points to the 1% level we have today.
share prices will surely be much higher than they are today. During that period the 10-year yield in Canada fell 21 basis
points. The direction of short term interest rates does not always
Terry Wong, cfa predict the direction of long term interest rates.
What do you believe will be the next names to perform well? Although short term interest rates matter, there are other
Cardinal certainly does not pick a stock based on expectations factors to concern bond holders when investing in longer term
of it being the “next great performer.” We look for great companies maturities; specifically, inflation risk and principal risk. With the
at great prices. However, experience has taught us that the market inflation rate in Canada averaging around 2%, bond investors are
will continually surprise. The U.S. stock market is up over 30% in consciously expecting to lose money after inflation. This is an
the past year based on the S&P500 Index,. Why is it up so much? interesting time where bond investors are demanding a return
The short answer is that it was down so much. No one wanted to of capital rather than a return on their capital.
own U.S. stocks a year ago. Similarly, natural gas prices were less With the North American economies receiving substantial
than $2.00 per thousand cubic feet at the start of the year. Stories monetary stimulus while the economies continue to grow, one
circulated on how the production boom in shale gas meant that would expect inflationary pressures to build. Once inflation
gas prices were doomed to wither for the foreseeable future, becomes apparent, we expect that bond investors will demand
perhaps even falling below $1.00. Recently natural gas prices higher returns to lend their capital for 5 and 10 year periods.
crossed the $3.50 level, for a 75% increase in nine months. The There is no crystal ball that can perfectly predict when that day
market has surprised again. will arrive. Our bond portfolios are positioned to minimize the
risk of this event.
David Atkins, cfa
Volume 17 • Issue 4 • october 2012 3

4. Cardinal Research DIVIDEND INCREASES
Canada % Increase
Stryker Bank of Montreal 2.9%
by Sheila Wilson-Kowal, cfa Bank of Nova Scotia 3.6%
S tryker is a prominent medical technology company that is well-known for manufacturing knee
and hip implants. They are also a leading manufacturer of surgical power tools and patient
handling equipment such as hospital beds.
Can Apartment Prop.
CIBC 4.4%
3.3%
H&R Real Estate 4.0%
In early September, we attended Stryker’s investor meeting in Mahwah, New Jersey and
spoke with Stryker’s product specialists as well as management. The product fair showcased Royal Bank of Canada 5.3%
many of Stryker’s products and provided a hands-on opportunity to learn about the products. Saputo Inc. 10.5%
A highlight was the tour of Stryker’s 500,000 square foot manufacturing facility where we Toronto-Dominion Bank 6.9%
were shown how knee and hip implants are manufactured. We were brought through the entire
process from casting and machining, to sterilizing and packaging the implants for shipping. U.S.A. % Increase
Overall, we were impressed by the organization of such a large facility and the meticulous
Cisco Systems 75.0%
attention paid to every detail of the manufacturing process. Their emphasis on quality and
Stryker’s well-refined processes gave us greater confidence that Stryker can maintain its position McDonald’s Corp. 10.0%
as a leading orthopedic implant manufacturer and remain one of the top three companies that Microsoft Corp. 15.0%
provide 2/3 of the knee and hip implants for the global market. Source: Bloomberg
Demographics are on Stryker’s side as the population ages and people strive to remain active Reported in domestic currency
long into their retirement years. For knees and hips, the replacement rate has nearly doubled over
the past 10 years in the U.S. and is forecast to increase.
We expect Stryker to grow earnings through both organic growth and acquisitions in core
and adjacent markets. Strong cash flows and no net debt have allowed Stryker to invest in
acquisitions AND grow the dividend. We expect another double digit dividend increase this year.
With a strong balance sheet, excellent dividend growth potential and the opportunity to capitalize
on growing demand for medical devices, we see Stryker as a core healthcare holding.
Cardinal News
Cardinal welcomes Allison Darroch to our team. Allison has joined Business Development as Assistant Vice-President and
will be working with our referral advisor network and their clients. Allison has extensive experience in the investment industry
having worked most recently with Wellington West (National Bank) since 2002. She was awarded the Chartered Financial
Analyst designation in 2004.
Cardinal also welcomes back Michelle Smith, a recent graduate from the University of Manitoba’s Asper School of Business.
Michelle returns to our Investment team as a research assistant.
Congratulations are in order to Timothy Burt! Tim was awarded the Queen’s Diamond Jubilee Medal last month by M.P. Joyce
Bateman before the season opening concert of the Winnipeg Symphony Orchestra. Tim’s devotion to community service, and
work on many city boards including the CFA Institute, Portfolio Management Association of Canada, WSO and Re-Fit all
contributed to the award.
Cardinal’s Knock Your Socks Off drive is back! Cardinal has once again partnered with Siloam Mission to collect socks for our
city’s less fortunate. This year’s Sock Drive will take place from November 12th through November 23rd. You may drop socks
off at Cardinal’s office at any time or call us at (204) 783-0716 to arrange pick-up.
Notice to Readers: Unless otherwise noted herein, the sources of all performance data in the Cardinal Quarterly is Bloomberg and Cardinal research. The Cardinal Quarterly is prepared for general informational
purposes only, without reference to the investment objectives, financial profile, or risk tolerance of any specific person or entity who may receive it. Investors should seek professional financial advice regarding
the appropriateness of investing in any investment strategy or security and no financial decisions should be made on the basis of the information provided in this newsletter. Statements regarding future
performance may not be realized and past performance is not a guarantee of future performance. This newsletter and its contents do not constitute a recommendation or solicitation to buy or sell securities of
any kind. Investors should note that income, if any, from any investment strategy or security may fluctuate and that portfolio values may rise or fall. Cardinal Capital Management, Inc. does not guarantee the
accuracy or completeness of the information contained herein, nor does Cardinal assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. The
information and opinions contained herein are subject to change without notice.
© 2012, Cardinal Capital Management, Inc. ALL RIGHTS RESERVED. NO USE OR REPRODUCTION WITHOUT PERMISSION.
4 cardinal quarterly