4th Quarter 2010 Quarterly Letter to Clients of South Shore Capital Advisors Cohasset

Provided below is the main body of the 4th Quarter 2010 Quarterly Letter recently mailed to clients of South Shore Capital Advisors' Cohasset office.

Investing Climate:

A generally improving business environment, and growth-friendly news out of Washington during the 4th quarter allowed investors to feel more comfortable putting money to work in the stock market, and less willing to accept the “return free risk” of sub 3% bond yields. Throughout the quarter with each passing week, buying stocks was rewarded with more good news about economic growth here at home.

The big developments in Washington during the 4th quarter were:

1. Quantitative Easing II: The renewed and expanded initiatives undertaken by the Federal Reserve to purchase government bonds that will see them purchase $600 billion in treasury bonds in the open market between November, 2010 and June, 2011.

2. Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010: The aggressive fiscal stimulus measures passed by Congress through its extension of the Bush Era tax cuts for two more years, the extension of unemployment benefits, and the reduction in payroll taxes from 6.2% to 4.2% for 2011.

The move to cut payroll taxes by 2% was unexpected, and it will be a shot in the arm for the 2011 economy. The Congressional Joint Committee on Taxation estimates that this will save Americans $111.7 billion for the year - roughly $370 for each of our 300 million people. The employed will experience the direct benefit of this. For that 90% of the 154 million U.S. workforce, the benefit will be about $800 apiece.

Human nature is such that when a stock or bond goes up in price people want to own more of it even though it is now more expensive. Nowhere during the past few years has this been more on display than the bond market. According to a recent article in Fortune, since the depth of the 2008 financial crisis in September 2008, a total of $937 billion has poured into bond funds – increasing the total investment in those funds by 55% and dwarfing the $195 billion that has flowed into stock funds over the same period. (“The Danger In Bonds”, Fortune, Dec. 27, 2010 p. 108) In my view bonds have become less attractive investments over this time, particularly bonds with longer durations that have prices more sensitive to changes in interest rates. I have reduced the duration of client bond portfolios and I am proceeding cautiously with allocations to that asset class.

When I look at client portfolios, I am heartened by the fact that stocks, which are the majority of most of our client assets, are still a good deal. Even after the market rise of over 80% from the lows in March 2009, there are still high quality companies with strong balance sheets, excellent free cash flow, and rising dividends that can be purchased at attractive prices. On current 2011 earnings projections of $94.80, the S&P 500 is trading at a 13.5 multiple. This equates to an earnings yield (earnings/price) of 7.4% versus a 10 year U.S. treasury yield that is right now around 3.4%. As a broad statement, this gap between the earnings yield and the bond yield makes stocks the better bet for price appreciation during 2011.

In addition to good value, business performance supports the case for owning stocks, as many companies continue to deliver earnings that are better than forecast, and estimates for next year’s earnings continue to rise. According to Standard & Poor’s, for the 3rd quarter 2010, 326 of the 500 companies in the index delivered stronger than expected earnings and analysts continue to raise their earnings forecasts for 2011.

Portfolio Comments:

Recently, two companies were added to your portfolio - Becton Dickinson and Canadian Oil Sands Limited.

Becton Dickinson (BDX) is a maker of hypodermic needles, syringes and test equipment for doctors. Over the past several years Becton had paid down its debt to a point where it was virtually debt free. It is a dominant player in its business and its products are non-discretionary purchases. In October, they decided to take advantage of low interest rates by borrowing $1 billion that they will use to repurchase their own inexpensive stock. They borrowed this money for 30 years at 5%. Over the next 12 months I expect them to buy $1.5 billion dollars worth of their own shares. If the company purchased all the stock at today’s $83 price, we shareholders would get an 8% raise even if their earnings do not grow at all. If next year is like any of the last 10 years, they will grow their operating income too, so earnings per share should grow more than 10%.

Canadian Oil Sands Limited (COSWF) is an energy company that generates substantial and growing cash flow as long as the price of oil remains high. The business’s asset is a 37% ownership of the Canadian Oil Sands joint venture known as Syncrude. Through this ownership, Canadian Oil Sands Limited controls between 40 and 80 years of crude oil reserves. It is costly to produce oil from oil sands, but becomes rapidly more profitable as the price of oil rises. At $80 oil, management has said that they expect to generate $2.35 per share in cash flow this year. At today’s $90 oil they will earn closer to $3.00 per share in cash flow. Its cash flows will be more volatile than those of Becton Dickinson, but an investment in oil is an investment in long term global growth. Global energy demand is expected to increase by 30% between now and 2020 with the lion’s share coming from faster growing developing economies. With a $13 billion enterprise value, the company trades at a substantial discount to what the Chinese entity Sinopec paid for Conoco Philips’ stake in Syncrude this past summer. A buyer paying Sinopec’s price of $515 million for each 1% of Syncrude would need to pay approximately $18 billion for Canadian Oil Sands shares or about 50% more than where the stock trades today. Speculating on a sale of the business is all “pie in the sky,” but since Canadian Oil Sands Limited is no longer a Canadian Income Trust as of December 31st, foreign holders can own more than 50% of the business leaving the door open for this.

Between now end the end of the 1st quarter, you will most likely receive another mailing from South Shore Capital Advisors that contains our revised SEC Form ADV Part II. The new financial regulations require us to revise these documents so that they are written in “plain English.” Our lawyers wrote the last ADV part II before that law was in place, and it could use a little editing in my opinion.

Please give me a call if you have any questions about your portfolio or if there have been any changes to your circumstances that warrant a fresh look at your investment strategy.

Sincerely,

Taylor Thomas


As of 1/25/2011 South Shore Capital Advisors clients and its employees are holders of Becton Dickinson and Canadian Oil Sands Limited. This content is provided for information purposes only and is not intended as research. Investing involves the risk of loss. South Shore Capital Advisors is a boutique registered investment advisory firm with offices in Cohasset MA, and Newport, R.I. For more information about South Shore Capital Advisors go to the link "About South Shore Capital Advisors" at the top of this page.