Although the results for the first quarter of 2003 have not been stellar, the performance of the month of April has helped eradicate all the losses and most of the indices registered a positive return year to date.
The following table summarizes the price performance of the main indices for the first quarter of 2003.
|In local currency||In Canadian Dollars|
|S&P 500 (U.S.)||-3.60%||-10.01%|
The U.S. economy continues chugging along, albeit at a slower pace. The Canadian economy, on the other hand, is outperforming the U.S. so much that the Bank of Canada has increased the short-term rate steadily and slowly in order to avoid potential inflation. Unlike the Governor of the Central Bank, we do not believe inflation is a problem. Interest rates will probably rise a little but nothing to be overly concerned about. Looking at the corporate bond market, we can even suggest that there are 2 interest rate environments: one for the government and related entities which shows low rates, the other for the corporations which shows fairly high rates. The market is depicting what we have been saying for a little while: a high debt situation and a lack of confidence towards the corporate management, problems that can only be solved with time.
The Canadian dollar has been extremely strong, going from US$ 0.6354 to US$ 0.6816, during the quarter. It is actually getting even stronger during April, reaching US$ 0.7170 in the beginning of May. For the longer term, with the expectation of political change in Ottawa, i.e. a move towards a less interventionist government (witness the change in the provinces, starting with Alberta, Ontario, British Columbia and even Quebec), we would not be surprised to see the Canadian dollar move towards the 80 cents level in the coming years. Who knows? May be we might even see parity some time in this decade.
As expected, oil prices have collapsed since the war of Iraq. Venezuela is also back on stream with its production. Overall, we expect lower oil prices as Iraq resumes its production with the help of the U.S. and the U.N. We should all remember that Iraq has the second largest oil reserve in the world after Saudi Arabia.
In the last several years, we have witnessed a lot of animosity, criticism towards the U.S.: economists predict the collapse of the U.S. economy, the U.S. dollar; politicians criticize the U.S. economic and foreign policies; even Canadians are not too happy about the way our neighbours handle international issues.
In the following comments, we would play the devil’s advocate here in defence of the U.S. Note that since we are, first and foremost, investors, we would put our clients’ money where we think the potential rate of return is the most attractive. Therefore, we tend to be quite one-dimensional when we analyze different situations: we judge the world in dollar signs and rates of return. So, let us first apologize if we happen to offend some of you who are a lot more multidimensional than we are:
Regarding the U.S. economy:
As you all know, the U.S. economy has done quite well over the last 2 centuries. In 1776, there were 3 million people. 227 years later, the U.S. represent 30 odd per cent of the world’s Gross Domestic Product (GDP) with 4.5% of the world’s population. The fact is that the American people are not smarter than other at all. But something about the system they embrace has unleashed the energies and talents of the people better than other systems. This has happened on American soil, with people who came from all over the world (Europe, Asia, South America, Middle East). They were not specially selected, but in this environment, they have flourished in a way that mankind has never seen any place else. So, although it does not mean it cannot be improved, it is a terrific system. Since 1776, nobody has ever made money by going short America.
Regarding the U.S. deficit:
European economists have been predicting the collapse of the U.S. dollar based on the size of the U.S. deficit. Amidst the “out of control” debate over the rising budget deficit and its impact on the dollar, fiscal policy and a multitude of other issues, perhaps a little perspective is in order:
As a percentage of GDP, the latest figure shows that the U.S. deficit is at 1.5% of GDP. This compares to 6% at the end of the recession in the early 80’s, or to 4.1% in the early 70’s or the 4.5% in the early 90’s. The sheer size of the current deficit is the largest ever; but so is the size of the economy. The same explanation would apply to the U.S. debt load. As an analogy, if a 10-unit apartment building can carry $100,000 mortgage, logically, a 100-unit apartment building should be able to carry a $1,000,000 mortgage, don’t you think? Furthermore, we wonder how the Europeans can justify taking the U.S. to task for its deficit when Germany’s, France’s and Italy’s deficit to GDP ratio are all above 3%, exceeding the maximum level mandated by the European Union.
Another way to look at the deficit is in terms of debt servicing, i.e. the amount of interest paid to service debt owed. Net interest paid as a percentage of GDP rose consistently during the late 70’s and the 80’s, moving from 1.5% to 3.3% in 1990. It is presently 1.6%, as low as it has been in the past 3 decades. Clearly, this is hardly an issue of concern. We believe the debt problem lies with individuals and corporations which can only be solved with time.
Regarding the U.S. Dollar:
The U.S. dollar has been quite weak recently. Some economists are forecasting some sort of “meltdown” scenario. We do not believe for a moment that the U.S. dollar is suddenly no longer going to be the world’s central reserve currency, given the superior productivity numbers in the U.S. versus most of European countries. However, we are certain that there will be a gradual shift towards a more balanced reserve system within most central banks around the world: instead of holding 90% of the reserves in U.S. dollars as in the past, central banks are selling some of those U.S. dollars in favour of the Euro in order to attain a more balanced reserve versus trade between different countries.
As you can see, we are a long-term bull on America (including Canada). After the bubble burst and more than 3 years of bear market, we believe that most of the excess has been corrected and we are on our way to an economic recovery. However, in a low interest rate and low inflation environment, stock market returns will probably hover around 6-7% on average over the next several years, occasionally with some wide fluctuations. Dynamic and well-managed companies should exceed that level, especially the small and medium size ones.
The Claret Team