A fairly quiet market

Quarterly Letter

It has been a fairly quiet market, considering all the news that came out regarding the Middle East (Iraq and the bombings in Saudi Arabia), overheating of the Chinese economy (the government there raised the banking reserve requirements several months ago) and Russia (with its billionaires being sent to jail on so called tax fraud charges).

Once again, the following table summarizes the price performance of the main indices for the second quarter and the first half of 2004.

  Second Quarter First Semester
  In local currency In Canadian Dollars In local currency In Canadian Dollars
S&P/TSX (Cnd) - 0.47% - 0.47% + 3.95% + 3.95%
S&P 500 (US) + 1.30% + 3.12% - 0.18% + 2.58%
Nasdaq (US) + 2.69% + 4.52% + 2.22% + 5.04%
Europe (EUR) + 1.51% + 2.36% + 4.64% + 4.16%
Nikkei (Japan) + 1.22% - 1.26% + 11.07% + 12.52%

The US and Canadian economies are chugging along nicely despite all the oil worries. Consumer incomes are growing at a healthy pace, justifying the recent spending growth. Saving rates, albeit very low, have been broadly stable over the last 4 years. Contrary to popular opinion, consumer spending has not been fueled by debt growth and home equity loans as much as some economists lead you to believe.

The US Dollar has been fairly stable versus the other main currencies. As we move closer to the US elections, we will probably witness more volatility. We do not believe the outcome of the elections will change the fundamentals of the US Dollar. As Asian countries become a more important part of the global economy, the relative importance of the US Dollar will shift. However, this is a long-term trend that will take decades to play out. In the meantime, although we are moderately bearish on the US Dollar, we still believe firmly in the dynamism of the American economy and its long-term strength.

Oil prices have been tremendously volatile lately. In Iraq, terrorists are blowing up people and oil pipelines on a daily basis without discrimination. We all wonder how all of this is going to end. The anti-war elements of the western media are blaming the Americans for having created this mess in the Middle East. However, if we looked closely at historical facts and statistics, we would quickly realize that although it is all well and good to blame the Americans, the Arab leaders are also responsible for the poverty of their country and the birth of all these fanatic movements whose only purpose is murder and destruction. In the only region of the world that has the potential oil reserves to satiate the growing global demand, these fanatics are devoting their energy to cutting off supplies of energy. If we compare South and East Asia with the Middle East, who could have predicted 50 years ago that the former goes on to become one of the most vibrant part of the world economically whereas in the latter, we find the most dysfunctional regimes in the world. With all the oil and the wealth it brings for the last several decades, Saudi Arabia should have been able to make the desert bloom like a rose. Instead, per capita incomes are down by two third from 1982. Across the Arab world, we can only witness dysfunctional educational systems and dysfunctional economies. What a tragic result! Unfortunately, instability in the region is the main threat to global economic growth due to its impact on energy prices.

The Canadian elections have come and gone. There was no big surprise. In fact, Quebec stands out again as the most enigmatic place in Canada. While they have decided to stay within Canada through 2 referendums in 2 decades, quebecers have chosen to send a separatist party to represent them in Ottawa and defend their interests. Could it be that the separatist movement is not a dead issue and that we could have another referendum in the making? We certainly do not know the answer. However, as time goes on in the next several years, we will pay close attention to this situation, for the impact on the Canadian Dollar (and real estate prices in Montreal for that matter) is not without consequence on our investment strategy in Canada.


We have not changed our opinion on the markets in general. Technology stocks still look expensive based on our quantitative analysis and risks of a major correction remain. Interest rates have started to move up recently, led by the quarter point increase of the fed funds. This is the first of several increases over the next 18-24 months. As you have noticed, we have not made any significant investments over the last quarter. Although holding cash is not our goal as managers, we have not found many qualifying investments and we are unwilling to force it. As Warren Buffett described in his 2003 Annual Report: “Our capital is underutilized now, but that will happen periodically, It is a painful condition to be in – but not as painful as doing something stupid.”

You might wonder why we are not selling some of the holdings if we think a correction is coming. Our response is two fold:

  1. We do not pretend to know where the market is going at any given time. We merely go through our database and note that stocks are not cheap. However, they can stay the way they are for a while longer. Do recall how overvalued the market was in 1999-2000 and how painfully long it stayed there.

  2. Past lessons have taught us to be wary of liquidating a position for reasons other than (1) truly extraordinary overvaluation, (2) a discernible decline in intrinsic business value or (3) the emergence of alternative opportunities that we think are simply to good to pass up.

In almost all cases, we do not think that any of these circumstances apply to our holdings.

In conclusion, let us quote one of the legendary money managers who says it so well: “full valuations represent the enemy of high investment returns. To borrow a phrase from a preeminent Midwesterner, if you don’t believe that, you should pursue a career in sales, but not mathematics!”.

The Claret Team