A substantial slowdown in the country

Quarterly Letter

Stock markets in North America ended the year with a disastrous quarter. The TSE 300 was down 13.92% ending the year 2000 with an annual return of 6.18%. The S & P 500 performed much worse than its Canadian counterpart, with a quarterly return of -8.09% and an annual return of -10.14% for 2000. The NASDAQ composite, which is the proxy for technology-listed companies, was down a whopping 32.74% for the fourth quarter and down 39.29% for the year. To return to the level of the beginning of the year 2000, the NASDAQ will have to rise by 67%.

Interest rates in North America have come down due to signs of substantial slowdown in the country. Layoffs and downsizing have been announced across industries from automotive to technology. Commodities prices remain weak (i.e., oil, natural gas and coal) with the exception of energy. The Federal Reserve Board decided to cut interest rates twice over the last two months in order to avoid an outright recession. History taught us that the Fed would cut rates again over the next two quarters.

The Canadian dollar finished the quarter unchanged, at US $1.4991-1.5030 – it lost value for the year 2000. The Euro has reversed the trend temporarily to end the year at US $0.9427. Our opinion has not changed regarding these two currencies, meaning that the Canadian dollar seems slightly undervalued and the Euro seems affected by Europe’s structural problems.

Oil prices finally peaked and started coming down to finish the year at US $25.98. However, since Saudi Arabia cut its production, prices have gone back up recently. We should all remember that too high a price (i.e., above $28.30 per barrel) is not good for producers as it encourages alternative energy research. The fuel cell industry is booming and companies such as Ballard Power, Smart Energy, and many more in the US have been successful in raising capital and advancing their research. Combined with environmental laws in California for example, regarding car emissions, the long-term picture for oil prices does not look very good.

Please refer to the portfolio valuation in the next section of the report for a complete list of securities you own. You will find a transaction report that includes descriptions of selected securities that have been purchased.


In keeping with the Claret tradition that started last year, we have highlighted some of the readings we made throughout the year which reflect our investment philosophy. Instead of paraphrasing the authors and doing a bad job of it, we will quote them as they are.

Regarding the stock market, speculation and manias

“We generally believe that you can see anything in markets. It’s extraordinary what happens in markets over time. It gets sorted out eventually. However, we’ve seen companies sell for tens of billions of dollars that are worthless. At times, we’ve seen a number of things – not hard to find with perfectly decent people running them – sell for literally 20% or 25% of what they were worth. So we have seen - and we’ll continue to see – everything. It’s just in the nature of markets that they produce wild, wild things over time”.

“And the trick is occasionally to take advantage of one of those wild things and not to get carried away when other wild things happen – because the wild things create their own truth for a while. That’s the reason they’re happening. And people are getting pleasant experiences and all of that. You will see everything if you’re around markets for a reasonable period of time.”

“Any time there’ve been bursts of speculation in the market, it does get corrected eventually. Ben Graham was right when he said that in the short run, it’s a voting machine – and in the long run, it’s a weighing machine. Sooner or later, the amount of cash a business can disgorge in the future governs the value its stock commands in the market. But it can take a long time.”

Manias don’t create wealth. They transfer and destroy it.

“It’s a very interesting proposition. If you take a company that in the end never makes any money, but that changes hands at a price representing a valuation of $10 or $20 billion for some time, no wealth is created. There’s a tremendous amount of wealth transferred. I think when we look back on this era, you will see it as a period of enormous amounts of wealth transfer.”

“But in the end, the only wealth creation comes about through what the business creates. There’s no magic to it. If a company that’s not worth anything sells for $20 billion and 5% of it changes hands, somebody takes $1 billion from somebody else, but investors as a whole gain nothing. They are all fee richer. It’s a very interesting phenomenon. But they can’t be richer as a group unless the company makes them richer”.

“It’s the same principle as a chain letter. If you’re very early on a chain letter, you can make money even though there’s no money created by chain letters. In fact, there are frictional costs – envelopes, postage and that sort of thing. So net, there’s some money destroyed by them. Likewise, money is destroyed by the frictional costs of trading…that comes out of investors’ pockets”.

“Manias happen. But they don’t go on forever.

But manias will periodically take place – and not just in stocks. We had a similar mania –well, I’m not going to say similar, but we certainly had a mania – in farmland here in Nebraska 20 years ago. Land which couldn’t produce, say, more than $70 or $80 an acre sold for $2000 an acre at times when interest rates were 10%”. (Warren Buffett)

“Well, that math will kill you. And it killed people who bought it at those prices and it killed a great many banks in Nebraska who lent based on that sort of thing. But while it was going on everyone thought it was wonderful—because every farm was selling for more than a similar farm had sold for a month earlier. It was momentum investing in farmland.”

“In the end, valuation counts. But it can go on for a long time. When you get a huge number of participants playing with every increasing sums, it creates its own apparent truth for what can be a considerable period of time—but it doesn’t go on forever”.

“Whether it has fallout to the whole economy – like it probably did in the late ‘20s – or just an isolated industry or sector where the bubble bursts and really doesn’t affect other values, who knows? But five or 10 years from now, you will know.” (Warren Buffett)

”If history is a guide, expect the unexpected and be prepared for the extremes. All intelligent citizens of a modern republic think some about interest rates. In my lifetime, I’ve seen interest rates at 1% and I’ve seen them at 20%. Now that’s one hell of a range. As you sit here, 1% seems inconceivable. However, in Japan, short-term interest rates are under 1%.”

“When I was in law school, I think interest rates were about 1- 1 1/2% for a long, long time. Common stocks yielded 6% or 7% and the Dow was a few hundred points. And those low interest rates lasted a long, long time. And nobody really thought we’d ever get a prime rate of 20-21% and government bonds yielding 15 – 16%. But we had those conditions and they lasted a long time…”

“Anyone with any intellectual curiosity has to be flabbergasted by Japan being in this heavy recession for 10 years in spite of taking interest rates down near zero and running a huge government deficit. In other words, they’re playing all of the monetary tricks and all of the Keynesian tricks – and yet they still have a recession that has now been about as long as our recession in the ‘30s, although it’s not as severe, of course.”

“If you’d taken economics at Harvard during the postwar years, you would have been taught basically that that was impossible – that with these modern macroeconomic tricks that wise governments have learned how to play led by Keynes and other, what happened in Japan can’t happen. But it has happened.”

“Economics by itself isn’t enough… For example, why does a crazy asset bubble in Hong Kong with a collapse that’s met with massive government intervention in the stock market result in a pretty temporary down blip in the economic performance of Hong Kong whereas an asset bubble collapse in Japan results in a 10-year recession? I don’t think economics by itself, as traditionally done, will give you the right answer.”

“I think that you’ve got to mix economics with other disciplines. And when you mix economics with psychology, you can begin to understand the difference. The truth of the matter is that people in Japan went catatonic risk-averse. You could ease up money all you wanted. But the banks who’d lost so heavily and were being criticized so much in a nation where people hate criticism and loss of face, just didn’t want to make loans- period – that might cause them more trouble.”

“The case of Mark Twain’s cat that, after a bad experience on a hot stove, never again sat on a hot stove – or a cold stove either. That’s what’s happened in Japanese banking. They just don’t want to make loans because it hurt ‘em so much last time. And the Japanese consumer is behaving the same way.”

“In Hong Kong, you have bunch of Chinese. That is a different ethnic group. The love of gambling and the love action among the Chinese compared to the Japanese – that’s just two entirely different conditions.”

“Taking into account things like that is not in the economics books. But that’s because the economics books are wrong. Economics will make better predictions when it learns to take in more and more from the other disciplines.”

“And I’m not kidding when I say that the economics profession has been horribly surprised by what’s happened in Japan – the fact that their recession has just gone on and on and on.”

“I’m not surprised. And that’s just because I’m using a slightly different model. Can you imagine standing up at an economics convention and saying that that happens in part because the Chinese are so different from the Japanese? My God, it wouldn’t even be politically correct.” (Charlie Munger)

Regarding technology and the internet

“We’ve had a distortion of capital – human and financial.

Technology has historically been created to solve existing problems. Today, we’re creating technology to solve problems that don’t exist yet. It’s no different than the way the real estate industry went through all of its oversupply by first building to supply pent-up demand and then building for theoretical future demand which inevitably led to massive oversupplies.”

“I think we’ve been investors in technology for technology’s sake – not investors because that technology was going to translate into high levels of profitability, other than by buying at one multiple and selling at another.”

“We’ve had a distortion of capital, both human and financial. We’ve put too much capital into too few areas and over-concentrated it. I ask the question, “How many start-ups are really needed in every arena? And can we as a country afford to spend our capital in such a fashion that we create four companies – and fund them with the…expectation that three of them won’t make it?” We’ve created too many competitors.”

“The internet will make us more productive. But wealthier? The internet – everybody’s magic words for the last couple of years – is nothing more than a network. In effect, it’s the interstate highway system – except that the interstate highway system is limited access, whereas the internet is total access. We’ve funded and been excited by a lot of ideas, but I don’t think those ideas are necessarily businesses.”

“I think our focus on technology has taken away our focus on operating our businesses better. Technology should be used to assist in the implementation and the increase in productivity. To the extent we’re over focused on technology, we’re taking our efforts away from the innate business that ultimately technology is supposed to make more productive.”

“In think that the internet is going to change our lives. It’s going to make us more productive. It’s going to make us better connected. But I’m not sure that it’s going to make us any wealthier.” (Sam Zell)

“Internet will be great for society, not so great for business.

Will the internet, by making competition so much more efficient, make business generally harder for American corporations – meaning more competitive with lower returns on capital? And my guess would be, “Yes.” So all of you can be happy that the progress of the species will affect your economic futures for the worse…there’s plenty to think about there. If you analyze the internet, you have to think it’s much more likely that it will reduce the profitability of American business than improve it. It will improve the efficiency of American business, but all kinds of things improve the efficiency of American business without making it more profitable. And I think that the internet is likely to fall into that category.”

“So far, the internet’s improved and monetized value of American business. But that (monetized value) will eventually follow the underlying economics of what the internet does. And I think it’s way more likely to make American business in aggregate worth less compared to what it would have been otherwise. That’s perfectly obvious and very little understood.” (Charlie Munger and Warren Buffett)

Regarding growth, value and business valuation

“That concept of a value trap is utter nonsense. While it may exist for individual securities, it does not exist for portfolios. If you invest right, there’s no such thing as a value trap…”

“I think the nature of value investing is that you have to ignore the (so-called) value trap. You own a portfolio. Buy interests in businesses. And you’re conscious of the businesses. You buy safe and cheap. And you don’t try to predict the market. You know most of your holdings are going to be non-performers, but that if you do it right, the portfolio – over a long period – will be OK. In other words, the value trap is (a trap) when it comes to individual securities, but not well-selected portfolios.”

“I’ll admit that the value trap exists if your goal as an investor is to outperform benchmarks consistently. “Consistently” is a dirty word used by academics. It means all the time or almost all the time. And nobody can do that. We certainly can’t.”

“But there certainly is no value trap for us insofar as our goal is to perform satisfactorily on a long-term basis regardless of what other portfolios other benchmarks do.”

“Growth stock investors make decisions about the market outlook. They look at the outlook for the general market and forecast growth rates in revenues, earnings and cash flows for individual companies – mostly for the next quarter. But what they do is forecast.”

“Part of the (growth) trap is that you might be wrong about the market. Second, I don’t think growth stock analysts forecasting future growth in revenues and cash flows or earnings for individual companies are any better at it than we are. And God knows that we stink at it. Nobody really can predict the future.” (Marty Whitman)

“Most fields that suck up cash don’t turn out very well.

The ones where the top line has changed are where there’ve been acquisitions or mergers. In airlines, you see just the opposite. You see this great movement in the top line, but again a disastrous amount of capital investment and very little in the way of returns. So it hasn’t been a great field.”

“Most fields that require heavy capital investment most of the time don’t turn out very well over time. There’s plenty of exceptions to that. But if you find a business that has to keep anteing up huge sums of money every year, there always will be a reason why they’re doing it. But the net result, after five or 10 or 20 years usually isn’t very good.” (Warren Buffett)

Regarding accounting principles and earnings reports

“Accounting abuse is regrettable now and will be more so…

Where so much money turns on numbers that happen to be reported, the human temptation to manipulate the numbers is bound to be pretty substantial. And then, when everybody’s doing it, you get what I call “Serpico Effects” – you know, everybody else is doing it and you’re a sucker if you don’t go along and so on and so on. So I do think we get tons of promotional accounting, particularly in a period like this – which is regrettable now and will look even more regrettable when we look back on it a few years hence.”

“I think it’s always been thus. You can see what human nature will do unobstructed if you go back to the days of the early Irish ruffians who ran the Comstock Lode. Those guys were not satisfied with having the heart of the Comstock Lode where they could mine silver more efficiently than it had ever been mined before in the history of the world. After all, you can only make so much money digging out all the silver and turning it into currency.”

“So they decided since they controlled the companies, they would turn a one-handled pump for making money into a two-handled pump. Mining companies in those days declared monthly dividends. So they’d run the dividends way up, put out a lot of wonderful rumors – and then they’d sell short heavily. Then they’d run the dividends way up, put out a lot of wonderful rumors – and then they’d sell short heavily. Then they’d fill the mine with water, cut the dividends to zero and buy the shares back. And you could do that over and over again. They turned a mine into something that would make money in two ways – mining silver and defrauding suckers.”

“If it were legal, it would be done enormously to this very day. People get pretty close to it in some ways by crowding in to take advantage of unsound accounting conventions. The standard way of doing it today is not so crude as the one devised by Fair, Flood, Mackay & O’Brien – the gentlemen who figured out the two-handled pump system for handling the Comstock Lode.”

“Today, it’s chain letter mechanics that people use to shuck the suckers. And since they’re mixing the mechanics of a chain letter with legitimate activities like venture capital, improving commerce and what have you, it gets respectable. I think we’re mixing those respectable activities with un-respectable activities.”

“And that’s being done in spades in the current era. There’s practically nothing in accounting that is carefully designed to limit what some sophisticated entrepreneur can do with chain letter principles skillfully worked into a legitimate enterprise”. (Charlie Munger)

Regarding life and business

“Not getting rich fastest is no tragedy. But trying to do so can lead to one…

I think there’s one big truth that the typical investment counselor will have difficulty recognizing. If you’re comfortably rich and you’ve got a way of investing your money that is overwhelmingly likely to keep you comfortably rich and someone else find some rapidly growing something-or-other and is getting richer a lot faster than you are, that is not a big tragedy. And if you’re not comfortable and don’t understand the fact that somebody else is getting rich faster, so what? How crazy it would be to be made miserable by the fact that someone else is doing better- because someone else is always going to be doing better at any human activity you can name. Even Tiger Woods loses a lot of the time.”

“A lot of success in life and success in business comes from knowing what you really want to avoid – like early death and a bad marriage…There are a lot of things that are really big troubles. And if you give them a wide berth, your life works a lot better.”

“And if somebody else is having a lot of fun with Zsa Zsa Gabor, why, you can say, “Pass this cup from me.” (Charlie Munger)

We hope that you have enjoyed these readings. Your comments are welcome.

The Claret Team