Abundant signs of an economic recovery

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Signs of an economic recovery abound: consumer confidence is up, so is consumer spending and housing starts in addition to many other indicators.

These signs also indicate that we should not expect interest rates to go much lower. they are at present. In fact, we expect rates to rise a little in the next couple of quarters if the economy picks up momentum. The operative word here is “a little”, thanks to a subdued inflation rate.

The following table summarizes the price performance of the main indices for the first quarter of this year.

Indices In local Currency In Canadian Dollars
  1st Quarter 1st Quarter
TSE 300 2.12% 2.12%
S&P 500 (U.S.) -0.60% 0.60%
Nasdaq (U.S.) -5.39% -5.27%
Europe (Euro) 1.55% -0.35%
Nikkei (Japan) 4.57% 3.86%

The Canadian Dollar has been quite steady for the quarter, moving from US$ 0.6277 to US$ 0.6269. A great help to our currency has been the strength of commodities prices (base metals, oil, gas, wheat etc.). As for the Euro, the fundamentals have not changed. However, it seems to us that the European currency has stabilized in the last year and a half. The Euro appears to have found support around the US$0.85 level. As we said in the past, at a certain price, CHEAP is CHEAP and this could be the price that makes Europe competitive. We shall see…

Oil prices have been quite strong due to the tension and violence in the Middle East. With Iraq threatening an oil embargo against The United States and the government “flip-flop” in Venezuela, it is impossible to predict what the short term outlook will be. However, the long-term trend is definitely not exciting. OPEC’s importance in the oil world continues to decline. In the 70’s, OPEC’s share of total US crude imports rose to nearly 70%. It is now down to only 45%, and showing a downward trend. With Russia maintaining a free market attitude towards oil exports and Venezuela not having much choice but to expand production in order to gain income, we believe oil prices will be coming down towards a more sustainable level at around US$ 20.00.


After two consecutive years of negative returns from major market indices, most analysts and investors are forecasting a positive return for 2002, based on the fact that statistically, the U.S. market does not like to drop three years in a row. Such a drop has occurred only twice since 1925 (in 1929-1932 and 1939-1941). Moreover, economists are forecasting a strong economic recovery that will help companies post much better profits. Unfortunately, we cannot provide more insight than what you are already reading in the news. However, we have the following comments that might help you understand our position and strategy:

  • Our approach in finding undervalued companies tells us that opportunities are scarce, especially in the large cap sector. Hence, we conclude that the Dow Jones Industrials, the S & P 500 and the NASDAQ 100 are not cheap (the average P/E ratio of the 100 largest NASDAQ stocks is in fact 64.1 and the S & P 500 has a P/E of 24).

  • The relationship between economic growth and stock prices is far from obvious, as economists want us to believe:

      US GDP Growth Dow Jones Industrials
    From Dec 1964 to Dec 1981 373% from 874 to 875 (0%)
    From Dec 1981 to Dec 1998 177% from 875 to 9181 (949%)

We strongly believe that stock selection is by far the most important factor in out performance. Index and large mutual funds will have a tough time over the next few years just as they have had in the past 2 years.

Lots of questions have come up since the “Enron Crisis” regarding the integrity and honesty of management and auditors. A witch-hunt mentality among speculators has added tremendous volatility in the market. Companies such as Tyco and GE have suffered as they saw their stock price plummet. Are they all crooked, from CEOs, managers to auditors? We don’t think so.

According to Martin Whitman, a value investor par excellence, the majority of U.S. corporate financial disclosure has never been better. If there is a “crisis”, it lies not with the numbers but with the people who use them.

Analysts, money managers and finance professors have been obsessed with earnings in the last decade—they are so obsessed about future earnings that they have ignored the balance sheet. It is wrong to value a business solely on the basis of what it might earn in the future to the exclusion of what it owns in the present. The fraud case of Enron (and others) is the result of the lamentable inattention to investment detail by the professionals in the finance industry. They were duped because they are indoctrinated in the spurious notion that share price is only related to forecast earnings per share. Unfortunately, studies have shown that predictions, even those of highly successful investors, aren’t worth much. If we can’t know the future, we can at least study the present. We can, but – in all too many cases – we don’t.

The benefits that emerge from this accounting mess will be even more transparency in corporate reporting. No one wants to be the next Enron or Arthur Andersen. In the long term, the U.S. financial markets are and deserve to be, the wonders of the world. It is up to us, analysts and money managers, to pay more attention to the financial documents we read. We should always keep in mind that they are not the truth but a set of objective benchmarks with which an intelligent investor can arrive at a useful semblance of the truth. In short, it is not what they are but what they mean that is of prime importance to us.