Buyers beware…

Quarterly Letter

Except for the Canadian market, which is mainly driven by the surge in commodities prices, the 1st quarter of 2005 did not produce any gain for equity investors. Moreover, the technology sector continues to decline after a 2-year corrective rally.

As we have said before, a bubble of this magnitude would take some time to completely deflate. However, it does provide some spectacular countertrend rallies like the one we witnessed from October 2002 to December 2004. It might even continue higher in 2005. We are just saying: Buyers beware…

The following table summarizes the price performance of the main indices for the first quarter of 2005.

  First Quarter
  In local Currency In Canadian Dollars
S&P/TSX (Cdn) +3.96% +3.96%
S&P 500 (US) -2.59% -1.90%
Nasdaq (US) -8.10% -7.45%
Europe (Euro) +4.30% +0.47%
Nikkei (Japan) +1.57% -2.04%

The US and Canadian economies seem to be on track to deliver another year of growth with moderate inflation. Meanwhile, with rising interest rates coupled with high energy prices, we should expect a slowdown or a recession sometimes in 2006, if not before.

The Canadian Dollar has suffered lately because of the soap opera like behavior of our federal politicians. As the saying goes, power corrupts and absolute power corrupts absolutely. Hence, what should we expect from a government in power for 15 years with basically no opposition? It sounds like “absolute power “ to us. To be fair, we would not have expected differently from either a conservative government or a NDP one if it were to stay in power that long.

Fortunately, the value of a currency is determined over the long term by the productivity of the country and by the abundance of natural resources. In this regard, we are quite lucky in Canada. As long as economic policies are generally set based on marketoriented principles, we shall not be bearish on the Canadian Dollar.

We do see a different trend for the US Dollar. In the short term, it has rallied since the beginning of the year. With rising interest rates on this side of the continent and stable rates on the European continent, the US Dollar can go higher still. However, with US$ 37 trillion of debt, it would be a miracle if we do not witness some sort of devaluation in the US some time in the future. What better solution is there than make the debt you owe worth less over time so that the cost of paying it back declines in real terms?


One of the hot topics most investors are paying attention to these days is the corporate scandals and their impact on the economy. They are stunned by the abuse of power of greedy CEOs and worry about the loss of confidence that could ensue. The bad news never seems to stop. Starting with Enron, WorldCom, it spread to Adelphia, Nortel and now, it is the insurance industry’s turn.

In the past few weeks, former WorldCom Bernie Ebbers was convicted of fraud, the SEC filed a civil suit against Qwest Communications ex head Joseph Nacchio, AIG CEO Hank Greenberg was forced to resign and Time Warner agreed to pay $300 million fine for accounting violations. Meanwhile, powerful CEOs continue to get huge pay packages.

Yet, despite their magnitude, these sins have done little damage to the economy as a whole. The fact is that these greedy CEOs only affected their own companies. They cannot hold back their competitors and they cannot shut down access to the capital markets for new and more efficient companies. All in all, they are a lot less harmful than an entrenched government bureaucracy (like the ones in France and Germany) or asingle party political system (like the one in Japan).

One of the great virtues of the US economic system is its ability to fix problems when things go wrong. That is tough for other countries to match, especially those with entrenched elites controlling entire industries. The pattern of “sin and repent” means there will be periods of shameful scandals but it also means the US economy can right itself, contrary to Japan for example, whose political system – dominated by a single party and supported by the bankers -- prevents the banking industry from going through much needed reforms. Japan is still suffering today from sub par growth and deflation. The US had to go through the same ordeal after the savings and loan debacle in the late 80s. The Federal Reserve decidedly restructured the banking system, weeded out the weak banks and let the survivors consolidate the industry. 10 years later, the US banking system is one of the strongest in the world. The conclusion is that the US system may not always be smooth, but it seems to work.


We have read recently something that truly reflects the economic malaise in Europe and we decide to bring it to your attention and let you judge for yourself.

The social reintegration of prisoners through labor programs in France has encountered some unexpected competition from emerging markets with the abundance of low cost workers, according to Le Monde. Instead of awarding contracts to the prisoners, several companies opted to move their production to Eastern Europe and to Asia. From 2001 to 2005, the French prisoners’ activity rate has fallen from 47.6% to 35.2%.

It seems to us that the French government is paying their prisoners a higher income than a Polish worker would earn on the job market. Would it not make sense for a polish worker to go to France, commit a crime so that he gets to go to jail and earn a higher salary? If it were not so sad, it would be laughable.

The Claret Team