Now that global markets have rebounded

Quarterly Letter

Now that global markets have rebounded from their spectacular declines of September 2007, investors are breathing easier, hoping that the worst is over for this bear market and the related economic recession.

Yet, adverse economic news continue to appear, such as the General Motors bankruptcy, the restructuring of certain financial institutions and the rising unemployment rate in the US and Europe. It seems that the only healthy part of the global economy is Asia, especially China.

While it is true that growth rates in Asia are spectacularly high when the global economy is expanding, we should not forget that these countries are mainly exporters and require healthy US and European economies to keep growing. The following statistics will help you keep this in perspective and not get carried away by media reports stating that China will overtake the US as the global engine of growth.

2008 GDP by countries (in US$ billions):

USA 13,751
Eurozone 12,277
Japan 4,384
Brazil 1,313
Russia 1,290
India 1,177
China 3,205

You will notice that 8% growth in China (8% * 3,205 = 256) is equivalent to only 1.9% (256 / 13,751) growth in the US or 2% in the Eurozone. In other words, given that last year’s aggregate US, Eurozone and Japan economies contracted by US$1,407 billions, the rest of the world would have had to grow over 20% to nullify the negative effect, let alone China by itself. (For your information, Canada’s GDP was 1,330)

While it may happen over time, it could take China as long as 50 to 100 years to overtake the US and it will most certainly not be a smooth transition. What will certainly happen, and already is, is that Asia’s share of global GDP is growing faster and represents a bigger percentage of the global economy. This is good news because it will put less strain on the big engine that is the US today.


In the short term (1-2 years), we believe we are currently in a cyclical bull market within a secular bear market that began in 2000 with the bursting of the internet bubble. Historically, cyclical bulls can take the market up 50-60%, and can last on average one year but could go as long as 18 months.

Using history as our guide, we noticed that similar market conditions prevailed in 1974 and, if history were to repeat itself, the market would still have quite a bit of rallying strength left. As for the economy, if it were to follow the 1974 scenario, it would be out of recession by this quarter. For now, economic stats regarding housing starts amongst others confirm that we are on track.

The observed market rally from the March 6th bottom is a typical “climb of the wall of worries”: While analysts and investors remained bearish and/or cautious, the marketkeeps climbing. Their mood improved slightly as the rally gathered strength but reactions to the recent market correction (-7%) were swift and now they are all back in the bearish camp. We believe that this rally still has some legs until most investors are back in the bullish camp, at which point we would start to worry.


Longer term, there are still many problems to be solved before we see a more normal economy. With governments borrowing like drunken sailors, much higher deficits are to be expected along with, eventually, higher inflation and higher interest rates. American consumers are overextended, carrying much too much debt. The deleveraging effect has already started (savings rate is going up) and it could take a while (3 - 5 years, maybe longer) before things normalize. Since consumption represents 2/3 of GDP, we would have to get used to lower growth, in the order of 1 – 2 % versus 3 – 5 % we were accustomed to during the last 2 decades of the 20th century.

However, in terms of investments, equities will likely outperform bonds (government bonds) over the next 10 years due to the natural hedge against expected inflation inherent in corporate assets. Corporations are generally able to pass on their higher input costs to the selling price of their goods or services and thus have some protection against inflation. More importantly, dividends will be an important part of equity returns as slower growth is expected. As much as investors dislike smaller companies, these willlikely outperform larger companies in a slow moving economy. In a nutshell, stock picking will be key. For income accounts, we believe investment grade corporate bonds represent good value versus comparable government bonds (unusually wide spreads. i.e. interest paid on corporate bonds much higher than government bonds). Spreads are wider still when we look at the junk bond category, albeit the risks are much higher.


We recently sent out a notice addressing our clients’ concerns regarding the “Earl Jones” fraud. For those who did not receive it, we are enclosing the same letter as part of this quarterly commentary.

Moreover, we would like to reiterate and add a few more points specific to Claret:

  • All five portfolio managers at Claret are CFA (Chartered Financial Analysts) charterholders. We must comply with the Code of Ethics and Standards of Professional Conduct and the rules and regulations of the CFA Program. We must annually complete and sign a Professional Conduct Statement, disclosing any allegations of professional misconduct. We strongly encourage you to visit the CFA institute website (http://www.cfainstitute.org/aboutus/conduct/index.html) in order to appreciate our commitment to professional ethics. Moreover, all our staff must abide by the same code of ethics without exception.
  • We are registered with L’Autorité des Marchés Financiers (AMF) in Quebec, the Ontario Securities Commission (OSC) and the Securities Exchange Commission (SEC) in the US.
  • The separation of the “money manager” and the “trustee” is at the core of our business model, hence our corporate structure. CIBC Wood Gundy and RBC Dexia are our main independent trustees. They are your gate keeper, making sure that any form of withdrawal payable to a third party must be accompanied by your written instructions.
  • Last but not least, remember the signature phrase of the late US President Ronald Reagan: TRUST BUT VERIFY.

Have a good summer…when and if it ever comes!

Claret