The bear market continued its damage in 2002


As you can see, the bear market that started in March 2000 at the peak of the technology bubble continued its damage in 2002. Most of the main indices have registered three consecutive years of negative returns, the first time since 1941.

The following table summarizes the price performance of the main indices for the fourth quarter of 2002 and for the year.

  4TH Quarter Year 2002
Indices Local Currency In Canadian Dollars Local Currency In Canadian Dollars
S&P/TSX (Cnd) + 7.02% + 7.02% -13.97% -13.97%
S&P 500 (U.S.) + 7.92% + 6.90% -23.37% -24.39%
Nasdaq (U.S.) +13.95% +12.87% -31.53% -32.44%
Europe (Euro) + 4.39% + 9.97% -31.81% -20.63%
Nikkei (Japan) - 8.57% - 7.13% -18.63% -11.01%

The underlying economy, contrary to the negative tone of most commentaries, grew by 3% in 2002, basically in line with its long-term trend. It is amazing to witness the resilience of the US economy after the collapse of one of the greatest asset bubbles of modern era.

The Canadian Dollar has been fairly stable during the last quarter of the year, moving between US$ 0.6302 and US$ 0.6362. Considering the US recent monetary and fiscal policies, which are to print money in order to avoid deflation, we would not be surprised to see our loonie appreciate to the US$ 0.70 level. The Euro, on the other hand, has had a great rally, having risen from US$ 0.9866 to US$ 1.0492. Several countries have manifested their desire to shift their currency reserve from the US Dollar to the Euro. Overall, the gradual devaluation of the US dollar is good for its domestic economy, although it will eventually hurt countries whose main focus is to export to the United States.

Oil prices have gone through the US$ 30.00 level, contrary to our expectations. While everybody is talking about Iraq and Saddam Hussein, the strike in Venezuela has created a mess in the oil industry worldwide. Production almost came to a standstill in that country, creating a shortage and driving up the prices. Although we don’t like the idea of war, an attack on Iraq would most probably result in a lower oil price since it will be short and swift.

After three years of negative return, most investors are totally discouraged by the stock market performance and have turned to fixed income (i.e. interest paying investments, GICs, bonds, etc.). As always, we believe this total change of heart to be ill timed in the long run for the following reasons:

  • Just as the media (and most investors) forgot about risk when returns were so high, the focus today is purely on risk and not on what returns might be. In an environment where interest rates are this low (long term bonds are yielding 4% these days), a market with a P/E of 16 (based on next year’s earnings) cannot be considered overvalued. Moreover, many stocks, larger caps as well as mid caps, are trading below that level.

  • Let’s use a simple example:

    $1,000,000 invested in the S & P 500 January 1st, 1973 would have resulted in:

    • 3 months later… $951,200
    • 6 months later… $896,310
    • 9 months later… $939,510
    • 1 year, 9 months later… $573,780

    The average investor would have given up and thrown in the towel at $573,780. He would have removed the money from the market, reinvested in term deposits at 8% for the first 5 years and 13% for the following 5 years. The result would have been:

    • 12 months later… $602,470
    • 5 years later… $843,070
    • 10 years later… $1,553,300

    However, if he had stayed invested in the market instead of going into cash, the result would have been:

    • 6 months later… $771.570
    • 12 months later… $792.620
    • 5 years later… $1,247,680
    • 10 years later… $2,444,370

    The above example takes you through the worst bear market since the crash of 1929, the oil crisis of 80-81 and the ensuing recession. Still, the result is quite in favour of equity investments, even assuming unusually high interest rates earned on term deposits.


  • Emotion creates confusion in the investors’ mind, thereby blinds him from seeing the fundamentals.
  • Combined with sound diversification and advice, patience is rewarded.

While we do not expect the market to repeat the performances of the 80s and the 90s, especially in the big cap category, we believe good performance can be achieved through careful analysis and stock selection. With inflation and bond yields being so low, we venture to say that equity will still be the place to be over the next decade.

As money managers, not only do we analyze companies and financial statements, we also read an awful lot of magazines, reviews and books throughout the year. We would like to share with you some of the extracts from these readings: bits and pieces of information and knowledge that reflect best our thinking and our investment philosophy going forward. We will quote them as they are from the authors:

Regarding the stock market

“…We really try to approach investing in as businesslike a fashion as we can. We focus on what individual companies are worth. And we want to buy them at a significant discount to what we think they are worth… If you think about the panoply of risks in investment – economic risk, interest rate risk, industry risk, management risk or time risk, etc.—Wall Street often treats time as the highest form of risk, which it is not. In fact, it’s just the reverse – it is really your lowest form of risk. If you‘ve got the other things right, you‘ll be OK…” (Henry Berghoef)

“…To make successful equity investments, you must have sufficient information to evaluate a business and its management… And you must act on the facts of the analysis with conviction when the requisite discount from appraisal exists…In fact, we’ve always been the rightest when we’ve been nauseous and about to throw up…” (Mason Hawkins)

“…You want the variability of stock prices to be your friend and not our enemy. If the direction of the market movements is telling you what you should be buying and selling, you’re using investment methods different than ours.” (Charlie Munger)

Regarding Wall Street and conflicts of interest

“…Will we get wonderful ethics? I don’t think so. The incentives are twisted against many customers. The firm can’t make much money selling some institution shares when the price for the execution is 2 cents a share – and yet the firm can make a lot of money from underwriting some company which its analysts praise…It’s very hard to expect the analyst to behave perfectly, given the facts. To set up incentives which reward A and then tell people that you want B … is always going to cause a lot of A. That doesn’t mean there aren’t some intelligent, honourable people on Wall Street – there are…” (Charlie Munger)

“… The quaint thing about Wall Street is that it always takes things to excess – good ideas become bad ideas fast. Just because something is independent research or it’s not from an investment bank doesn’t mean it’s quality. It doesn’t mean it’s credible. And it doesn’t mean it ought to appear on the front page of the business section of The New York Times. Some people read those things and it scares the heck of them. And as a result, they do things that aren’t necessarily rational.” (Bill Nygren)

As a final note, thanks to your continuing support and encouragement, Claret is expanding. We are staying on the same premises but have decided to take on some more space from our neighbour. Our team has expanded to 5 professionals, 2 administrative assistants, 3 operations staff and a receptionist. Feel free to call us, come by and pay us a visit.