The best rally since September 1999


What a difference a quarter makes! From the gloomy outlook of the last quarter, stock markets around the world staged the best rally since September 1999. There was a sense of relief that the Iraq war would not last months. We barely noticed any new news regarding the US economy, nor about deflation coming from China, etc. The market, indeed, is climbing a wall of worries.

The following table summarizes the price performance of the main indices for the second quarter and the first semester of 2003.

  Second Quarter First Semester
  In local Currency In Canadian Dollar In local Currency In Canadian Dollar
S&P/TSX (Cnd) + 10.09% + 10.09% + 5.57% + 5.57%
S&P 500 (U.S.) + 14.89% + 5.45% + 10.76% - 5.10%
Nasdaq (U.S.) + 21.00% + 11.06% + 21.51% + 4.11%
Europe (Euro) + 14.67% + 11.00% + 1.24% - 4.83%
Nikkei (Japan) + 13.93% + 3.07% + 5.88% - 10.05%

The US Federal Reserve has been very accommodating in its monetary policies. It plans to keep short-term rates at close to current levels for an extended period until the economy moves onto more solid foundations. The Canadian economy, on the other hand, has suffered some setbacks due to the strength of the Loonie, mad cow disease and SARS. Consequently, the Bank of Canada has decided to cut interest rates in order to inject some stimulus in the economy.

The Canadian Dollar continued its uptrend to reach US$ 0.7481 by the beginning of July. It has weakened somewhat recently due to mad cow disease and SARS related economic weakness. The sharp rise of the value of our dollar will create problems for Canadian exporters who did not have time to adjust to the new reality. In fact, thanks to a policy of cheap currency implemented by the federal government over the last decade, exporters did not have to worry about productivity and efficiency. Today, they will have to adjust quickly or face stiff competition from other countries. We believe that the strength of a currency reflects the strength of an economy over the long term. So we welcome the loonie’s recent rise and hope that the government will not intervene in any way, thereby forcing our economy to become more efficient.

Regarding the price of oil price, Iraqi production has been moving up steadily. Moreover, the under-production by the African countries, the Venezuelans and the Indonesians has been more than offset by the over-production in the Gulf States.

After a strong second quarter and first half of stock market performance, investors are left to wonder if this “Bull market” is for real. We would like to reiterate that this is a stock picker’s market where selectivity is of primary importance. Thus, a rifle approach will outdo a shotgun approach.

We would like to share with you the following observations that, we believe, give us some perspectives on the direction of the stock market:

  • Since September 11, 2001, consumers in the US have gone on a spending spree and have kept this economy alive. Unfortunately, debt levels are high now and it will take time and savings to bring them down. Therefore, although the US economy is chugging along, there is no large pent-up demand for goods and services.
  • Interest rates are near 40-50 year lows. Money supply has been strong. It is difficult to imagine lower rates and stronger money supply at this level unless one believes in an imminent deflation scenario, i.e. à la Japan, which we think has a low probability of occurring. Without big help of lower interest rates, we cannot count on the “High Tide Raise All Boats” effect that we witnessed in the 80s and 90s, when rates went from 16% to 4% (the Dow Jones Industrials Index went from 875 to 11500).
  • We all know that the infamous Bubble has burst. Yet since the beginning of the year, the Nasdaq has outperformed the S&P and the Dow by a margin of 2 to 1. is trading at 73 times earnings, Yahoo at 91x and Ebay at 74x. Without even mentioning others that have no earnings whatsoever, we are witnessing a rebirth of speculation in the technology area to some degree. Historically, there has seldom been a new secular bull market without a change of leadership.

As mentioned in previous quarterly comments, we believe this is a cyclical bull market within a secular bear market. We would like to emphasize to you readers that cyclical bull markets can be very powerful and rewarding. As an example, take the Dow Jones from December 31st 1964 to December 31st 1981 (17 years): although the index started at 874 and ended at 875, there were periods where it plunged 45% (1973-74) only to recover 70% (1975-76). We would like to take advantage of these situations by focusing on fundamental analysis and stock selection.

The Claret Team