The performance of the Canadian market affected by commodities

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The correction that started in May 2006 mentioned in our last quarterly letter seems to have been short-lived. The market resumed its upward trend in July. Commodities and their related stocks were especially hard hit, thus affecting the performance of the Canadian market.

The following table summarizes the price performance of the main indices for the third quarter and the first nine months of 2006.

  Third Quarter First 9 months
  In local currency In Canadian Dollars In local currency In Canadian Dollars
S&P/TSX (Cnd) +1.28% +1.28% +4.34% +4.34%
S&P 500 (US) +5.17% +5.32% +7.01% +2.96%
Nasdaq (US) +3.97% +4.13% +2.41% -1.47%
Europe (EUR) +5.95% +5.14% +10.16% +13.37%
Nikkei (Japan) +4.01% +0.86% +0.10% -4.04%

The currency market has been abnormally stable considering the volatility experienced in commodity prices. The Euro finished the quarter at USD 1.2674 versus USD 1.2790 in June whereas the Loonie stood at USD 0.8940 versus USD 0.8960 last June.

In the meantime, the Fed has decided to hold interest rates steady hoping that the U.S. economy will slow down to a more sustainable (i.e. non inflationary) level. Although the housing sector has shown signs of retrenchment, there is not enough evidence of the same on the consumer spending side, which currently accounts for 70% of the US Gross Domestic Product (versus a historical average of 64%).


The media bombards us everyday with news and comments on current events, the economy, political and social issues. Often, we come across information that is taken out of context to prove the writers’ point of view. In the interest of investors, we would like to share our point of view on these issues by providing some facts, perspectives and our “two cents worth” of comments.

1. How many articles have you read about the housing bubble in the US, record borrowings, excessive consumer debt and the coming disaster when this bubble bursts? With the US economy showing signs of slowing, fears of this bubble bursting are mounting. What would be the likely outcome?

There has been, and continues to be, quite a bit of speculation in the housing sector over the last couple of years and the downturn will certainly have some effect on the consumer sector. However, several facts have to be emphasized, as we believe that persistent worries about excessive consumer debt during past decades have been misplaced. Most of the increase in household debt is mortgage related, which means that the debt has been backed by an asset. Moreover, thanks to financial deregulation, more people have access to home ownership as more efficient credit facilities emerge throughout the economy. It is not always the case of the same consumers taking on ever increasing amounts of debt.

Presumably, there is a limit as to how high one’s debt can go in relation to one’s income but there is no indication that it has been reached.

It is important that the labor market stays healthy and house prices do not decline too much in order to avoid a housing meltdown. If people have jobs, they can service their debts. Therefore, it is critical to keep a close watch on the labor market, quality of jobs created and housing prices.

2. We have been asked quite often about the upcoming Asian dominance in the global economy and our strategy regarding the supposedly inevitable decline of US influence.

There is no doubt that China, along with India, has been growing at a fast pace. However, let us put Asia back into perspective: China’s economy is less than one fifth that of the US. Toss in India and the rest of Asia – excluding Japan – and we are talking about less than 40% of US Gross Domestic Product. Much of the region is running trade surpluses (especially with the US), meaning its economies are demanding less than they are producing. It would seem to follow that if the US slows significantly, so too will Asia.

Realistically, China is simply not stable enough to play the role the US does in Asia. Its USD 2.2 trillion economy is loaded with risks ranging from rickety financial system, rampant pollution to social instability. Someday, China may have the booming domestic market that will let it become Asia’s economic engine; for now, that market does not yet exist. The economic future may indeed be Asia’s, but the irony is that the region may have a hard time realizing it without help from the US in the short run.

By the way, we learned recently that in the five years since the attack on the Twin Towers, America’s GDP has increased by USD 3 trillion. This increase alone is roughly equivalent to the entire output of the world’s fastest-growing economy, China.

3. Have you ever been in a debate regarding big government versus small government? About social security spending such as medical insurance and the welfare system?

We recently came across some information regarding the German social security system, published by the Federal Statistics Office in that country. We thought it would be of interest to you next time you are involved in such a debate.

In a big, industrialized country like Germany that exports more than any other European nation, do you know how many Germans are dependent on the state?

About 42% rely on the state through welfare payments, jobless benefits or pensions. Only 55% of German households live off their own incomes. Social security spending has now reached a record of 695 billion Euros a year (USD 892 billion).

The trouble is, very little of the spending is alleviating poverty or hardship. It has all become a pointless exercise in money shuffling: taxing the population and then giving some of the money back if people ask nicely. It is just a money-go-round involving lots of bureaucrats and it is not actually helping anyone.

Why such high levels of state dependency? Surely governments are just trying to help people who otherwise wouldn’t have enough money to live on.

The main problem is that the government taxes people, particularly low earners, at high rates, and then those people don’t have enough money to live on, so the government has to give some back to them.

Extensive welfare systems are dressed up as helping to alleviate poverty and to reduce inequalities. Both are worthy aims but as the saying goes, the road to hell is always paved with good intentions. If you took money only from the rich and gave it to the poor, that might be the result. Yet what happens in reality is that the very weatlhy can hire professionals to help them reduce their tax bills and the poor have no money to be taxed on. Therefore, most governments take money from people in the middle and then give them the same money back again, but only after paying for all the costs involved in collecting the money in the first place (they have an army of tax collectors to do this) and redistributing it (another army of welfare officials).

There could be a better way. Taxes could be concentrated on genuinely high earners and welfare could be directed to people truly in need. Meanwhile, the vast bulk of middle-income earners could be allowed to become self-sufficient.

Of course, it would reduce the power of big government and the politicians, wouldn’t it? Now that is something many of us would see as a step in the right direction … Unfortunately, complex social programs are designed by governments to have their hands in your pockets … food for thought when you vote in your next election …

We hope you have found our perspective insightful, or at the very least, “worth two cents”!

Claret