The year-end bonus is finally a reality!

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Two consecutive quarters of positive returns! Investors are getting jubilant about the markets. So are the brokers and investment bankers as they see their commissions go up and their underwriting fees skyrocket. After three years of meagre results, the year-end bonus is finally a reality.

The following table summarizes the price performance of the main indices for the first nine months of 2003.

  Third Quarter Nine months
  In local Currency In Canadian Dollar In local Currency In Canadian Dollar
S&P/TSX (Cnd) + 6.27% + 6.27% + 12.19% + 12.19%
S&P 500 (U.S.) + 2.20% + 2.61% + 13.20% - 2.62%
Nasdaq (U.S.) + 10.11% + 10.56% + 33.8% + 15.10%
Europe (Euro) + 2.08% + 3.78% + 3.35% - 1.23%
Nikkei (Japan) + 12.51% + 21.37% + 19.12% + 9.17%

The US economy is even creating jobs now, according to recent employment reports. As long as the Fed maintains its accommodative policy, short-term interest rates will stay low. However, the Canadian economy might need some adjustments to the new reality that the Loonie, having been undervalued for a decade, is appreciating steadily.

Although the Canadian dollar and the Euro seem to have changed little from quarter end to quarter end, the underlying fluctuations have been quite volatile. The US dollar has been on a downtrend against most other G 7 currencies since the beginning of 2002. We believe it will continue going lower for the foreseeable future. As for the Canadian dollar, surprisingly (or not), the only people we find who are negative on Canada are the Canadians. There are so many reasons to be bearish on Canada: SARS, mad cow disease, dollar too strong, inventory build up etc. Yet, the Loonie keeps going higher, much to the surprise of many economists. We, on the contrary, are quite bullish on Canada and the Loonie. As the world economy picks up steam (especially China), we will witness increasing demand for our natural resources, from oil and gas to metals and lumber. As investors realize how rich this country is, the Loonie will go higher and who knows, parity with the US would not be unthinkable. Do some of you remember that not too long ago (in 1974), the Loonie was even stronger than the US Dollar?

Oil prices did not move much during the quarter. It actually was trending lower until OPEC announced the surprised production cut in late June. Then prices rebounded from US$ 27.00 to US$ 30.36. Iraq oil seems to be flowing steadily and at an increasing volume through the southern port of Al-Bakr, judging by the amount of tankers that have been booked in September and October. Russia production also has been increasing steadily and so have the productions of other non-OPEC members. Thus, we believe that there will be no shortage of oil in the foreseeable future.


After two positive quarters and a huge rally on the NASDAQ, lots of questions have been asked as to whether this is the rebirth of the bull market led once again by technology growth stocks. We have read some really interesting historical facts and market valuations on the tech sector and we would like to share them with you. We certainly hope the following comments would give you some perspectives on the complexities of markets and the irrationality of the human mind:

Value Line Investment Survey has been the leading independent equity research firm for the last 40 years on Wall Street, covering mainly all established companies that trade on the New York and OTC Nasdaq Stock Exchange. 20 years ago, in 1983, the Value Line Tech section updated 33 “Computer and Peripheral Industry” stocks. For a trip down memory lane, here they are: Amdahl, Apple Computer, Applied Magnetics, Barry Wright Corp., Burroughs, Centronics Data Computer Corp., Commodore Intl, Computer and Communications Technologies, Computervision, Control Data, Cray Research, Data General, Datapoint, Dataproducts Corp., Data Terminal Systems, Digital Equipment, Electronics Associates, Electronic Memories and Magnetics, Gerber Scientific, Honeywell, Intergragh Corp., IBM, Management Assistance, Mohawk Data Sciences, NCR, Paradyne Corp., Prime Computer, SCI Systems, Sperry Corp., Storage Technology, Tandem Computers, Telex and Wang Labs.

Some of you might recognize some of these names. Today, all but a handful is long gone. A few have changed business, filed for bankruptcy and then emerged a different company. If you have invested in these stocks 20 years ago and held on, you’d be a very poor man today.

The reality is that tech stock investing, while offering great potential reward, is extraordinarily risky. Obsolescence is an ever-present threat. Unlike the steady, true blue chips such as Coca Cola, Procter and Gamble, Gillette, Du Pont whose market position is tremendously well defended and whose products are rarely obsolete, the term “Blue Chips” in the tech industry is tremendously misleading. In fact, it should not even exist. Witness the rise and fall of the following three groups of so-called “Blue Chip” companies of their time: the mainframe manufacturers of the 60s (IBM, Sperry, Burroughs, Honeywell), the minicomputer manufacturers of the 70s (Prime, Wang, Digital Equipment, Data General) and the PC companies of the 80s (Compaq, Tandy, Commodore, ATS Research, Osborne).

After raking up billions of dollars selling mainframe to Corporate America, these companies saw their stock prices skyrocket, earning them the “Blue Chips’ title of the 60s.

Little that they knew, a different group of companies was about to eat their lunch. The 70s saw the minicomputer manufacturers rendered the mainframe obsolete by lowering the cost of computing. They took over the tech industry, their sales soared and so did their stock prices while the mainframe group began their long march into oblivion: Burroughs stock plunged over 80% between 1973-1982; NCR’s stock lost 85% of its value in the 73-74 bear market and changed business; Control Data’s stock plummeted 94% from 1964 to 1974 before becoming a rental and services company; and the list went on.

Then came the 80s when a new group of companies started chiselling away at the minicomputer manufacturers’ business. The PC manufacturers managed to again lower the cost of computing and destroyed the likes of Prime, Wang and Data General. The minicomputer companies are now all gone, with the last of them, Digital Equipment, selling out to Compaq in 1998 for one third of its peak value eleven years earlier.

During the 80s, the PC companies dominated the scene. Compaq held at one point the record for the fastest growth to $1 billion in annual revenues in the shortest period of time and ruled the PC industry. That is until Dell Computer showed up with a more efficient business model that provided cheaper PCs and delivered better price performance. It basically drove almost everybody out of the business, including the one time leader Compaq which had to sell out to Hewlett Packard a little over a year ago at 20% of its peak value.

Historically, investors have not paid wild premiums in order to own technology growth companies. In fact, except for some brief periods (late 60s, mid 80s and late 90s), tech stock valuations have always been penalized because of the inherent obsolescence risks. Then, might you ask, why are investors paying:

  • 50 times earnings, 7 times sales for Intel
  • 35 times earnings for Dell
  • 120 times earnings for Applied Materials
  • 100 times earnings for Ebay
  • 130 times earnings for Yahoo
  • 100 times earnings for Amazon.Com.

We honestly cannot give you any sensible answer to this question except the following:

  • The market can stay irrational a lot longer than any investor can stay solvent;
  • After having suffered big losses, investors tend to follow a double up catch up approach.

Finally, we can always choose not to participate in a sector whose fundamentals seem to escape us. And so we did.

The Claret Team