Commentaries

While it stems from a philosophy I do not embrace, the expression "everything is relative" comes often to mind of late. Relative to last year, I cannot help but think that 2002 will indeed be a happy new year.

Last year will no doubt be remembered, but not fondly. It proved to be disastrous in the most important of ways, but was also a frightening and upsetting year for investors all over the world. The calendar year turned out a negative performance for the North American and most World markets, making for back-to-back negative years for the first time since 1973-74.

Those two negative years have tested the mettle of even the most devoted of long-term investors. Five year annualized rates of return for the U.S. (S&P500, Dec. 96 to Dec. 01) now average 9% (closer to 11% for C$ investors in the U.S. as the decline of our currency helped foreign investments), and just 5.33% for the TSE300. However, the story of investing has changed little. During those five years, interest and inflation rates have declined drastically. The "risk free rate of return", as represented by short-term government guaranteed securities is now very low. Even the depressed average returns quoted above would represent two to three times the after tax return of today's money markets.

With lower interest and inflation rates, the way is paved for improving equity market returns. Indeed, the strong rally of the past three months has been an encouraging signal that investors are beginning to look ahead to a recovering economy. The combination of low inflation and interest rates, plus a return to sustainable growth rates, is the perfect elixir for a strong stock market. I predicted in a letter to clients on September 12th:

"The world's greatest democracies and economies are more than a building or any one symbol. They will stand and prove their resilience in the face of this challenge as they have in dozens of crises in the past. In fact, if history is any guide, the economies and stock markets may use this sad day as a catalyst to even greater prosperity."

There is little risk in predicting the ongoing success of liberal democracy. As for the predictions of stronger markets and economies time will soon tell, however, markets recovered rapidly, and at this moment, all major North American markets stand substantially higher than they closed on September 10th.

Following the heady tech-led days of the late nineties, the decline of the past two years served as a shockingly stark reminder of the value of diversification. Approaching the investment markets with rather more modest expectations will make for less disappointment in the future. I have in the past assumed real rates of return (the nominal rate of return minus the rate of inflation) of between five and six percent for client portfolios. I continue to believe this assumption to be reasonable. However, in an inflationary environment of just one percent, the resulting six or seven percent nominal returns are a far cry from the expectations of the typical 1999 day trader. No matter, my clients are just as well served by a 12% return with 6% inflation, as they are with 7% and inflation of just one percent.

There are some effects from the past year that I believe will linger on into the years ahead and will therefore have a bearing on my clients' financial plans. In a letter to clients in October 2001, I wrote:

"I do not believe that Canada will be among the chief beneficiaries of this recovery. In short, there has been nothing in the Canadian response to the tragedy thus far, nor in the likely outcomes of a post 9/11 world, that will benefit Canada disproportionately to the rest of the world. I do not think it is accidental that our dollar has hit a historic low since the attack nor that our market has been slower to recover. I will begin a rather gradual but deliberate reduction of the Canadian weightings in our portfolios over the months and years to follow. Sadly."

This view has not improved. In fact, the recent federal budget only serves to drive the point home. Spending by Canadian governments (certainly federal, and to a lesser extent provincial) is rising too fast. Under the guise of greater security, our government is quick to announce new spending. Unlike your household and mine, when necessary but unexpected expenses surface, there is no attempt to reduce spending in other areas. We all too easily slide back into deficit spending, and without, I would argue, the consolation of a very much more secure nation. Federal government spending for the current fiscal year is estimated at just over $130 billion. Two years ago, this year's spending was projected to be just $118 billion. This increase of $12 billion over projections does not reflect the spending from the recent "security budget". That goes to the next few fiscal years. Taking the 2003 fiscal year estimates at face value (rather charitably since this government's actual spending figures have always come in higher than projected), federal government spending will have increased $25 billion in three years. We will make no payment to reduce the federal debt this year, nor it would seem for the several years to come. An ageing baby boom, nearing retirement, needs a government more committed to fiscal prudence, and less prone to politically-driven spending. Our children need it even more. My long-term investment dollars will continue to seek responsible governments wherever such may still be found.

I believe the U.S. will benefit economically from the tragedies of 9/11. This is not only due to an improved, bipartisan political climate, a renewed sense of purpose and determination, patriotism, and a rejuvenated national (and perhaps international) commitment to the liberal democratic values that have created the riches of the United States. It is also due to the fact that the U.S. will now draw in greater foreign investment and enjoy a stronger currency than they might otherwise have done, and will benefit from the fiscal and monetary stimulus occasioned by the attacks. While international trade may be hindered in the near term, the United States is better equipped to weather such a reduction in trade than almost any other nation.

I once read that the wish "I hope you get what you deserve" stands as either threat or kindness, depending upon the purity of the recipient's conscience. I extend it as the kindest of wishes for you and your family in this New Year, and as my hope that this year will see justice done throughout a more peaceful, prosperous and secure world

Alan Cameron

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