Commentaries

It is a refreshing change of pace to be able to write clients – after more than two years of very trying times in a bear market of rare severity – and discuss some particularly good markets of late. Investors who have stayed the course, and remained focused on their long term goals have seen their portfolios rewarded for their patience and discipline these past seven months. From the low points touched just days before the beginning of hostilities in Iraq, markets have staged an impressive rally.

In my commentary of March 21, 2003, four days after the first bombs hit Baghdad, I said: "My expectation, my hope, for the markets is that they will rally on the removal of uncertainty, the cessation of hostility, and the removal of Saddam Hussein." I believe the rally we have experienced has largely been a result of greater certainty in the geopolitical realm. Further market gains may yet come as investor sentiment continues to improve. Better sentiment may mean a return to stocks for some of the trillions of dollars sitting in cash instruments on the investment sidelines. This buying pressure for stocks will bid prices higher. It appears that quite a number of economic indicators and company fortunes are improving rapidly. For instance, estimated earnings for the S&P500 companies are likely to meet or exceed their previous record high, reached in 2000. However, the S&P500 index would still have to rally by 50% to reach the index highs of that same year. This economic strength should help to buttress the rally and prevent any excessive near-term overvaluations from occurring.

Bad news continues to cloud the media landscape. Such, it seems, is the inescapable reality of a media saturated world. I continue to dig for the information I believe to be important, and I have come to discount, if not ignore, the screaming headlines of each day. As the excruciatingly long U.S. election cycle begins for the November 2004 presidential elections there has been much talk of a jobless recovery. There has been little mention of the fact that the current U.S. unemployment rate is lower now than at the corresponding point after the 1990-91 recession, and that this September's rate of 6.1% is just 0.5% higher than in the corresponding month of Bill Clinton's first term in office. This also obscures the fact that U.S. workers on the whole are vastly more productive now than they were then. Canada's current unemployment rate, for comparison, is 8% (regardless of this, our federal government boasts of superior economic performance!). Healthy economic growth is with us and appears to be the most likely scenario for the year ahead.

The strengthening Canadian dollar (or more accurately the weakening U.S. dollar), while good for travelers to the U.S. is likely to mean tougher times for Canada's exporters. For this reason, I expect there to be no pressure on short term interest rates to rise. In fact, I continue to forecast a decline in short term interest rates over the months ahead. The weak greenback has actually restrained the performance of client portfolios this year. For all U.S. denominated securities in our portfolios, the loss for the dollar is a loss for our holdings. If a U.S. holding were to appreciate in value by 30%, but the U.S. currency decline by 18% (as it has done this year), the return to our portfolio is just 12%.

Two years ago, the world's financial markets were forced to quickly factor in a risk they had previously ignored. Terrorism was a reality of life before September 11th, but it was not one the stock market had yet considered worthy of attention. The depth of the market decline, and more importantly, the duration of the decline, was the market's adjustment to a new risk factor. While the risk was, is, and will likely remain with us for some time, the perspective of time has perhaps brought on a more coldly rational evaluation of the impact of terrorism on financial assets. Two years ago, few, if any, pundits would have predicted that no new attacks would be visited upon U.S. soil. While markets still discount financial assets with a view to this risk, it is likely now done with a more rational assessment than would not have been possible a year or two ago.

Certainly, stock markets are not yet back to their all-time highs. However, as has so often been the case in the past, stocks seem to be the most attractive means of not only recovering the portfolio values seen in the past, but of generating the long term rates of return necessary for most individuals' financial planning goals. The rally of the past seven months has once again shown that for those not sufficiently clairvoyant (and therefore unable to predict the market peaks and move to cash), the greatest mistakes are made by selling at the bottoms. With money market rates of return at approximately 2% per year, missing out on the past seven months market rally will have meant missing the equivalent of more than seven years of returns.

Alan Cameron

Commentaries

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