April 2001

Feeling a little confused lately about the direction of the economy and the ongoing drama in the stock markets? If you are, you are not alone. And if you are feeling unnerved by it all, I’d like to help you make some sense of what is happening and put any concerns you may have to rest.

Economic outlook

Since I last wrote to you, the economic forecast for North America has become quite cloudy. Although there is no evidence to suggest that we are headed into a recession, we know that economic growth has slowed down substantially, particularly in certain sectors of the economy. The sharp downturn in our equity markets since the beginning of the year is largely a reflection of that economic uncertainty. What’s more, as long as that uncertainty prevails, we can expect more volatility in the stock markets.

To understand that dynamic, one has to remember that stock prices are based primarily on corporate profitability. When profits go up, the market goes up. Conversely, when profitability starts to sour, the market goes down. The stock market does not cause economic downturns, but it does try to anticipate the direction of the economy. As long as the economic outlook remains unclear and the earnings of companies continue to disappoint, the market will push prices lower. What is important to remember, as an investor, is that just as our economy is cyclical, so are the ups and downs of the market. The trick is to be prepared for the inevitable downturns and maintain a well-diversified investment strategy through thick and thin.

The market in perspective

All of the major North American indexes are currently down by at least 20% from their most recent highs.

Since 1955, our benchmark Canadian index, the TSE 300 has gone through eight of these “bear markets” or periods where the market experienced a loss of 20% or more. On average, these depressed markets have lasted 10 to 11 months at a time racking up losses of 25-30% on average. Sounds nasty, but the point is there is nothing new or different about what we are experiencing today and as such there is no cause for concern. This time around, the economy in the US, and in particular here in Canada, is in much better shape than it was during many of these other bear markets. Government debt is under control, inflation remains low. And the cuts in interest rates and taxes are very positive. That means we can anticipate a relatively speedy recovery in historical terms. It is also worth pointing out that, at least in Canada, the broader market (i.e. all but the high tech sector) has not experienced significant losses to date. Let me explain.

To date, the TSE 300 has fallen almost 30% from its last high set in October 2000. But remove our infamous Nortel from the picture, and the results suddenly look very, very different. In fact, the recent drop in the value of the index would not even qualify as a “correction”, let alone a bear market, were it not for Nortel. The explanation is quite simple. Before its fall from grace, Nortel accounted for as much as 35% of the index. Since its stock value plummeted, it now represents closer to 10% of the index. So when Paul Martin likes to remind us that Canada can expect to come through these uncertain times relatively unscathed, it would seem that the markets agree with him. This may be the first time in decades that the Canadian economy out-performs that of the United States!

What you should do

Many of you will be receiving interim statements within the next several weeks. Although you can expect to have lost some ground, you will probably find that you have done better than you might have expected. More importantly, as long as you keep your focus on the long term and maintain a well-diversified approach, what happens in the market on the short term is of little concern. If anything, as I have said many times, a downturn in the market is a buying opportunity.

Here’s some food for thought. According to Warren Buffet, one of this century’s most successful investors, if you had made regular purchases of the Dow Jones Industrial Index during the worst period of market history this century (i.e., 1929 to 1948) you would have earned a compound annual return of 8%. This is despite the fact that the index started at a level of 300 in 1929 and finished at 177. (Today the Dow Jones is hovering around 9,500!)

As long as there is economic activity on this earth and as long as we are still inventing new ways to do things, the stock markets will continue to generate new wealth. That is a fact. So don’t be afraid to maintain your strategy and buy the downturns. We’ve been here before.