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Year in Review
2001 in Perspective,
from the January 2002 issue
What a difference a year makes. Last January we smarted from a lousy outing in 2000, our first negative year in a decade. Undeterred, we suggested that our gut instinct told us we had the best portfolio in years.
It was. With only one addition to the lineup until December, we focused on harvesting gains as company after company soared into sell territory, yielding a sparkling annual performance of 64.8 percent.
Luscar Coal got the ball rolling, when the miner Sherritt International teamed up with the Ontario Teachers’ Pension Plan in a takeover.
The theme of unloading our fully valued resources stocks continued with another takeover — Gulf Canada — and the disposal of Occidental Petroleum and the pipeline assets of Kaneb Services.
Our timing on this sector rotation was propitious, as our prediction of a souring economy with crumbling oil and gas prices was dead on.
Another theme that contributed to our success was the fruition of some of our defensive value plays. The heavyweight in this division was the grocer Fleming, which made a huge contribution to our bottom line.
Spar Aerospace and Utah Medical also kicked in with handsome profits; in both cases it would have been even more lucrative to hold these firms a little longer, but our policy of getting out a little early rather than late was verified.
On the other side of the coin, our ability to avoid disasters was instrumental in our performance. We certainly made mistakes. Our handling of Dynex Capital lacked finesse; we overestimated how much Dylex would be worth on the auction block; and we got bamboozled by the berserk management at Hartmarx; but none of these were ruinous blows.
Alliance Pharmaceutical and Bethlehem Steel were washouts, but the main damage was done in prior years, so the effect on 2001’s tally was small.
Our 10-year performance, the primary benchmark by which we evaluate ourselves, improved modestly to 25.4 percent. That’s because 1991, at 59.4 percent, was another giant year, which coincidentally followed a poor result in the previous annum.
Why this seemingly lock-step pattern? “Regression to the mean” might seem to proffer an explanation, yet it doesn’t account for the extreme swing in our performance in the other direction. Another statistical concept that came into play is “survivorship bias.” The big gainers had been sold, the weakest links culled, and the majority of the remainder were beaten but not broken and ready to return from furlough to form.
The pattern also offers encouragement for the next couple of years. We followed up 1991 with a fine 50.1 percent gain in 1992 and a stratospheric 77.8 percent in 1993. That will be an extremely tough act to duplicate, but the balance and quality within the portfolio remains very favourable.
We had a lot of very attractive candidates to choose from for our December buying spree. Still, lots of capital remains on the sidelines, and it is likely that a trickle of buying activity will occur throughout the year.
We had a couple of primary goals in mind last year. The first was to reduce the number of stocks in the portfolio from 29 to between 15 and 25. At year end, the roster stood at 22.
Second, we wanted to reduce exposure to the USD. Our goal was achieved, as it now accounts for a more modest 54 percent of the portfolio, compared with about 68 percent at this time last year. This decline was achieved through the natural course of sales, with a focus on buying Canadian in December. Although the greenback climbed, our reduced exposure pleases us.
In sharp contrast to the run in the 1990s, the indexes fared poorly in 2001; even most mutual funds managed to beat them for a change. The TSE 300 finished with a 14 percent loss, as Nortel was again a black sheep, losing three-quarters of its value.
On the US Big Board, the S&P 500’s diminishment of 13 percent trailed that of the Dow, which limited its toll to 7.1 percent. After the blowout of the previous year, the Nasdaq again wilted badly, down 21 percent.
But if corporations and investors had a tough time last year, you wouldn’t have known it by listening to professional economists. Economics has long been nicknamed “the dismal science,” but these folks carried on like the life of the party. As conclusive evidence mounted that the economy had tilted into recession, they only acknowledged a “slowdown.”
Finally, after September 11, when it had become impossible even for the most ostrich-like to rest in denial, one august body came to a startling conclusion: “Oh, yeah, we are in recession, and it started last March. But guess what? Since the recession has already been going on for so long, it must mean that it’s almost over.” If these guys were weather forecasters, there would only be sunny days.
This theme of “see no evil, speak no evil” had its correlation in the Enron debacle. This one has been accompanied by the usual deluge of media hype, but make no mistake: this really is a huge story.
US Attorney General John Ashcroft, who came up big against bin Laden, ran for the hills when this monster got loose. The elite accounting firm Arthur Andersen, the big brains who are supposed to make sure this kind of kitchen book cooking doesn’t happen, were either incompetent, deceitful or, perhaps, incompetently deceitful.
Wall Street analysts, who are supposed to take company guidance with a grain of salt, instead engraved it onto their foreheads. Meanwhile, the SEC was busy nailing 15-year-olds for pumping stocks on Internet message boards.
As the press concentrates on the political connections and the sad stories of employees who have lost not only their jobs, but their retirement savings, what is being overlooked is that Enron is basically another derivative crash-and-burn.
Standard & Poor’s pegs the corporation’s derivative exposure at $3.3 billion. The total value of assets represented by those derivatives, the so-called notional amount, is a colossal $79 billion.
The company was very clever about creating various financial instruments to help customers mitigate their risks in trading in various commodities. The other side of the equation meant that somebody was absorbing that risk — and that somebody was Enron.
Looking ahead, we expect that a recovery in profit levels will be stubbornly slow in coming. Recessions provide corporations with the opportunity to restructure their operations and blame everything on the woebegone economy. Seeing a company like Ford announcing the closure of several plants — in 2004 — leaves one to assume that they don’t see the economy storming back soon.
The larger point is that it is tricky for management to conduct “big bath” accounting when times are good. Those losses, even if mostly non-cash items, sully the bottom line, and that doesn’t do much for stock prices or executive options. By taking their licks now, a lot of ugly stuff can be swept under the carpet, and the inevitable recovery greeted with a clean slate.
Two thousand and one was a banner year. We wish to thank all of our subscribers who stuck by us when times were leaner.
The Contra Guys
Buys & Sells