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Gal^Stad
Investments Inc.

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Year in Review

2002 in Perspective,
from the January 2003 issue

What a delightful year it has been for the Contra portfolio! While stock market angst has run rampant, our companies again turned in a boffo performance. This all seems so reminiscent of the early '90s for us: each decade has begun with a loss, followed by two major-league gains.

And since 1993 was also good for us... hey, why not dream big for 2003? After all, there is reason to hope that markets will not do as poorly as they have the past three years, and all the new additions mean the portfolio is young and vibrant. Of course, past returns are not necessarily indicative -- well, you know the disclaimer by now.

In 2002, we were up 47.3 percent -- a banner number in any year, but even more impressive set against the agony that was prevalent: the S&P/TSX composite was down 14 percent; the Dow Jones Industrial Average dropped 16.8 percent; the S&P 500 sagged 23.4 percent; and the Nasdaq nosedived by a staggering 31.5 percent. Quick, grab the Maalox!

The impact on our five- and 10-year annualized returns were negligible -- both slipped a tad due to the magnificent gains rung up in 1992 and '97. The numbers are now 17.1 and 25.2 percent respectively. As long-term readers know, the 10-year tally is our primary focus and the source of our greatest numerical pride.

The combination of mutual fund annihilation and our success sent investors scurrying in new and often contrarian directions. This was clearly evident both in the renewed interest in our investment letter and the fact that the National Post ranked Benj's book, The Contrarian Investor's 13, at #1 amongst investment and financial works. Who'd have thunk they would even list a Globe and Mail columnist?

The sector that fired our returns last year was one that had long been tarnished: gold, whose 42.5 percent gain led the S&P/TSX. Our forays into the sector paid off in spades as Claude Resources and Richmont Mines yielded particularly handsome returns. They weren't the only heavy hitters, though: Bombay Co., High Liner Foods, Kelman Technologies, Northstar Aerospace, Roman Corp. and Worldwide Restaurant Concepts all gained more than 50 percent.

The downside was slight, as only two stocks lost more than 10 percent of their value last year. Service dropped by a third and Xanser -- a gift we received when it was spun off from the very lucrative Kaneb Services -- by about 25 percent.

This year, for the first time in a decade, there were no juicy takeovers in the portfolio. Shoney's was the only one snapped up by an outsider, and it went at a penny and a half less than our purchase price. That's three ha'pennies for those of you clicking your fingers.

Twelve months ago, we wrote in our Year in Review, "Looking ahead, we expect that a recovery in profit levels will be stubbornly slow in coming." At the time, we contradicted the vast majority of market soothsayers, who were calling for a major upturn before the end of the year. (Heck, most analysts were saying the same thing at the beginning of 2001!)

Call us skeptics, but our crystal ball held a far more negative forecast. Now, however, we're more wishy-washy about the future.

One thing is certain, though: we still believe that when the U.S. coughs, Canada catches a cold. And we hear wheezing coming from south of the border, where attention and money that should be invested in the national economy is largely being wasted in the hunt for invisible terrorists and enemies whose apparent compliance is not quite compliant enough.

And this time around, the Saudis and Kuwaitis are not signing a blank cheque to underwrite American escapades. Fortunately for Canadians, we don't feel the need to police the world. Heck, we're so confident in our own civility that we spend over a billion dollars in hopes of convincing the criminal element to register their guns.

Many think our country's economy will remain exceedingly robust, despite the stateside palpitations. Time to think again. We remain dependent on our neighbours for the bounties that our economy brings.

On the plus side, Ottawa has acted responsibly in recent years, eliminating budget deficits and even running a series of modest surpluses, adding to the breathing space we'll need during a downturn. If Brian Mulroney or Pierre Trudeau were still at the economic helm, we might be stealing coal from the neighbours!

The carnage of 2002, while somewhat macabre to behold, is also fascinating. In the U.S., it was a record-breaking year for corporate bankruptcies in terms of asset value. In all, 186 firms, with aggregate assets of $386 billion, joined this lowly club. Among them were five of the 10 biggest Chapter 11 filings in history.

Much of the blame can be assigned to the lack of corporate governance, as firms blithely adopted policies that favoured management and directors while ignoring the rights of shareholders. Oh yeah, and that funny accounting thing often reared its ugly cranium.

Some other intriguing notes: the S&P 500 lost $2.41 trillion in market capitalization in 2002, for a total of $4.27 trillion since the end of 1999. Not one stock in the index doubled in value last year, while 41 turned the trick in '99. The year 2002 saw the worst annual breadth in well over 20 years, as only 131 issues increased in value while 368 were down. Only three of the 30 blue chip Dow stocks managed to climb the ladder.

This wreckage certainly did not help the USD, which, while dropping only a single measly percentage point against our buck, plummeted 18 percent against the Euro. We continue to believe that the C$ is undervalued, although we concede that our prediction in this regard is becoming somewhat hackneyed.

Still, we stand by our view, and we are therefore a tad concerned at our weighting in the States, which has once again increased to about two-thirds of the portfolio, encumbering our shift north of the border over the past couple of years. This is a matter we aim to rebalance once again -- as usual, in an orderly, patient fashion.

Overall, it is fair to say that we are more confident in stocks now than at any time since the fall of 1999, when we were firing warning flares against the valuations of the day. However, we are not by any means bullish, and "wariness" remains the watchword. Our hope is that careful stock selection will enable us to maintain high returns going forward.

A number of flies are writhing in the economic ointment, ready to spoil a recovery. For example, the price of oil is alarmingly high. This will dampen spending, as corporations and consumers struggle to keep the lights turned on.

On the other hand, one may assume George Dubya's buddies will prosper from this state of affairs -- he wouldn't be threatening war to fill his cronies' pocketbooks, now, would he? Naah -- they'd only have to pay additional taxes on their handsome dividends.

But wait a second -- no, they won't! The Republican-controlled Congress simply has to eliminate that tax -- and after all, isn't that what is best for the economy? Rich folk, and even some of the middle class, will benefit handily. And the poor? Oh, well, throw them another spoonful of molasses and hope they remain distracted by the Super Bowl countdown.

Besides the peril of high energy prices, the fact that housing and automobile sales have been steaming along suggests there should be a downturn in these critical sectors. People don't need new homes and cars every year. Even a swaggering president hoping to light a fire under consumers in time for his next run at the White House may have difficulty overcoming these obstacles.

We'll say it again: we're more confident than we've been since 1999, but don't colour us bullish.

The portfolio has certainly undergone a major transition this year. It is evident that we have shifted a portion of our assets back into the tech sector. It was almost three years ago, in early 2000, that we abandoned this field after our hefty gains on CompUSA and Mitel. The more things change...

One caveat about the portfolio: in January 2001, after our dismal showing in 2000, we wrote that we believed our portfolio was the best in years, in part because the vast majority of stocks in the stable were losers that retained our confidence.

Currently, 21 of our 23 positions are winners, raising the fear of regression toward a Contra 10-year annualized mean, so to speak. Offsetting this danger, we trust, is that our attempt to buy positions later in their cycles seems to be paying off.

Also, better than half the current companies have been purchased since the millennium, making this a young portfolio. Hopefully, these stocks are ready to pump upward on their long, slender legs. While we make our share of mistakes, the majority of our recent calls have worked out well.

When asked about the markets' future, our response is often a simple "I don't know." Many people still do not realize that this is a perfectly valid answer. Our wavering contrasts with the predictions of many prior to 2002. UBS PaineWebber's strategist, Ed Kerschner, expected the S&P 500 to climb to 1,600, about twice where it landed.

Abby Joseph Cohen was closer, at 1,300, but still miles off target. And of the 22 analysts who paraded their numbers on Louis Rukeyser's Wall Street Week, not one had the Dow ending the year under 10,000. Aah, the power of groupthink.

Once again, we would like to thank all of our subscribers who stuck by us when times were leaner. And to those of you who have recently hopped aboard, welcome. These are definitely uncertain times. Then again, aren't they always?


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