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Year in Review
2008 in Perspective,
from the January 2009 issue
The year 2008 was such an eventful one, it’s hard to know where to start. Without a doubt, commentators often spice up their missives with a liberal dash of hyperbole so that readers can marvel about the terribly exciting times they live in. But there are periods, like this one, when the chroniclers struggle to do justice to the scale of the transformations that confront them.
Housing “slump”? It’s more apt to say housing got sucked into a black hole that rendered any particle of good news contrary to the laws of physics. The price of oil “retraced” its gains? Yeah, the chart looks like the topography of Monument Valley.
Huge write-offs at banks? Heck, they lost more money in a year than a typical African government could dream about in a generation of spending. Market “panic”? More like wild-eyed terror as traders whacked their keyboards like piñatas. No candy or toys inside, though, just sour grapes.
Our first pull quote in last January’s Contra stated, “Given the fine overall performances of markets since the tech bubble deflated, might it be time for a regression to the mean? There are many reasons to wonder whether the end is nigh for this boom.” Evidently, we’ve retreated way beyond the mean, which confirms the market’s manic propensity to overshoot the target in both directions.
If you think it has been fun for us the past few years to grumble about the dark clouds advancing from the horizon, you’d be wrong. We are not curmudgeons by nature, and take no pleasure in making dire warnings about things going to hell in a handbasket. Subscribers who did magnificently in the 2001–2005 time frame, and were eager to redeploy profits into new opportunities, know well that we have not been buying much, and mostly at minor-league weightings.
And now that our worst fears are being realized, the fact that we saw it coming is of limited solace.
But we aren’t here to recite the long litany of disasters that struck the world’s economic system in 2008. Unless you’ve been living in a cave for the past 12 months, you have probably heard more about Fannie Mae, Lehman Brothers and Bernie Madoff than you could stomach. Instead, let’s examine the big picture.
First, consider the astonishing breadth of the stock market mayhem. Even during severe downturns, such as occurred during the tech wreck, investors usually flee the epicentre of the earthquake for the relative safety of other sectors. However, 2008 made a mockery of the notion of “defensive” investing. Of the 500 stocks in Standard and Poors’ flagship index, 482 declined — 183 of them by more than half.
The crash was truly global in scope, with a consistency that saw all of the world’s bourses in negative territory, though to varying degrees. In North America, Mexico’s Bolsa, surprisingly, fared best: down 24.2 percent, compared to a loss of 38.5 percent for the S&P 500 and 35 percent for the TSX.
In Europe, the UK’s FTSE 100 index was the relative winner, down 31.3 percent. Germany’s Dax took a 40.3 percent beating, Paris 42.7 percent.
But the emerging markets of the eastern part of the continent got hammered the worst. Bulgaria’s was drop-kicked for an 80 percent loss. And at the bottom of the list was poor Iceland — almost a complete wipeout, a 94 percent loss.
A wrench was also thrown into the dynamos of Asian economic power. High-flying Shanghai was busted by 65 percent, while India’s Mumbai wilted by 52. And anybody thinking that the Japanese were fresh out of crashes would be mistaken: the Nikkei was blasted for a 42.1 percent loss, an annual decline worse than in 1990.
When we discuss the scale of the global financial crisis, it’s instructive to note that one thing we’ll have to get used to is the “T-word.” As in trillion. The once-mighty billion-dollar chip, even when stacked in neat piles of hundreds, is no longer a sufficient measure. The problems, and perhaps the solutions, must now be reckoned in much larger sums. The US is projecting a budget deficit for 2009 of $1.2 trillion.
The decline in American home values, to date, is roughly $4 trillion — and counting. The amount of money spent, lent, printed and earmarked for loan guarantees, through the combined efforts of the U.S. Department of Treasury, Congress and Federal Reserve to stem the crisis, is reckoned to be $8.5 trillion. And global stock markets were like magicians making money disappear, with $12 trillion in wealth seemingly evaporating into the ether.
For individual investors, the losses require far fewer zeros to tally, but they are still painfully significant. We knew that many of the stocks in our portfolio were already beaten up enough. What we didn’t know was that, virtually right across the board, they would take an even greater shellacking.
We were handed our poorest annual performance in history, a pummelling of 36.8 percent. And even that dreary result was softened by the sharp drop in the value of the loonie, which helped to alleviate the decline on our US holdings. Without that assist, our loss would have been more than 44 percent.
Midway through the year, the outlook was actually fairly decent. Norsat was on a tear, and our decision to average down aggressively on ATS Automation was looking mighty sagacious. We had taken a fine, quick profit on Iomega after its takeover by EMC. Viterra had marched well past our target, and we’d taken some money off the table.
At that point, many analysts believed that the credit crisis was waning, and they urged investors to be ready for the economy to pick up. That didn’t make any sense to us, but neither can it be said that we were alert to chances to mitigate the risks to our own portfolio.
In hindsight, selling Stewart as it cruised at around our target for much of August, or selecting a lower price on the Dutch auction of Franklin Covey would have reduced our exposure nicely. And being more aggressive with our tax loss selling, as with the decisive move to dump Penn Treaty, would have helped, too.
The buy side of the equation became stronger as the turmoil deepened through the autumn, and we elected to wade back into the market in a very limited fashion. That’s because this appears to be no garden-variety recession. The media has often reported that the average economic downturn is around ten months in length, which might lead one to believe that this one is already getting long in the tooth.
But such talk isn’t of much use; it’s a bit like contemplating an "average" car accident — there may be a theoretical midpoint between a fender-bender and a head-on collision, but what we're really concerned about is the probability of a catastrophic crash. From our vantage point, we believe this one threatens to shape up like a 50-car pileup on Highway 400.
The list of reasons why a severe contraction can be expected is long and complicated. What many of them have in common is that they are essentially systemic problems that have resulted from policies and behaviours that allowed for short-term gains at the expense of long-term risk and instability. The attempts to thwart the unpleasant parts of the business cycle, which are an inherent component of capitalism, resulted in a buildup of deadwood.
The apparent lack of nasty consequences encouraged people — and that includes everybody, including consumers, homeowners, banks and business leaders — to take on more and more risk.
What we are in now is the “Big Blaze,” an inferno that has jumped the firebreaks and is still spreading despite the best efforts of the water bombers and suppression teams. There was somewhat of a lag here in Canada, being some distance from ground zero, but the integration of the Canadian economy into the global one means that we are in for a rough ride in 2009.
Timing a major re-entry into the stock market is going to be tricky. We expect the economy to get worse before it gets better, which means lower corporate profits and negative investor sentiment. Historically, the market tends to “anticipate” the end of a recession by about six to nine months, so the time to buy will be when the economy still appears deeply under water.
There are legitimate grounds for optimism that even the most skeptical amongst us might appreciate.
Despite the already-widespread cuts in dividends, the yield on the S&P 500 now exceeds the yield on 10-year government treasuries. The last time that happened, we were still in diapers. The amount of cash piled up in US money-market funds is a record $3.8 trillion and now exceeds the total amount in equity funds. That hasn’t been the case in eons. At some point, the balance will tilt, and the opinion that stocks provide superior returns will regain currency.
We firmly believe, albeit 2009 might not ultimately reflect it, that there is more upside for the portfolio now that at any time since January 2001, when we wrote about having the best portfolio in years.
That observation came after an aggregate negative return over the preceding three years. It also harks back to 1990, when 15 of the 16 positions in the portfolio were down; there followed a three-year run of annual returns of better than 50 percent.
Historically, our projections for the overall Contra portfolio have been darn good. Nevertheless, if the economy does suck dirt, excellent returns almost anywhere within our ionosphere will be scarce.
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