1998 in Review

If the dominant storybook metaphor for this historic bull market has been “The Goldilocks Economy: not too hot, not too cold, but just right,” then 1998 was a script right out of “The Little Engine That Could.’

Despite a derailment in Russia, Japan looking tired and rusted, and the teetering trestle of commodity deflation gnawing closer to home, the US locomotive just keeps chugging along. When it seemed to be in danger of losing steam, engineer Greenspan was there to furiously shovel in the coal.

For us, the year was a nasty roller coaster ride that left us feeling woozy. In April, the Contra portfolio was cruising along beautifully, up over 30 percent.

We cashed in some nice gains, but in hindsight, we might have been a bit more flexible with some of our sell targets. For as the small cap market cascaded downwards, our returns plummeted with them, finishing the year a tinge in the black at 0.5 percent.

After commissions, this number clicked in at virtually dead even, with the slightest hint of red showing. In fact, if it hadn’t been for a currency translation gain because of the decrease of the Canadian dollar versus the US greenback, we would have been in the ballpark of the TSE 300, which was down 3.2 percent, and the Russell 2000, which was off 3.4 percent.

On the face of it, 1998 was a good year for US stocks. The Dow finished up 16.1 percent and the S&P 500 put together another remarkable 26.7 percent gain. But these solid moves were dwarfed by the Nasdaq, where the “nerdy 30”–dominated index leapt an astonishing 39.6 percent.

Not only was there a yawning divergence between the big cap and small indexes, but even among the blue chips, success was extremely spotty. A mere 2 percent of the firms in the S&P 500 were responsible for 43 percent of the total gain.

At the other end of the scale the carnage was deep and widespread: 66 percent of all listed shares on US markets were losers for the year, while 1,100 of those firms saw more than half of their value melt away.

So, though we are not thrilled with our own results, capital preservation was a big concern for us, and that was achieved as our sales cut our stock market exposure by about half. Our five- and 10-year numbers are down to 19.4 percent and 24 percent respectively. Certainly, these are excellent returns against virtually any yardstick — but lower than previously enjoyed.

So, what went right in 1998? Well, the profits from those early sales balanced the losses on some dogs. And for the seventh year in a row, takeovers consumed pieces of the portfolio. This year there were two, FCA and Farah, both being quite profitable. Cambridge remains in play, albeit in arguably one of the most boring possible buyouts in history.

Turnover in the portfolio amounted to almost 25 percent. This is about half the number of two years ago and down around the 25 percent from last year. The primary reason for the figure wasn’t higher is that a number of our tax losses, which might have been dispensed with again previous gains, were held.

After careful analysis, it was decided that these losers were so badly beaten, that their upside potential exceeded the benefits of dispensing with them and taking a tax loss now. But a strong possibility certainly exists that many, if not all, of our losers could be ejected in the coming year.

What will 1999 bring? Tough to tell. By most standards, stocks remain at high levels. Millennial panic is in the air. Sales of dehydrated food, wood stoves and non-hybrid seeds are booming and Amish and Mennonite technology is actually becoming trendy.

At this point it is difficult to know if the excitement is peaking or heading for full-blown mass hysteria. What is greatly complicating the issue is that most company lawyers are advising their employers not to use words like compliance and guarantee, regardless of how much testing has been done. Legal semantics and obfuscation won’t do much to build public confidence.

Our portfolio is highly diversified with 30 stocks. Money rests on the sidelines, awaiting buying opportunities as they appear. We’re not believers in the forecasters bellowing, “Bull onward,” nor disheartened by the prognostications of the doomsters and gloomsters out there.

We feel that the Contra portfolio is well positioned regardless of the upcoming weather. We won’t expect clear sailing as high volatility and dramatic swings remain a strong probability. Pass the Gravol and full steam ahead.