Golden Capital Securities

Investment Outlook

January 2001

Once again, it is that time of the year in which we take a look back at the year that was, try to make some sense of it and see if the calls we made were good ones.  Each highlighted month is a link to that month's Investment Outlook, just click the link to refer to that month's articles.

Overall, the year 2000 saw, literally, the best and the worst in the same year.  In March we hit high after all-time high on both the NASDAQ and S&P 500, while the Dow Jones Industrial Average hit its all time high just prior to the NASDAQ in January of 2000.  YEAH!  However, as everyone is all too aware, the last year of the Twentieth Century was also the worst single year for the tech-heavy NASDAQ Composite.  OUCH!

Domestically, Nortel Networks was both our saviour and then our bane.  Nortel alone drove the TSE 300 (and the composite sub-indices: TSE 100, 60, and 35) to new highs.  For a substantial portion of the year, the Canadian stock market was the best performing market of any industrialised nation. YEAH!  However, all this unravelled when Nortel's earnings were not what the market had expected and the stock price dropped from a high of C$124.50 to its current range of just under $50. OUCH!

February was perhaps the month with the greatest level of stock fever, "irrational exuberance" and instant millionaires.  Venture Capital companies were throwing money at anything with a business plan longer than a paragraph and a "dot-com" in their name; and why not?  Internet-based, initial public offerings that did not bounce at least 200% in their first day of trading were considered failures.  Those were heady times.  At that time we recommended participating in the Internet Revolution, but also to not dump your IBM's and GE's.  Diversification, then, as much as now, or anytime, is the key to a well positioned and long-term investment portfolio.

March saw the peaks of the small cap markets and the vertigo felt by institutional and retail investors alike began to affect the market.  During this month we proposed that the period of low inflation with high levels of productivity growth could not go on forever and that the high costs of oil and gas would eventually cause inflationary pressure on the US and Canadian economies.  It has taken a lot longer than we had originally expected for these pressures to affect the market, but the economic slow-down is finally being predicted now in December, nine months after our first prediction.  We were not wrong, which is nice, we just had not expected that the economy could bear a cost tripling in a crucial economic input like gas and oil for so long.  March also so the freeing of several million shares from escrow of recently IPO'ed stocks.  As these shares became free trading, Insiders scrambled to sell their "overvalued" stocks on to the market to realise some of the substantial gains; the peak had been reached.  Finally, we again tried to impress on our readers that if/when the NBT (Next Best Thing) stocks did fall, that they would fall by more than the Old Economy blue chips: Diversify, Diversify, Diversify (do you sense a theme here?)

In April the markets began their gyrations at dizzying heights.  Investors saw their friends and neighbours bragging about the "killing" that they made on XYZ.com in two days and figured they could do it too.  The day-trading phenomenon was at its peak and much like trendy clothing, companies that had a thin business plan and poor management, but interesting concepts, were being swept up in utter euphoria.  The cracks in the Internet economy were starting to show.  April also saw the fall of some of the industry's best known hedge fund players and several market strategists began calling this the end of the cycle.  The Internet economy was becoming unraveled.  

May was the heart of the market correction that had been predicting for months by the pundits.  Unfortunately, we had not sold all of our NextBigThing.com stocks at their highs, but did try to reinforce the diligence needed in stock investing.  We made the suggestion that this was not the end of the bull market, but rather a shift from the New to the Old economy.  History did bear this out, considering that if Microsoft and Intel were excluded from the DJ Industrial Average, the Dow would have been up for calendar 2000.

As we entered June, the markets began to take a slight breather and consolidate after the precipitous drop they had just endured.  In hindsight, our suggestion to investors to "Go away in May, come back in September" seemed to be a good idea.  Predicting that the markets were going to be volatile, but moving sideways as they consolidated, we were getting ready for the next big move upwards; we were half right.  Most of the summer saw a rotation from technology sub-sector to sub-sector (wireless networking, optical switching, hand-held devices), but as of the end of the year the upturn has not occur, yet (we're eternal optimists). 

In July all eyes were on Alan Greenspan (Chairman of the US Federal Bank) as the markets vainly attempted to get an idea as to the direction of the economy and thus the stock markets.  Several recent increases in the over-night Fed Funds Rate had added further to the downward pressure on the markets as bonds became more and more attractive.  We hypothesized that the fabled economic "soft landing" might actually occur, but even 6 months later we still cannot be sure whether or not this has actually happened.

Nortel Networks alone dragged the TSE up in August.  At the height of its valuation, this one stock comprised almost 35% of the capitalization weighted index as it soared over 200% in a 52 week period.  Harkening back to our theme, this is not a good example of diversification.  We also looked at a variety of techniques that could be used in valuing a high technology company, using Chapters Online as the example.  Of the three examples that we had assumed, being reacquired by the parent company was not one of them.  However, our valuation of $3.25 was very close to the $3.40 that Chapters offered shareholders for the division, although the stock did trade as high as $4.50 after the article was written.  The whole transaction turned out to be a beautiful short on Chapters' part; taking the division public at $13.50, then reacquiring it at $3.40.

September was when investors were supposed to have returned to the market and when we had expected the next positive trend in the market to begin.  However, more negative sentiment in the market, continued dot-com failures and the spectre of a slowing economy resulted in a downward trending month.

In October we discussed some possible leading indicators to help investors with longer-term investment decisions on the overall market.  The high correlation between the months of September and November since 1991 did continue in the year 2000 as predicted.  If investors had followed our recommendation, they could have saved themselves the pain of the further 8% drop that occurred in November.  Mind you, what's a further 8% when one has already lost 90% of one's portfolio value.

Nortel's overvaluation came crashing down during October and in November we looked at the reasons behind it.  Revenue growth, the quality of the earnings and other non-operational income all affect the valuation of a company and investors must work to dissect these factors. One of our examples of companies that report significant non-operational income, Intel, has estimated that for their fourth quarter they will realise US$675 million in interest and investment income, or approximately 10 cents a share on 38 cents in estimated earnings, or 25%.  Internet shopping was the other topic and initial sentiment from retailers, both on-line and retail, is that this year's Christmas will not be as lucrative as last year's.  Although definitely not the death knell for Internet Commerce, we'll likely see many more online casualties and reorganisations in the New Year. 

Finally, in December we made predictions for the upcoming year for the Canadian Dollar and the overall stock markets.  To date, the Dollar has certainly had a nice rebound, currently around 66.2 cents, from a low of 64 cents just before the Federal Election.  It has just entered our long-term expected trading range of 66 to 68 cents, and will likely stay within that range barring some unforeseen shock: Quebec separation, overly strong Canadian economy or high relative interest rates vis-à-vis the United States.  Our call for the equity markets, volatile but trending sideways, has been somewhat true; the markets have certainly been volatile.  However, the continued downward trend in December and the new 52 week lows below several key support levels may indicate that even further weakness is ahead before the anticipated US interest rate decreases in the Spring.

So, where are we now?  Most investors are concerned with when the Nasdaq, and in particular technology stocks, will recover.  Generally speaking, stocks that have experienced a collapse in their price will go through a protracted period of consolidation before beginning a sustained recovery.  The good side of this consolidation is that there will be substantial trading opportunities over the next several months as the equity markets attempt to find a direction and appropriate valuations.

Our recommendations for both Canadian RRSP and US Core Holdings as of the end of the year performed slightly under their respective indices.

In our Canadian holdings BCE and Imperial Oil represented substantial gains in the portfolio.  A powerful combination of strategic acquisitions and divestitures helped drive up BCE's share price.  While Inco and Onex dragged our portfolio down.  Recent investment downgrades of Celestica pushed down the prices of Celestica and Onex right at the end of the year.  

As we do every year, we will be starting fresh in January with Royal Bank (RY-TSE), Nortel Networks (NT) and MDS Inc (MDS-TSE), while retaining BCE (BCE-TSE), Celestica (CLS-TSE), Onex Corp (OCX).  Further companies will be added as we progress through the year..

The weakness in the US retail industry slashed Best Buy in half, while the technology downdraft caught GM Hughes, HP, IBM, Intel, and Motorola and slashed the prices of these good companies as well.  Citigroup was up nicely, as was Pfizer.  Several stocks were traded during the year, improving the performance slightly over the number reported as of year end.

Our US list for 2001 will begin with EMC Corp (EMC), Enron (ENE), Exxon Mobil (XOM), Integrated Device Technologies (IDTI), Johnson and Johnson (JNJ), Medtronic (MDT) and Sun Microsystems (SUNW).  Again, as the year progresses we will be adding and removing companies as the year progresses.

Overall, we have had a relatively good year.  We certainly enjoyed the market's rocket ride during the year's first quarter, but also endured some pain on the way back down.  Generally, the Internet's "revaluation" that has occurred was expected, it was just a matter of when, not if, and well needed.  Investors that thought the markets just went up have been rudely awakened and the long-term market Bears can finally say "We told you so", although it took them over 5 years to be right.  We are looking forward to 2001 as a year of change and opportunity, but one based on solid fundamentals and valuations, not hype and speculation. ... Well, one can always hope.

Until next month.