Investment Outlook 1995

Head Table Guests

Blake Goldring, Senior Vice-President, Sales and Marketing, AGF Management Limited and a Director, The Empire Club of Canada; Don Davis, Senior Vice-President and Director, Richardson Greenshields of Canada; Meri Rawling-Taylor, Mutual Fund Marketing Manager, Wood Gundy Inc.; Ian Cook, Senior VicePresident and Director, ScotiaMcLeod Inc.; Gilles Ouellette, Executive Vice-President, Private Client Division, Nesbitt Burns Inc.;

The Rev. Bill Steadman, Minister, Rosedale United Church; and Dan Brintell, Senior Vice-President, Midland Walwyn Capital Inc.

Introduction by John Campion

Tulips for Sale: $70,000 per Flower

While there were active security markets in Genoa, Florence and Venice as early as the fourteenth century, the first modern stock market--modern especially in the volume of transactions--appeared in Amsterdam at the beginning of the seventeenth century.

That land was certainly suited for the creation of such a significant mechanism for the funding of economic activity. The land of the Dutch was stable and wide horizoned.

Its people were sensible and somber. It was an auspicious beginning--filled with great expectations that have indeed been fulfilled as we survey the landscape of world economic activity and modern markets in the 1990s.

The whole process of investment is now a world-wide phenomenon of critical importance to the well-being of individuals whose personal wealth and future is at stake, to the participants in local, national and international markets, whether they be start-up companies or large international conglomerates and to governments who can no longer hide behind the stature previously accorded to governments as they carried out their activities in domestic, monetary and fiscal policies.

Much of the investment world is represented by the somber, professional, sensible and stable side of investment activity. But, as a means of contrast, and a note of colour, I would like to review the opposing forces in the international market to sound investment advice.

A major force that has been with us since the early 17th century is what John Kenneth Galbraith calls "financial euphoria" or "speculation." Professor Galbraith attributes the continuing episodes of speculation in markets over our modern history to the fact that anyone, taken as an individual, is tolerably sensible and reasonable, but, as a member of a crowd, can at once become a blockhead.

The only protection from what can conservatively be called mass insanity is a clear perception of the characteristics common to speculation, whether it be in property, securities, objets d'art, gold or even the lowly tulip. I note, with John Maynard Keynes, that speculators may do no harm as bubbles on a steady stream of enterprise.

But, the position is serious when enterprise becomes the bubble on a whirlpool of speculation.

Let me, for contrast and colour then, turn to the tulip.

In the 1630s, in the stable and somber land of the Dutch, speculation began in tulip bulbs. There were 160 species growing wild in the Eastern Mediterranean countries and on east from there. The bulbs first came to Western Europe in the sixteenth century. In time, enormous prestige was attached to the possession and cultivation of the plant.

Speculation came, as it always does, when the popular imagination settles on something seemingly new in the field of commerce or finance. The tulip, beautiful and varied in its colours, was one of the things so to serve. The rush to invest engulfed the whole of Holland by the mid-1630s and no person of even minimal sensitivity of mind felt that they could be left behind.

One bulb was exchanged for a new carriage, two grey horses and a complete harness. At one point in time, a merchant who had paid 300 Florins, or $70,000 in today's currency for one bulb, had the misfortune of rewarding one of his servants with a fine dinner when the servant returned from the Levant with a boatload of important goods, including the valuable tulip bulb.

The tulip bulb went missing. When the owner sought out his servant to find out where the missing bulb had gone, it was discovered that the servant had eaten $70,000 worth of plant, along with his dinner, thinking it was an onion.

Lest we think that this story is too quaint to be instructive, we can only look at the wreckage of property companies around the world who are caught up in the same speculative euphoria in the 1980s.

The men who inspired this story are three broadly respected financial advisers, who by their reputations represent the sensible and reasonable, and through their experience have shown they have the clear-headed capacity to distinguish between a good investment and a speculative enterprise.

The first is Warren Goldring, Chairman and Chief Executive Officer and Director of AGF Management and AGF Trust Company, who will speak to us on fixed income markets.

The second is Michael Landry, President and Chief Investment Officer of Mackenzie Investment Management Inc., who will speak to us on international equities.

The third is John Zechner, who is the Chief Executive Officer of his own investment counselling firm, J. Zechner Associates, who will speak to us on the Canadian equities market. This series is a first for our Club; please welcome these three financial experts.

Warren Goldring

Mr. Chairman, honoured guests, ladies and gentlemen, I want to praise you for your faith. You applauded before you heard my forecast. I'm standing on the platform of this illustrious room to which some of the most famous entertainers have come to amuse and bring joy and fun and laughter to an audience just like you. It is with some reluctance that I come today offering as my entertainment this interest-rate forecast for Canada in 1995. i am reminded of that scurrilous old saw that if you really want to turn the rate of interest, ask the bond manager to speak.

I'm also honoured to be on the same platform as two illustrious co-panelists, and I look forward to the chance of discussing things with them.

I just want to mention that I am going to be speaking to you as individuals in the bond-investing way, and that I will be talking only about government bonds when I use that term in my short address.

In order to put a benchmark for this talk, I'm going to use a definition from Ben Graham which is: investing is a process which, after thorough analysis, promises the preservation of your capital and some return.

That's really why I am quite interested in bonds; I always have been. I have been a bond manager. Let me just put this proposition to you: where in the world can you get an investment which gives you 9.375 per cent income this year, next year and for the next 20 years, with virtually no chance of loss of your capital, and a reasonable probability of making 20 per cent or more on your money in the next two or three years--and with marketability so at any time you can change your mind and get out?

No, this is not Britain and it's not South Africa. This is right here in Canada, with the Government of Canada 9.375, 20-year bond. This is a unique situation. Whatever we think of these bonds, the people I talk to around the world rank this kind of bond as one of the best in terms of historical cheapness and attractiveness of the market for the next few months and years. They recommend it. Your attitude about bonds is probably scornful.

What about Mexico? Well, Mexico is a poor country, which has never had a domestic bond market. The U.S. pay issues which they have are down 10 per cent compared with the losses they have had on their currency of 60 per cent and their stock markets are down 50 per cent.

I don't even like to put Canada in the same category. I think I must say that Canada is so different from this. Canada has had the tradition of sanctity between the lender and borrower and we are really quite a rich country compared to Mexico. Our wealth is built on that simple concept that we honour our obligations. And I'm quite confident that what has happened in Mexico will never happen here, because of all the alternatives that face us as Canadians, that would be absolutely the worst.

But you would be concerned, I'm sure, about inflation. Inflation and bonds don't seem to match. We are prisoners of our own time-frame. If you have looked back in history, the best way to make money from 1920 to 1946 was through bonds. On the other hand, from 1946 to 1981, stocks were better than bonds. That's partly because the stock market was so extraordinarily cheap in 1946 and 1949. Since 1981, the bonds and stocks have moved about parallel to each other. I'm going to say that you now have a choice of both. While I'm going to espouse the bond side, I'm certainly endorsing stocks at the same time.

But to make a choice, you'd have to make some estimates of future inflation. And future inflation depends upon a lot of different figures which are coming out. Bond-market holders all over the world are watching those figures. They are not dumb people. They have experienced the time when inflation eroded the buy of the bonds in the 1946 to 1981 period. Therefore, once they see a symbol or a sign of any inflation, they sell the long-term bonds, and go into cash, causing interest rates to rise.

And I would say, and this is not starry-eyed idealism, that the bond-fund managers, of whom there are 40,000 or more around the world now, are enforcing that contract between lender and borrower in a way that has never been done before. If this persists for two or three years, we will have a whole new type of ball game--one which is much closer to the gold standard in the 1800s, and one which promises great, great prosperity. I think that if you look at those who benefit and at those who are hurt by inflation, the ones who are hurt most are real estate developers, largely because of the time-frames they have to operate in.

This brings us to global investing. Actually, in global investing you get a broader range of opportunities, with good-quality bonds, but you also get the opportunity to make or lose on the currency. It's strange though how countries, like companies, can sometimes get it altogether and have good economic growth, low inflation, steady interest rates and strong currency. When you have got that kind of combination, you have got an excellent bond environment.

I like German bonds at eight per cent. British guilds look good to me at eight and a half per cent. I think they will be down well below eight per cent by the end of the year. French bonds are in a similar position. I think the U.S. market will benefit not only from certain technical factors, but also because of a flight of money from more difficult parts of the world back home to the safe haven of their bond market.

I would like to make a forecast now. I expect that the bond market will be up sharply in the first quarter of this year, of course starting tomorrow. This is because we have a flat yield curve in Canada and the United States.

That leaves lots of room in the very short term to have that curve rise by quite a margin (as I expect it will) in order to quell any further inflationary worries.

Inflation is well under control. In the U.S., the consumer is over-indebted. In Canada, we are over-taxed. But the main reason why I expect an up-tick in the bond market here is: real rates are high. They are comparable to the period before the bond market rally in '84, '82 and also back in 1932. In the third and fourth quarters, I believe we'll have a really strong bond market.

Warren Buffet stated that there was no purpose of forecasting other than to make fortune-tellers look good. I'm happy to make fortune-tellers look good, but my own thought is that a forecast can stimulate you and your investment opportunities. I'm optimistic that we'll have not only a strong currency but a strong bond market. Thank you.

John Campion

As I've indicated Michael Landry is the President and Chief Investment Officer of Mackenzie Investment Management Inc. He has been involved in investment management for over 20 years. Prior to becoming President of Mackenzie Investment he was the Senior Vice-President and Global Portfolio Manager with Templeton International. He is a founding member and former director of the International Society of Financial Analysts and a former director of the Canadian Pension Fund Management and a co-manager of the Universal World Growth RRSP Fund. i would ask you please to welcome Michael Landry to speak to us on international equities.

Michael Landry

Thank you, Mr. Chairman.

It is a difficult time to be speaking about international investing. I just got off the phone with our Latin American analyst. The analyst was extremely optimistic about every country in Latin America besides Mexico.

I think we have to look at the world differently than we have in the past. Things have changed quite a bit. I think that is causing a lot of the confusion that we see in the market. Over the past five years, we have seen four billion new capitalists come into the system and that has to be taken into consideration in the investments. We've gone from a billion capitalists to five billion capitalists.

I just got off the plane after two weeks in the Far East, in almost every country along the Pacific Rim. The business activity that's going on does not match the negative attitudes towards emerging markets, towards Hong Kong for example. There is so much opportunity out there at this particular time. At this juncture, I think we should be a lot more positive, not only about the prospects for the Canadian market, but, I think, for the prospects of most international markets. But, as usual, I think you have to be selective.

I'd like to start by saying that global competition isn't going to go away. So we have to look at the companies that have done the right things, wherever they are, in terms of restructuring, whether it is closing marginal plant facilities, getting wages in order, or doing whatever it takes to be able not only to stay in business but increase profits, equity return, assets, and all the important numbers that the analysts look for.

First of all, we expect that interest rates over the year will go down as people see that inflation is not going to be a problem. Technology is changing, that so I think that long-term interest rates probably will come down 50 basis points or more. Short rates will go up. The market is expecting that. But we'll learn to live with that. We had very strong markets in the 80s, when we had short rates that were much higher than that. People will adjust to that. Where do we think the best values are? Well, first of all, we think the economy will continue to be led by investment spending. So the capital goods companies will continue to do well. The technology area will give a positive impetus towards lower inflation. Another area in the United States that we think will do very well is that of the small capital emerging growth stocks. Emerging growth stocks are halfway through a bull market. This started about three and a half years ago. Right now you can buy stocks that are growing at 25 per cent per annum in the U.S., at market multiples around 16 and 17 times. As we get more and more mature markets in that area, a multiple expansion should give some substantial returns to well-managed emerging growth stocks.

Looking over to Europe we should see some strong markets, a return to what we saw back in 1993. Of the best value in Europe right now (in terms of a bigger market) is France. The market is selling on perspective earnings of 10 to 11 times next year's earnings. There's been substantial restructuring among French companies, whether in the cyclical stocks or in the financial sector. So that's the market that we expect should do best next year.

Germany still has a lot of problems. They are trying to integrate such a large population from the former East Germany. They have one of the highest wage levels there in the world because they have been integrated with the rest of Germany. They have one of the lowest productivity rates at this point because of moderate plant facilities. This will change over time.

The Spanish market looks very cheap at this particular time. They've learned how to be corrupt like the Italians did. That's just a joke, but they've learned about corruption and scandals and that sort of thing. But it provides buying opportunities. The Italian market is selling on next year's cash flow at about 3.8 times.

I'd like to look at Hong Kong for a second. I know we see a lot of press about an inflated real estate sector comparable to Japan. Well, there are a lot of big differences. In Japan, when it has its inflated real estate sector, you have stocks selling at 60 or 70 times earnings. We've got stocks selling in Hong Kong on next year's earnings at less than 10 times. The market in general is selling at about nine times next year's earnings. We've got corporate property growth over the next five years at 15 to 20 per cent. So the economic prospects are extremely good. Well, what about 1997? As Li from Singapore said, " What happens after 1997? 1998." That's it. It's going to be business as usual, and so there's very, very good value there. The market is off somewhere around 35 per cent last year. It's down some more this year quite a bit. It is a tremendous buying opportunity.

It is expected that 60 per cent of world output in the next 25 years will come from developing nations. Within five years, there'll be more world output from developing nations than the developed nations. So you have to take that into consideration in your investment programme. And in Asia, some of the countries that look extremely attractive, especially on a valuation basis are Indonesia, Korea (particularly on a cash flow basis), Malaysia and Taiwan.

But you always have to take into consideration how much you pay for something. In South America a lot of extremely good value has been created by the Mexican situation. Canada isn't similar to Mexico; nor is Brazil, Argentina or Chile. The fundamentals are extremely different. Whereas Mexico only had 15 per cent of its GDP in exports, Brazil, Argentina and Chile are substantial export countries.

So all that's happened in the past little while has created a tremendous buying opportunity in these markets. The market we like in that area the best, because of valuation, is the Argentinean market, which was significantly undervalued. In the last few days, we have been buying utilities at five and six times earnings, with yields of over 10 per cent in Argentina and with growth rates of 15 to 20 per cent. So we're very positive about some of the countries in Latin America.

Again you have to be selective. Not all companies are going to do well. You have to pay attention to how much you pay for things.

I'd like to say that Canada and Australia will probably do well, because commodity prices should be very firm over the next year and in the years to come. We expect commodity prices will remain firm over the next three to four years, if not longer. And that's very good for Canada. That'll be very good for the dollar here. And it will be good for the markets.

So I would like to finish by saying that as we move to the next century, the world will be a lot different than it is today. New economic players are going to emerge, and it's going to be important for everyone to identify those and to make investments. At the turn of the century, the British identified a lot of investments overseas, Canada was an emerging market and so were Argentina and the United States. The United States and Canada got it right for most of that period. Unfortunately Argentina didn't. But it is interesting to note that by 1915, 50 per cent of the British portfolio holdings were in emerging markets at that time. So this is not a new phenomenon.

It is another turn of the century. There are new things going on, and I think we have to open up our minds to those things, and look at volatility as an opportunity rather than as a crisis.

When it comes to RRSP investing, there are now ways to invest in RRSPs on a world-wide basis. I think that investors should take some of their money and put it overseas. Even though Canada looks like a very attractive market for the next year or two, the number one notion in investing is diversification. Any time you can increase your diversification, the better off you are. Canada isn't any bigger, from an economic standpoint, than California, and a Californian would never think of just putting all of his investments in California. Putting all your investments in one country is no different than investing only in stocks that are located east of the Mississippi. Make sure you open up your universe and have as much potential as you can. So I will leave you on that note. Thank you very much and good luck in your investing in 1995.

John Campion

Our final speaker today is John Zechner who, as I have indicated, is the Chief Executive Officer of his own investment counselling firm. This firm was established in June of 1993 and has grown in the first 18 months of its existence and has assets under administration of some $900 million. The Canadian International Group of Funds became his first client and he currently manages the top performing Cl Canadian growth and CI Canadian Balanced Funds. Mr. Zechner graduated from the University of Western Ontario with a Masters degree in Economics in 1980. He spent time working for External Affairs and Bell Canada in Ottawa. He began his career in the investment field in 1983 with Pitfield, Mackay Ross in Toronto and later joined the Morgan Group as a portfolio manager. In 1987 he became a partner in Andy Silos Associates and was an investment counsellor with Elliot & Page as a lead equity manager. I would ask you please to welcome John Zechner to speak to us on Canadian equities markets.

John Zechner

I want to outline a few things today. I'd like to talk a little bit about the Canadian market going forward, some of the good news I see coming out of corporations, some of the bad news I see and just some of the overview of the economy.

I think when you are looking at stocks and bonds in Canada or in any country, you've really got to focus on one thing. These are financial assets, not real assets. I have no doubt about where the economy has gone in the past year. You can see the growth rates there. You can see the huge corporate profit growth. But when you think of it, last year in Canada we had corporate profits growing over 100 per cent. We had an economic growth rate that led the OACD, and it will probably come in by year end around five per cent. And we had a measured inflation rate of basically zero. How could you expect a better environment for financial assets? And yet the TSE was down about three per cent on the year, and bonds were down double digits.

So there is a real separation of what is going on in the real economy and what is going on in the financial economy. That's why I start to focus a little bit more on what's going on with the U.S. Federal Reserve and where interest rates are going this year. Maybe I spend too much time trying to figure out what Mr. Greenspan is actually up to. But if you can tell me what he is going to be doing this year, I can tell you exactly what I want to do in the market.

Last year was a classic example. You could have every economic earnings release a week in advance. I doubt it would have helped you make more money than you would have made without them. It was that type of a year.

Though looking forward, let's get this right first. Figure out where interest rates are going. If Alan Greenspan is going to come out aggressively and push up interest rates another two or three hundred basis points, bonds may ultimately rally on that, but we are not going to have good stock markets.

So I try to figure out what is occurring in the U.S., and why the Americans have been so aggressive on short-term interest rates. Well the main reason seems to be the end of the worries about inflation. I don't think inflation is going too much higher.

Look at some commodity prices. Fertilizer prices are up. A lot of costs associated with final producer or consumer prices are coming down. Even wage pressures are non-existent right now.

Why aren't corporations suffering profit decreases because they have to absorb the higher prices? Well, because technology, downsizing, restructuring and improved productivity have all improved the cost structure of these companies during the last couple of years. The auto companies are more efficient.

What's been going on in corporate Canada? We have got a lot of companies that have achieved substantial turnarounds in Canada. I'm going to see great profit growth going forwards. I'm very positive on what's happening on the corporate side. I think corporate Canada has largely done its job, and has done the cost restructuring.

I don't think we'll get run-away inflation in the next couple of years. I think we are starting to see some slowdown in the increases in short-term interest rates. Inflation is not coming back in a big way. So real interest rates are higher than they have been in decades. At some point, that's going to make a difference, whether it happens today, tomorrow, next week, or next month.

I'm getting very comfortable. I was starting to put money into the long end of the market. There's still some risk from the currencies but there I'm a little bit more bullish on the North American side than the rest of the world. I think the U.S. dollar is probably our key starting point. And the U.S. dollar to me is an extremely undervalued currency. I think there has to be a little bit of a restructuring of currencies out there, and I think the U.S. dollar will end up being one of the big winners. So that it is the view on the currencies.

Going forward to the stock market, this could work out very well for Canadian stocks. We're still going to have an economy going forward at a pretty strong rate. We are going to have corporate profits growing, as I say, better than 50 per cent. I still see some benefits here. I think there's a lot of opportunity in the Canadian market going forward.

That's the good news. I'm going to talk about the companies, and a few other things. Let me give you, quickly, the bad news out there. Unfortunately, the bad news is that the deficit is going to come right back. This has not been addressed properly. It is talked about; some people say the government is addressing it slowly; it is not happening fast enough. We cannot go into the next downturn basically with a $25 or $30 billion federal deficit. This has to be addressed now. I think they are going about it the wrong way. You have to change the mentality of Canadians in general. You have to sell this idea like any product or anything else. This has to be marketed. Canadians are still believing too much that with a few more taxes on the rich, and a few more taxes on corporations, this problem will be gone. Well, did we not learn anything from Massey-Ferguson moving to Buffalo and taking all the tax revenues away? These companies can move anywhere in the world. If they don't like it here they'll move elsewhere, and 60 or 70 per cent of nothing is nothing. So this is not the way to address a deficit problem. The mentality has to be changed.

This is the time to do it. We've had the creation of over 300,000 jobs in Canada in the past year. We have got on the leading OECD growth rate right now and have low inflation. This is the time to cut the deficit. We can't go into the next downturn with this. That is a negative. I say that corporations have done their job. It's not necessarily the government's fault. The government is just a manifestation of the people. Thank you very much for listening. That's my part.

The appreciation of the meeting was expressed by Blake Goldring, Senior Vice-President, Sales and Marketing, AGF Management Limited and a Director, The Empire Club of Canada.