The Maclean’s Excerpt


How the markets came to crash—and why Canada looks good In the future

DONALD COXE July 14 2003
The Maclean’s Excerpt


How the markets came to crash—and why Canada looks good In the future

DONALD COXE July 14 2003


The Maclean’s Excerpt

How the markets came to crash—and why Canada looks good In the future


Maclean’s columnist Donald Coxe, chairman and chief strategist of Chicago’s Harris Investment Management Inc. and chairman of Jones Heward Investments in Toronto, is one of North America’s most influential institutional investors. In The New Reality of Wall Street (McGraw-Hill), Coxe provides a trenchant and witty explanation of how the U.S. economy came to be mired in its current doldrums, and a survival guide for investors trying to divine the future. And in a book that’s unstinting in its criticism of American capitalism’s recent excesses, Coxe—a native of Newmarket, Ont.—offers praise for oftmaligned Canadian economic policy.

CANADIAN INVESTORS had a rough time of it during the early to mid-1990s. They were forced to invest 80 per cent of their taxdeferred RRSPs in Canada at a time the

Canadian stock market was an underachiever compared to the U.S. and most European markets. Personal income taxes were among the highest in the G7, and the economy underperformed that of the U.S. These were the consequences of decades of tax-and-spend policies. As if those weren’t enough reasons for Canadians to look south in envy, their currency responded to mismanagement by sliding south. The loon is a diving bird, and that’s just what the loonie did.

The good news is that the Canadian attitude toward taxation and spending is changing. The federal Liberals were first elected on a platform of rejecting the key economyopening policies of the previous Conservatives. Once in office, they reconsidered. Canada also became a participant in NAFTA, and, arguably, a far bigger beneficiary from that treaty than the United States. Canada

consistently runs trade surpluses with the U.S., the destination for 82 per cent of Canadian exports, and exports are now more than 43 per cent of Canadian GDP, among the highest in the world.

Canada has also benefited recently from having an independent central bank with a flinty attitude to inflation. Governor David Dodge is on his way to being a global star in the rarefied world of central banking.

Those positive factors are paying off. The Canadian dollar is recovering. Canadian stocks have solidly outperformed U.S. stocks in this millennium, and I believe they will continue to do so. Canada has a wide range of fine short-duration stocks, including its big banks and insurance companies and its leading oil and gas and mining companies.

Meanwhile, Canada is way ahead of the United States in two very important kinds

of taxation. What many investors—including many Canadians—do not realize is that Canada has two tax advantages that outweigh almost all the nation’s perceived disadvantages: a dividend tax credit that goes a long way to eliminating the double taxation of dividends, and no inheritance taxes.

Double taxation was used by the U.S. technology and other go-go companies to justify their refusal to pay dividends. They argued that stockholders did far better when the corporation bought back its own stock in the open market, which drove up the stock price, giving shareowners capital gains at the low rate. This proved to be another example of a principle I learned years ago: “To almost every question there is an answer that is clear, concise, coherent, and wrong?

Why are tech stockholders worse off when management buys back stock? Because the really big winners are not the public owners of the company’s shares, but the owners of tens of millions of stock options. The share buybacks are needed to prevent massive flooding of the market by the insiders when they exercise their options, and to support the stock price. Look at the most conspicuous losers of recent years, such as Nortel and Lucent. If they still had the money they spent buying their shares at prices 20, 30, or 60 times current levels, they would not be on the death-watch list.

Canadian tax law mitigates the double taxation effect by granting a tax credit for 20 per cent of the dividend. The effect is that Canadians should have greater interest in reliable dividend-paying companies than do Americans. It means that Canadian retirees should be emphasizing quality dividend payers, such as the banks, rather than bonds.

On inheritance, Canadians are not liable for estate taxes, but their estates are liable for capital gains taxes, since the deceased was deemed to have sold the stocks held at the time of death. From a tax standpoint, compared to the U.S., Canada is an expensive place to work but a cheap place to die. Many Canadians die in residences they own in the southern United States, having retired to sunnier climes. That can create estate tax problems. If the reader is in this category, he or she would be wise to get advice from U.S. tax professionals.

One other aspect of Canadian investments is worth special mention: the Canadian equity market offers a wide range of income tmsts, including oil and gas, energy, mining,

and other income streams. The best of these are splendid short-duration investments that have very attractive tax treatment. The U.S. market also offers tax-advantaged trusts, but not to the extent available in Canada.

HISTORIANS MAY well conclude that the collapse of technology and telecom constitutes the greatest ever blot on the escutcheon of capitalism. From 1993 to 1999, the yield from the financial environment was Blueberry Hill with unlimited fish and game. Even careless novices lived sumptuously without stress. But the collapse turned the financial environment from inviting to hostile. Not only did it unleash a bear market that wiped out US$7 trillion of wealth, it caused an utterly unnecessary recession.

Those who abused the capital markets to enrich themselves on a grand scale, while inflicting damage to the economy on a grand scale, are the most disappointing exemplars of capitalist morality in history. They professed the virtues of risk taking and gutsy entrepreneurship, but they designed their compensation programs to enrich themselves in the way big-city politicians used to ensure

of sustained growth. That will help faltering economies in the rest of the industrial world. Asia is already in its strongest economic and financial shape since 1996. Global economic recovery should unfold by the end of2003.

The War on Terror will take many twists and turns. If the United States is seen to have achieved an overwhelming victory against terror groups and terror-sponsoring states, insurance rates will pull back from their onerous levels, and so will oil prices. The global economy would be a big beneficiary from a prolonged period in which terrorist activity was small-scale. If, on the other hand, terrorists acquire weapons of mass destruction and murder hundreds of thousands or millions, then the consequences for financial markets and the global economy would be catastrophic. Is it moral and ethical to raise the question in public? Is there any real hedge for investors against the economic consequences of a nuclear explosion in New York or Chicago? Should investors think about the unthinkable?

Successful investing is about trying to discern future reality and then deciding how much to pay for it. We may have entered a

THOSE WHO ABUSED the capital markets to enrich themselves on a grand scale, while inflicting damage to the economy on a grand scale, are the most disappointing exemplars of capitalist morality in history

their personal wealth from the perquisites of office. In many cases what they did—and are still doing—is legal, but it belies their rhetoric about identifying their interests with the stockholders’.

In the coming years of fallout from the endless investigations, lawsuits, and bankruptcies, we will hear continued assaults on capitalism itself. We will be told that some new economic system is needed to protect us from its evils. In fact, what’s needed is accounting reform—and that has begun. And investor skepticism about Wall Street research that overlooks spurious accounting— that is emerging. What’s needed most is investor rage against those who cashed fortunes in stock option profits on companies whose share prices were on the verge of collapse.

At some point, the U.S. economy will surprise the doubters by moving back to the path

period in history where the risks are unquantifiable. Chances are, few of us will see such a beneficent confluence of sustained peace, falling inflation, falling interest rates, strong economy, and strong stock prices as the 1990s offered again in our lifetimes. But we do need to invest in our lifetimes, even if there are terrorists and terrorist states out there, and even if they are acquiring access to weapons of mass destruction.

When, in The Lord of the Rings, Frodo learns of the threat of the Ring, he says to Gandalf: “I wish it need not have happened in my time.” “So do I,” Gandalf replies, “and so do all who live in such times. But that is not for them to decide. All we have to decide is what to do with the time that is given us.” Use your time with wisdom. lifl

Copyright 2003 by The McGraw-Hill Companies Inc. Reprinted by permission.