SEARCHING FOR A BOTTOM: We suggested in our last update that equity markets had still not reached bottom and that a final capitulation was necessary before markets could turn. As evidenced by global markets in the third quarter, we believe we are certainly much closer to some sort of resolution. Unrelenting sales of equities in July verged on panic selling and the total fixation on negative news made investors wonder just how worse the environment could become.

As of the beginning of October, the S&P 500 had lost a record $8 trillion and is down 49% over 927 calendar days. It is now the second longest and third worst (after 1929 and 1930) bear market in history. As we have previously commented, equity markets will likely go to extremes on the downside much like they did on the upside in early 2000. In a nutshell, psychology is driving equity markets at the moment and we need an "event" or trigger in order to change course. Unfortunately, history shows that we seldom see the "event" beforehand. Suffice it to say that things are moving quickly. What we do know is that we have suffered one of the greatest and longest cyclical bear markets in history.

Be that as it may, we are now more constructive on equities then we have been in sometime. The Canadian economy has surprised on the upside while the U.S. economy, despite some faltering, has remained amazingly resilient exhibiting GDP growth of 3% in the first half. Equity valuations, ex telecom and technology shares, are now at much more reasonable levels. Based on the CPMS data base, that the current price/earnings ratio on the S&P 500 for the next 12 months is 14.02 times and 13.33 ex tech. While bonds have certainly had a great run, they are now at their lowest yields in nearly two generations. With the growing magnitude of underfunded pension plans worldwide coupled with still too high actuarial return assumptions, we wonder if an asset mix shift may not be too far in the offering. Common sense would suggest that bonds just cannot 'cut it' from here in terms of total return.

To be sure, there is much to worry about. Excessive corporate debt levels need to be addressed. Ongoing strength in real estate has generated talk of another bubble (however we don't see signs of rank speculation just increased affordability). Competitive global markets and excess capacity have raised the spectre of deflation and the looming showdown with Iraq has also contributed to investors fears. All are certainly very real and serious concerns. Yet we would suggest that many corporations have already begun to implement the steps necessary to exhibit improved earnings going forward. Cost-cutting is rampant. Inventories are in very reasonable shape. Earnings quality and financial disclosure is improving dramatically in response to the litany of corporate scandals. In fact, earnings quality has never been better. Nothing like a little fear to keep a CFO on track. Iraq remains a wild card.

Yet, we can't help but remember all the doom and gloom naysayers the last time around. Does anyone really think that Iraq's military capability is any better today? The uncertainty of an attack is likely worse than the reality. We feel it worth repeating an interesting quote that we came across from one of our research services regarding turning points in the market. "Risk is the lowest when the danger of loss is the greatest." It may sound rather counter-intuitive but its absolutely true.

Our strategy going forward remains unchanged. We plan to maintain our relatively high cash reserves to take advantage of market opportunities. Price discipline is paramount on purchase. We have invested in companies that, based on our research, can show improved earnings without any heroic assumptions of an improvement in the overall economy. We continue to favour investments in the energy sector, specialty retailing, property/catastrophe reinsurance, growth gold shares and drug manufacturing outsourcing. We have also identified several unit trusts that offer very attractive yields combined with growing underlying businesses that are not simply a return of capital.

Based on our many combined years of experience in the business, it would be a very major tactical mistake to capitulate at this very late stage in what has turned out to be the biggest bear market since the depression. History shows that when equity markets turn, they do so unexpectedly and with a vengeance. We believe that our portfolios are well-positioned on a relative basis regardless of which direction the economy heads. To be sure, this has been a trying time for all and we greatly appreciate your patience and understanding. We remain totally focused and committed to generating outperformance in our portfolios.

Disclaimer:
This report is intended for clients of Galileo Global Equity Advisors Inc. Galileo Global Equity Advisors Inc. invests on behalf of its clients in the issuers mentioned in this report. Employees of Galileo Global Equity Advisors Inc. may own shares. This document is not intended to sell or promote securities.

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