July 9, 2008

Dear Unitholders:

The net asset value of the Formula Growth Fund as of June 30, 2008 was $3,233.62 per unit. For the quarter, this represents a 0.1% increase in Canadian dollars and a 1.0% increase in U.S. dollars. 

In the first half, our results were in-line with the U.S. indexes listed in the table above as well as in-line with the average small-cap growth manager who has lost 11.8%.   It has been a very difficult and turbulent year so far.   It has been so difficult that the performance of the market in June was the worst month of June since 1930. Similarly, the first six months of 2008 represents the worst first half since 1970.  To top it off, both of these milestones have occurred during the worst decade ever for U.S. stocks.  It is little consolation that all major global markets are in negative territory for the year.

The reasons for the volatile stock markets are numerous.   Record prices for oil and other commodities are pushing inflation higher.   American economic growth is slumping to recessionary levels amid months of difficulties with housing and credit. Worldwide, many longstanding, venerable companies are facing fundamental troubles with their business models.   Among them are banks, brokerages, retailers, home builders and auto makers.

While the bear market could persist, it is important to remember that stock market bottoms happen well before economic activity bottoms.  The current environment is an excellent one in which to buy growth stocks at discounted prices. When it comes to stocks, if it’s in the headlines, it is reflected in the stock price. The extreme pessimism has driven stock market valuations down to reasonable levels and this should encourage bargain hunting. We remain fully invested and find ourselves amongst the bargain hunters.  

A quote from Warren Buffett seems very relevant at the moment: “I will tell you how to become rich…..be fearful when others are greedy.  Be greedy when others are fearful”.  We look forward to seeing the portfolio marked back up when fear subsides.

These days, there is a growing perception that the U.S. has lost its pre-eminent position as an economic power.   The reasons behind this thinking are explained in the following facts.   As recently as 1995, the U.S. represented one third of the world’s output as measured by GDP and one half of the world’s stock market capitalization.   Today these ratios have declined to one fifth of the world’s GDP and one third of the world’s stock market capitalization.   Clearly America’s share of the global pie has shrunk by some 40% in twelve years.

What is being lost in this analysis is that since 1995, the U.S. stock market capitalization has tripled to $20 trillion (see diagram below).   While America’s piece of the global pie is getting smaller, it is simply because the pie is getting enormous as the rest of the world rushes to industrialize.   New markets, such as China, are creating billions of new customers for American products and services.   In 1995, only 15% of U.S. corporate earnings came from international markets.   Today, international markets represent 50% of total earnings.  One of the reasons that in-roads into global markets are possible is because the U.S. remains a leader in science and technology.   The U.S. still accounts for 40% of world spending on scientific R&D, employs 70% of the globe’s Nobel Prize winners and is home to 30 of the top 40 universities. Resilience, not complacency, is the watch word for our friends to the south.

The rise of the rest of the world, as it competes for its share of the pie, will continue relentlessly. There is no doubt that globalization is tumultuous and unruly to the old order of commerce. There are many supply and demand imbalances being created. This is obvious from the upheavals in stock, debt, commodity and currency markets in recent years. Yet the growth in addressable markets for U.S. goods and services will also be robust. The U.S. will participate in this new world and opportunities should abound for investors in US stocks when the dust finally settles.

For those unitholders who were unable to attend our annual meeting on May 26^th, 2008, the presentation is available online at our website www.formulagrowth.ca.

For our taxable Canadian residents, there are no realized capital gains so far this year. We will provide an update in the next quarterly letter. 

Yours truly,