APRIL 3, 2003
I. MARCH 2003 COMMENTS … STOCKS RALLY ON WAR
NEWS…BONDS HOLD VALUE…OIL,
GOLD LOWER, DOLLAR RISES
- As war with Iraq began, stocks mounted their best weekly
rally in 20 years. This rally can be interpreted in many ways:
reduced levels of uncertainty, protection of American interests,
lower oil prices, high approval ratings for President Bush, and
improved chances for passage of significant tax rate reductions.
Short-covering was doubtless at work as well. We see the rally
as significant in that it is a graphic illustration of the risks
of remaining bearish.
- Bonds have held value fairly well in this environment, and
we would expect to see bond prices come under some pressure when,
and if, the stock rally accelerates.
- Oil prices are well below their pre-war highs. The U.S.-led
coalition forces moved quickly to secure Iraq's oil fields and
avoid a repeat of the Kuwaiti oil well fires set by retreating
Iraqi troops in the first Gulf War. Falling oil prices will
have the effect of a tax cut for American consumers this summer.
- Short-term economic indicators will be negatively affected
by war news, and data reports in the weeks ahead must be considered
in that light. Reports will show little evidence of an economic
recovery but the key ingredients are now in place
II. ECONOMIC OUTLOOK …UPCOMING DATA DISTORTED BY WAR…RECENT DATA DISTORTED BY WEATHER…CONTINUE TO EXPECT MID-YEAR RECOVERY
- Consumer credit rose in January at a 9.1% annualized rate.
Auto sales were weak in February leading GM to reinstate significant
incentives to reduce inventories. Non-auto inventories seem
quite low, therefore modest demand increases should stimulate
production. Excluding gasoline sales, retail sales fell 1.4%
in February after a sharp upward revision in January. Poor weather
and war worries appear responsible.
- Construction trends were mixed. Housing starts fell 11%
but building permits were little-changed. New and existing home
sales fell as consumer sentiment declined and employment-related
indicators remained depressed. Durable goods orders fell 1.2%
in February. Leading indicators fell 0.4%.
- The environment of recent weeks has hardly been conducive
to economic participants making commitments: consumers to buy
homes and automobiles, or businesses to hire staff and purchase
capital goods. War uncertainties, job worries, and higher gasoline
prices need to recede before growth plans are made. We expect
these concerns will diminish by mid-year.
- Government spending continues to move higher and there is
anecdotal evidence that the weak dollar is stimulating export
sales. Energy prices have moved sharply higher in the past few
months and will begin to cut into disposable income. Recently-proposed
Bush Administration tax cuts would tend to mitigate energy price
increases if Congress acts quickly. Cash flow benefits of mortgage
refinancing will taper off towards year-end. Thus, the importance
of business investment spending over the course of 2003 is clear.
III. FIXED INCOME OUTLOOK …YIELDS REMAIN AT 40-YEAR LOWS…FED LEAVES RATES UNCHANGED…INFLATION MEASURES RISE
- Producer prices rose 1.0% in February, but core rates excluding
food and energy actually fell 0.5%. Consumer prices rose 0.6%
but core prices rose by only 0.1%. Clearly, the effects of the
recent surge in oil prices are being felt at both wholesale and
retail levels. With the onset of Iraqi hostilities, oil prices
fell sharply and inflation measures should be much better behaved
in the months ahead.
- Gold prices moved lower as war-related uncertainties diminished.
Falling oil prices also helped, as did recovery in the dollar
over the past few weeks. We remain concerned about the rapid
increase in government spending in virtually all areas, not only
defense.
- Our position on bonds can be characterized by the word, "cautious."
We expect the next major interest rate move to be upwards but
this may be quite some time in the future. Federal Reserve policy
will not become restrictive any time soon and the central bank
is always reluctant to raise rates as elections draw near. If
anything, the Fed will follow the market up later this year when
some increase is likely as businesses borrow to strengthen working
capital.
IV. STOCK MARKET OUTLOOK …VALUATIONS AT HISTORICAL AVERAGES…UNDER-FUNDED PENSION PLANS…RELUCTANT MUTUAL FUNDS…INDIVIDUALS INCREASE SAVINGS
- By most measures, stock valuations are at average historical
levels. Prices are neither dear nor especially cheap. This
suggests that stock selection skills are of paramount importance.
- Pension funds drove stocks higher during the 1980s but many
large pensions are considerably under-funded and companies are
being forced to make sizable contributions to bring assets into
closer balance with pension liabilities. It is unrealistic to
expect managers to enlarge their commitment to equities under
such circumstances.
- Individuals, through mutual funds, remain more interested
in bonds, including high-yield bonds, than in growth stock funds.
This is understandable in light of three years of falling stock
prices.
- Our sector emphasis is little-changed from last month, as
is our attention to demographic factors and China. We prefer
companies that benefit from a growing market in China to those
which compete with China. Overall, we remain focused on companies
with market leadership that dominate profitable and growing niches
of the economy.
NOTE: VISIT US AT ANY TIME IN OUR OFFICES OR AT OUR
WEBSITE, www.beacontrust.com