DECEMBER 5, 2003
I. NOVEMBER 2003 COMMENTS … STOCKS CONSOLIDATE RECENT GAINS…BONDS TRADE LOWER ON ECONOMIC STRENGTH
- The S & P 500 was basically flat for the month of November following
some modest profit-taking early in the month as investors digested October's
big gains. Economic indicators remained firmly positive. Bonds drifted lower
as strong economic growth will likely put upward pressure on credit demands
throughout 2004 and beyond.
- Domestic business strength was echoed by continued growth in China,
recovery in Japan, and better data from Europe. Surging demand for
industrial commodities also benefited such areas as Canada and Australia.
Fiscal and monetary policies favoring growth are now virtually worldwide in
scope. With inventories at record lows, improving demand is being reflected
in rising production.
- Capacity utilization and employment rates remain low, suggesting that
higher output can put people and machines back into production before
inflation becomes a pressing issue. With world economies growing, idle
resources returning to the production process and credit plentiful, the
positive tone for equity markets should continue.
II. ECONOMIC OUTLOOK …GDP REVISED UPWARD…CONSUMER SENTIMENT IMPROVES…JOBLESS CLAIMS FALL…PROFITS SURGE
- GDP rose at an annual rate of 8.2% in the third quarter of 2003, the
fastest pace since 1983. The increases from the initial estimate in October
reflect strong data on inventories, business capital investment, and
international trade.
- Output of goods and services is rebounding and accompanied by relatively
small increases in costs. The result is substantial profit growth and wider
profit margins. Consequently, business spending on equipment and software
has risen rapidly. Benefits are now being felt through the supply chain,
from production to distribution, due to rising business activity and low
inventories.
- Employment data are also much improved. The layoff rate is down and
announced hiring intentions have rebounded. Help wanted advertising is
recovering and temporary employment data is strong. With recovering jobs
growth, further gains in after-tax income and the wealth effect of this
year's stock market gains, consumer confidence should be on a multi-month
uptrend.
- Consumer confidence data from the Conference Board rose to 91.7% from
81.7% in October, indicating that consumers believe a steady turnaround in
the labor market is underway. GDP should be able to expand at a 4% rate in
2004.
- Strength in industrial production is only partially offset by weaker
residential construction. Non-farm productivity rose at a 9.4% annual rate
in the third quarter, but new home sales are modestly weaker due to higher
interest rates.
III. FIXED INCOME OUTLOOK …INTEREST RATES EXPECTED TO RISE IN 2004…INFLATION REMAINS LOW…ADMINISTRATION RETREATS FROM PROTECTIONISM…WEAK DOLLAR CONTINUES
- Consumer prices were unchanged in October as energy prices declined. The
core CPI, excluding food and fuel, rose 0.2%. Producer prices were also well
behaved.
- The Bush administration is bowing to pressure to rescind high tariffs on
imported steel and has been sharply criticized for imposing quotas on
certain types of Chinese textiles and clothing. Federal Reserve Chairman
Greenspan warned against protectionism in very strong terms in mid-November,
noting that such efforts rarely succeed in protecting domestic manufacturers
for very long. Despite dollar weakness, he noted "little evidence of stress"
in funding the deficit by borrowing from foreigners. Continuing weakness in
the dollar makes U.S. Treasury issues less attractive to foreign investors,
but thus far, there is no evidence of massive liquidation of Treasuries. The
main effect of the weak dollar so far has been to raise prices of goods
imported to the U.S.
- There seems little doubt that bond prices will tend to move lower in the
months ahead. Under these circumstances, we caution against extending
maturities; indeed, opportunities to shorten should be seized. Next year the
Federal Reserve will start to prepare the market for higher rates,
especially at the very short end of the maturity spectrum.
IV. STOCK MARKET OUTLOOK …RAISE EXPOSURE TO CAPITAL SPENDING…RAISE EXPOSURE TO PROFIT RECOVERY…SELECTIVITY IS THE WATCHWORD IN FINANCIAL SERVICES
- Higher interest rates next year will likely force investors to be much
more selective in their interest in technology stocks. Secondary, leveraged
concerns may find next year to be difficult despite generally better demand
conditions for products.
- Low gasoline inventories and rising travel and entertainment spending by
consumers and businesses suggest investment opportunities in these groups.
With housing expenditures set to decline somewhat, consumer spending should
focus more on leisure activities, services and food, both at home and in
restaurants.
- Business emphasis on productivity is paying off. Positions in producers
of productivity-enhancing equipment, software, and technologies are
recommended. Industrial commodities, machinery and industrial equipment
stocks remain interesting.
- As Federal Reserve actions to raise rates draw near, defensive issues
such as health care, personal products, and packaged foods will offer
appeal. Financial services continue to look attractive. Rising stock market
levels will favor capital markets companies more than life insurance stocks.
Similarly, rising employment will favor firms that are leveraged to employee
benefits, help wanted advertising, and related
areas.
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