JANUARY 6, 2004
I. DECEMBER 2003 COMMENTS … STOCKS RISE STEADILY AND
SHARPLY…BONDS ENCOURAGED BY FED COMMENTS…DOLLAR REMAINS WEAK
- Stock prices rose in December as economic data supported expectations of
a self-sustaining recovery led by business capital spending and followed by
employment growth in the New Year.
- The Federal Reserve commented on several occasions that rates would
remain low for an extended period. Inflation news remains positive and
supports stable bond prices in early 2004.
- Currency trends suggest stronger exports, as U.S. goods are now more
affordable to overseas buyers. The value of the U.S. dollar, relative to the
currencies of our largest trading partners, is down about 10%. Thus far, its
decline has been orderly, and no panic has developed in foreign exchange
markets.
- Based on such factors as election year stock trends, interest rates,
consumer confidence, job creation and worldwide economic strength, equity
prices seem likely to rise again in 2004. Bond prices suggest greater
caution as the year progresses.
II. ECONOMIC OUTLOOK …UNIFORMLY FAVORABLE DATA…JOBS OUTLOOK POSITIVE…CAPITAL OUTLAYS RISING
- In December, the number of unemployed Americans seeking first time
benefits fell to its lowest level in about three years. The four-week moving
average of claims fell to 355,750, well below its April high of 459,000.
Monthly data on new jobs and unemployment trends have turned positive.
Monthly job creation may approach a 200,000 rate in coming months.
- The manufacturing sector, an area of considerable weakness in recent
years, expanded strongly in December with its most robust month in twenty
years. New order momentum is strong; the order index reached its highest
level since 1950. Industrial production posted its largest gain in four
years. Businesses, encouraged by final sales, have started the process of
restoring depleted inventories.
- Consumer confidence, while on a high plateau, may rise upon further
progress on the jobs front. Key industries such as housing and autos have
remained strong longer than expected. Consumer surveys suggest even more
positive expectations for the months ahead.
- Quarterly GDP data indicates a much-improved capital spending
environment. Profit margins are at multi-year highs, encouraging business
outlays for new equipment, and hardware/software. Labor costs are quite
contained, supporting rising profit margins.
III. FIXED INCOME OUTLOOK …FED RESERVE POLICY REMAINS ON HOLD…INFLATION STILL LOW…COMMERCIAL AND INDUSTRIAL LOANS SLOW
- Federal Reserve meeting minutes and comments suggest a long period of
low interest rates, perhaps lasting until 2005. Sensitive market indicators
such as gold and the dollar imply that inflation worries are in their early
stages. We think the Fed will move to tighten by late 2004.
- Inflation data remains mixed. Producer prices fell 0.3% in November with
the core rate (less food and fuel) down 0.1%. Inflation was also tame for
intermediate and crude goods. During the past year, crude materials' prices
rose more than 18% but the intermediate core rate is up less than 2%.
Finished goods producers have little pricing flexibility. Consumer prices in
November fell 0.3%. The core rate declined 0.1% as energy prices fell, but
food rose sharply.
- Business loans remain muted. Commercial and Industrial loans as well as commercial paper outstanding trended downward for all of 2003. Thus, we are still in the early stages of inventory accumulation. Corporate cash flow is up strongly, in line with margins. Surprisingly, the economic recovery, at this early stage, has already helped move state budgets from deficits to surpluses.
IV. STOCK MARKET OUTLOOK …2004 OUTLOOK - EXPECT LEADERSHIP TO CHANGE…SECTOR OUTLOOK - SELECTIVITY
- With the economy improving, the stock market environment should remain
constructive in the year ahead. Earnings growth will be very strong,
especially during the first half of the year. Dividends are being raised at
a rapid pace but the background environment is shifting: in contrast to
2002-2003, interest rates may be rising, Europe and Asia will be stronger,
gold is rising, the dollar is weak, and capital spending is stronger than
consumer spending. Housing and auto production should grow at a slower pace
than over the past 18 months.
- The weak dollar and strong foreign economies suggest industrial
equipment and materials will continue to do well. Energy prices are likely
to remain high as world demand increases.
- Healthcare and consumer staples tend to outperform when investors expect
rising interest rates. In contrast, such conditions raise questions about
several financial sub-groups.
- Dollar weakness is a positive for selected technology stocks as well as
consumer staples. Rising employment will support consumer discretionary
groups.
- In light of expected changes, market leadership should gradually shift
from small and mid cap issues toward large cap stocks; from volatile issues
to more stable performers; from low-priced stocks to higher-priced issues;
and from companies with checkered earnings and dividend records to more
predictable, shareholder-friendly records. While favorable sector trends are
always desirable, specific stocks must be evaluated in terms of expected
growth, profitability, financial strength, and relative
value.
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