JULY 8, 2003
I. JUNE 2003 COMMENTS … STOCKS STRONG…BOND YIELDS RISE…MARKETS SUGGEST ECONOMIC REBOUND IS ON ITS WAY
- Stock prices advanced again in June. Healthcare and telecom
stocks were especially strong. For the first time in many quarters,
high-profile earnings warnings did not derail an incipient rally.
Fundamentals appeared to support a more optimistic view on the
second half of the year.
- Bond prices fell significantly, suggesting bond buyers also
believe in the economic recovery and are reluctant to commit
funds when rates are at 45-year lows. Bond investors with international
flexibility are likely moving funds out of dollar-denominated
bonds and into issues in stronger currencies such as the Euro,
Yen, and Pound Sterling.
- According to trade sources, yields on taxable money market
funds average 0.60%. Investors have been net sellers of such
funds in recent weeks, searching for higher yields.
- The next few weeks will see the usual seasonal barrage of
earnings reports. We expect most reports to meet or exceed expectations,
providing more fuel for somewhat higher prices. If funds continue
to move out of bonds, stock prices could work their way substantially
higher.
II. ECONOMIC OUTLOOK …INDICATORS MOSTLY POSITIVE…UNEMPLOYMENT RISES… LEADING INDICATORS AHEAD SHARPLY
- Housing starts and permits both rose in May, as did sales
of new and existing homes. Consumer confidence was little-changed
in June after the April-May surge from earlier war-related worries.
- Unemployment reached 6.4% in June. While payrolls fell by
about 30,000, government data indicated that about 610,000 people
resumed searching for work. In addition, the labor force swelled
because high school and college graduates began to seek employment.
- Leading economic indicators were ahead sharply. Of ten individual
indicators, eight were higher and two were unchanged. Various
reports suggest that the manufacturing sector is starting to
improve, aided by dollar weakness, falling energy prices, and
considerable monetary and fiscal stimulus.
- Corporate profits were nicely higher in the year's first
quarter and the relatively light warnings for second quarter
earnings suggest further gains in profits. The stage is being
set for higher business confidence, with improved capital spending
and positive hiring decisions likely in the second half.
III. FIXED INCOME OUTLOOK …FED REDUCES RATES FOR 13TH TIME SINCE EARLY 2001… WHOLESALE PRICES DOWN…CONSUMER PRICES SHOW SOME UPSIDE
- The Federal Open Market Committee (FOMC) reduced the fed
funds target to 1% at its June meeting. One dissenting vote on
the FOMC was in favor of a half-point cut. Clearly, the FOMC
will not be raising rates until a significant economic recovery
is firmly underway. We would guess that no rate increase would
be seen until next year, and then perhaps not until after the
November Presidential election.
- Wholesale prices declined 0.3% in May. The core rate, excluding
food and energy, rose a scant 0.1%. Among specific areas, gasoline
prices fell 11%.
- Consumer prices were unchanged in May while the core rate
rose 0.3%. Rising prices for medical care and lodging more than
offset declines in energy products and clothing.
IV. STOCK MARKET OUTLOOK …VALUATIONS VARY WIDELY…INSIDER SELLING RISES… SENTIMENT MEASURES SUGGEST PULLBACK
- Weekly insider sales exceeded purchases by more than 4 to
1. The gap between bullish and bearish advisors is historically
wide. Earnings of the S&P 500 are inflated by pension accounting
gains and the exclusion of stock option expenses. Most tech stocks
trade at price/earnings multiples that are twice their historic
averages.
- Reasonable values exist among financial issues, especially
asset managers and insurers. Business services providers will
likely respond to improving employment levels later this year.
- As noted earlier, health care industry groups are enjoying
higher prices and strong secular demand trends. Industrials and
materials producers should fare well as the recovery accelerates.
- With sector valuation ranges very wide, careful stock selection
remains critical to success.
- We continue to emphasize purchase of stocks with strong cashflow
characteristics, consistent dividend increases, increasing market
share, and future earnings growth.
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