MARCH 7, 2003
I. FEBRUARY 2003 COMMENTS … STOCKS DRIFT LOWER…BONDS
RALLY TO NEW HIGHS…WAR NEARS?
- Stock prices drifted lower last month although strong, intermittent
rallies punctuated the decline. Earnings reports for 2002's final
quarter were generally quite positive but prospects for war have
dominated investor decisions and certainly have affected business
and consumer planning as well.
- Speculation is growing that the Federal Reserve will reduce
the Fed Funds rate to 1% at its next meeting. Money market rates
are below 0.75% for taxable funds and about 0.60% for tax-free
funds. As of this writing, ten-year Treasury notes are trading
at 3.60%, also a record low yield.
- Speculation over war with Iraq has dominated the news. As
we suggested a few months ago, this issue is nearing resolution
and should weigh less heavily on the markets in the months ahead.
In the meantime, risks can be reduced by balancing stock portfolios
with significant cash reserves. When and if hostilities break
out, we expect renewed attention to solid fundamentals and reasonable
valuations.
II. ECONOMIC OUTLOOK …REPORTS MIXED…CONFLICTING READINGS ON CONSUMER CONFIDENCE…GDP REPORT SUGGESTS TURN IN CAPITAL OUTLAYS
- GDP estimates for 2002's final quarter were revised significantly
upward. Business investment rose 2.5%, the best gain in nine
quarters. Anecdotally, several of our customers have indicated
similar experience in their own businesses. Durable goods orders
rose 3.3% in January, confirming earlier strength in factory
orders. Purchasing managers surveys confirmed this strength,
as did the 0.7% jump in industrial production.
- Consumer sentiment surveys reported conflicting data. Data
from the Conference Board suggested a sharp decline but this
was not confirmed by the University of Michigan survey. Clearly,
however, the consumer is cautious, responding to continued "stickiness"
in the unemployment rate, war jitters, oil price increases, and
weather conditions. We expect retail sales to be sluggish until
April-May data are available and warmer weather returns. Energy
prices remain hostage to weather conditions and geopolitical
developments. February unemployment, at 5.8%, reflected cautious
hiring decisions across a wide array of businesses, including
services, construction, and manufacturing. The exception, mortgage
banking employment, reflected very low interest rates and continued
high rates of refinancing.
- Leading indicators are flat after three positive months.
This change probably reflected stock prices as much as anything
else, but rising jobless claims also played a part. We still
believe that a halting recovery is underway that will gather
steam when geopolitical concerns recede.
- 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 …FED TO CONSIDER RATES AGAIN…GOLD STABILIZES…INFLATION MEASURES RISE
- There is some speculation that the Fed Funds rate will be
reduced to 1% from 1.25% later this month. We would not be surprised
at this, nor would we expect the market to react very much.
- The price of gold has moved down about 7% from its high but
is still well above its average price over the past five years.
Oil prices have been strong, as investors fear supply disruptions
may accompany any increase in Middle East hostilities. We have
seen projections for gasoline ranging up to $3 per gallon if
hostilities persist into the summer driving season. We suspect
that actual increases will be much more modest, but investor
fear is every bit as potent a force as investor greed.
- Rising energy prices made themselves felt in producer prices.
Producer prices rose 1.6% in January, and the core rate rose
0.9%. Consumer prices rose 0.3%, and only 0.1% excluding food
products and energy. Consumer prices seem apt to rise in the
months ahead as rising energy costs work their way through the
production chain.
- In our view, the next major move in interest rates is up but it may be 2004 before significant rate increases are seen. In anticipation of such developments, we would reduce our positions among longer bond maturities.
IV. STOCK MARKET OUTLOOK …DIVIDENDS ARE IMPORTANT…DIVERSIFICATION AND FINANCIAL STRENGTH…SERVICE ECONOMY…DEMOGRAPHICS AND CHINA IMPACT
- In an uncertain market, we are making every effort to ensure
that new stock purchases have attractive dividend histories and
prospects. Available yields are not high by historical standards
but we like to see a policy of regular increases under various
market conditions.
- Among the sectors we are emphasizing are personal and business
services. Valuations here have come down from earlier levels,
as have those of health care stocks. The outlook for financial
services stocks is more mixed but the aging population of the
U.S. favors these groups over the next decade.
- We continue to place modest emphasis on technology and telecommunications.
- We remain interested in companies that produce goods needed
by China, the world's fastest growing major economy. In this
vein, we include certain consumer goods, fertilizers, transportation
products, and financial services.
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