MAY 5, 2003
I. APRIL 2003 COMMENTS … RAPID AND SUCCESSFUL WAR EFFORT…POSITIVE SURPRISES DOMINATE EARNINGS REPORTS…STOCKS RALLY, BONDS STABILIZE
- A successful conclusion to a short war saw Saddam Hussein
removed from power and efforts begun towards a new government
in Iraq. The next phase of rebuilding Iraq will take longer
but the United States can begin disengaging relatively soon.
- Nearly 85% of S&P 500 companies that have reported so
far have reported earnings at or above expectations. Further,
this positive experience has been shared by virtually all sectors.
The weighted average growth rate has been about 10%.
- Stocks responded to positive news in April by moving ahead
by about 8%, as measured by the S & P 500. This is the best
month since last October and lends credence to the view that
the bear is now behind us.
- Bond yields remain at historically low levels but economic
news is not yet strong enough to prompt higher yields. We expect
rates will begin to move higher later in the year.
II. ECONOMIC OUTLOOK …WAR AND WEATHER DISTORTIONS AFFECT DATA …EMPLOYMENT DATA STILL POOR …SUDDEN ACUTE RESPIRATORY SYNDROME (SARS) IMPACT PEAKING
- Consumer confidence rebounded in April from earlier war-related
lows, with the Conference Board index rising to 81.0 from 61.4
in March. At the same time, new claims for unemployment benefits
rose to 455,000, the highest level in a year.
- The employment cost index rose 1.3% in the year's first quarter
as both wages and benefits rose. The increase in benefits, at
2%, was the largest since 1988. Compensation appears under control
but benefits are surging. The data suggests that private sector
profit growth will require some combination of rising demand
and higher prices rather than cost control.
- GDP growth rose 1.6% in the first quarter and it is likely
that war worries and the SARS outbreak affected business investment
decisions. With energy prices now falling and other concerns
fading, we will be watching second quarter trends very closely.
III. FIXED INCOME OUTLOOK …MIXED SIGNALS FROM PRICE DATA…BONDS LITTLE CHANGED
- Producer prices rose 1.5% in March. Excluding food and energy,
prices rose 0.7%. Consumer prices rose 0.3% and were unchanged
excluding food and fuel. In March, gasoline prices rose 4.1%,
natural gas gained nearly 15% and fuel oil rose almost 10%.
April saw reversals of these trends and aggregate price data
should reflect these declines in May - June.
- There is nothing in the price data that would prevent the
Fed from lowering rates in May or June should they wish to do
so. Federal spending is strong, however, and added tax cuts
of some magnitude seem likely. Keep in mind that the stimulative
impact of federal actions will be muted by state and local budget
cuts and tax hikes.
- Our caution towards bonds has not changed. Short maturity
patterns seem to be the path of least risk.
IV. STOCK MARKET OUTLOOK …VALUATIONS REASONABLE . . .EARNINGS GROWTH DECENT… YIELDS LOW ON ALTERNATIVE INVESTMENTS
- Earnings valuations are at historic averages and not at the
extreme lows that characterized 1982, 1987 and other years that
marked the beginning of major bull markets. The nature of the
2001 recession was also atypical, as consumer spending on durable
goods remained high throughout the slowdown. Business capital
spending bore the brunt of the cutbacks and manufacturing was
the source of most of the layoffs of the past few years.
- Returns on alternative investments such as bonds and cash
reserves are at record lows, and price increases on residential
properties may well have peaked. Investors will find the stock
market more appealing as corporate earnings continue to recover
and equity prices edge higher. One area we are emphasizing for
current purchase is equity with above-average yield and better-than-expected
revenue growth.
- With economic recovery expected to accelerate later this
year, we also emphasize stocks exposed to better economic conditions
in manufacturing and industrial materials. Regional banking
institutions and energy companies will also tend to benefit from
improving business conditions.
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