NOVEMBER 6, 2003
I. OCTOBER 2003 COMMENTS … STOCKS SHARPLY HIGHER…BONDS SLIP IN VALUE…ECONOMIC BACKGROUND STRENGTHENS…EARNINGS & DIVIDENDS DO INDEED MATTER
- The S&P 500 stock index gained more than 5% during October with
virtually all market-moving data releases positive. Among S&P 500 Index
issues, positive earnings surprises exceeded disappointments by a 5 to 1
ratio.
- Bonds, which had been weak in the second quarter, drifted lower as well.
Investors expect the Federal Reserve will have to raise rates in 2004.
- Led by the reported gain of 7.2% in the third quarter real GDP, economic
statistics were almost uniformly stronger. This is the best quarterly rate
of growth since 1984.
- Major problems faced earlier in the year have vanished or receded
greatly. The war on Iraq has passed its most active point, SARS receded with
warmer weather, and consumers have continued to spend. Global growth is
stronger. The domestic recovery has expanded to manufacturing. Inventories
seem poised to recover and business capital spending is on the rise. Better
employment trends lay ahead.
- With the broad economy recovering nicely, and investors expecting the
Federal Reserve to raise interest rates sometime in 2004, it is logical to
expect a change in market leadership toward issues of substance: strong
earnings, rising dividends, reasonable valuations, financial strength, and
high profitability. In the months ahead, we suspect that investors will
increasingly value that which matters most.
II. ECONOMIC OUTLOOK …MANUFACTURING EXPANDS…INVENTORIES BARE…CONSUMERS CONFIDENT …EMPLOYMENT OUTLOOK IMPROVING
- Regional purchasing manager surveys and Federal Reserve district reports
confirm that factory activity is on the upswing. Business confidence surveys
also show widespread improvement. The inventory to sales ratio is a record
low of 1.20. Business capital investment rose about 15% in the third
quarter, responding to dramatic improvement in profits. In turn, profits
benefited from stable labor costs.
- Consumer confidence remains healthy. Confidence measures are higher with
regard to future economic expectations and future availability of jobs.
Temporary employment companies report a brisk business pickup and help
wanted indices are moving higher. First-time claims for unemployment
benefits are falling.
- In addition to stronger domestic economic conditions, the U.S. balance
of payments deficit is declining as dollar weakness has raised the relative
price of imports and lowered the price of U.S. exports to overseas buyers.
Global economies are strengthening as well.
- In the past, we have made cautionary comments regarding the rapid growth
of government spending. Given the war with Iraq and efforts to rebuild that
nation, some of this spending is inevitable. We hope that spending growth
will moderate and that rising tax revenues will aid the Treasury in
2004-2005. Otherwise, interest rates may move a good deal higher later in
the decade.
III. FIXED INCOME OUTLOOK …INFLATION REMAINS LOW…FEDERAL RESERVE HOLDS RATES STEADY… BE DEFENSIVE
- At its October meeting, the Federal Reserve held short-term rates at a
45-year low, indicating that rates could stay low "for a considerable
period." Forecasts suggest no action prior to mid-2004. We think the
December meeting date will pass with no rate action. In our view, the Fed
wants to be sure that the economic recovery is durable and that employment
trends are stronger before raising rates.
- Consumer prices rose in September by 0.3% while the core rate rose only
0.1%. Producer prices also rose 0.3% but were unchanged excluding food and
energy. Crude materials prices rose 3.5%. Energy prices tended to be weak,
as inventories were reported higher than expected. In addition, Iraqi crude
supplies should start to return to markets in quantity in 2004. Industrial
commodities have been very strong as world economic activity quickens and
China builds inventory.
- Bond prices seem likely to fall in the periods ahead. Investors should
emphasize shorter rather than longer maturities and concentrate on quality
issues rather than lower grades. In other words, it is time to be more
defensive in bond portfolios.
IV. STOCK MARKET OUTLOOK … RAISE EXPOSURE TO CAPITAL SPENDING…RAISE EXPOSURE TO CYCLICAL PROFIT GROWTH…DEFER ADDITIONAL DEFENSIVE INVESTING
- As market leadership shifts to earnings-driven situations exposed to
recovering economic conditions, so too should portfolios move capital toward
issues leveraged to the dominant themes of the months ahead.
- Business services linked to employment, such as payroll processing,
401-K investments, uniform rentals, and the like offer good prospective
reward profits. Banking services may be included in this category. Among
consumer areas, providers of advertising, entertainment, magazines,
restaurants, and select computer software look appealing as well.
- Rising corporate profits and improved capital spending favor industrial
machinery, electrical equipment, and other makers of durable goods. Energy
stocks in exploration, oil field equipment, production services, and natural
gas offer appeal. Organizations that transport energy and manufacturing
goods will benefit from higher volumes and incremental shipments to overseas
markets.
- As world markets for manufactured goods improve, so will volumes and
prices of a broad array of industrial commodities. Many defensive sectors
continue to offer very good value, excellent free cash flow, and
above-average dividend growth prospects, but may not return to positions of
market leadership until the Federal Reserve finds it necessary to raise
rates.
NOTE: VISIT US AT ANY TIME IN OUR OFFICES AT 333 MAIN STREET OR AT
OUR WEBSITE, www.beacontrust.com
John W. Gustafson
Senior Vice President
| 12/31/02 | 10/31/03 | ||
| S&P 500 Index | 879.82 | 1050.71 | 19.42% |
| Dow Jones Average | 8341.63 | 9801.12 | 17.50% |
| Treasury Bonds (10 yr.) | 3.82% | 4.30% |
Beacon Trust Company
333 Main Street, Madison, NJ 07940
(973) 377-8090