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:: July 2003 | Page 1 of
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Dear Clients and Friends,
A CHANGE IN SCENERY
At the time we wrote our previous quarterly letter to clients,
the U.S. was fully engaged in the conflict in Iraq, the
world looked like an increasingly dangerous place, investor
morale was in a deep depression, and the stock market was
in a swoon. Now, three months later, equities have staged
an extraordinary rally from the early March lows.
The most vigorous advance occurred in technology and the
other, more volatile sectors of the market, but the gains
have been sufficiently broad to authenticate the recovery.
Observers have cited a wide range of explanations for the
surge that, ironically, was expected by so few. The standard
list of contributing factors includes the end of the armed
conflict in Iraq (one should perhaps refer to the end of
the “formal” conflict, since the situation remains
quite unstable). There also has been an encouraging shift
toward improved corporate earnings reports. Additionally,
interest rates on money market funds and certificates of
deposit have declined to levels best observed under a magnifying
glass. Finally, the bond market, repository of huge amounts
of institutional and individual funds, offers yields that
have no appeal, particularly if one considers the potential
risks associated with a reversal of the trend in rates. It
cannot be predicted when rates will begin to rise again,
but it is very clear that they will at some point. Against
this backdrop, the stock market appears to have been the
beneficiary of this “flight” from low rates.
THE FED AS STEWARD
The Federal Reserve Open Market Committee (“FOMC”)
is charged with the responsibility of keeping the economy
on a sustainable growth path, while managing the impact of
inflation. This is an important mandate that benefits from
steadiness in policy making, from deliberate actions and
from reasonably predictable outcomes. If the charge is executed
well, such success contributes to an environment that engenders
confidence.
Unfortunately, to this observer, the FOMC in recent years
has not been particularly adept at assessing what is happening
in the U.S. economy. Further, because its diagnosis of
risks has tended to be either inaccurate or late, it
has ended
up adopting responses that have either been inappropriate
or excessive. The skeptical observer might view the net
effect of Fed actions as simply setting fires. As it
turns the dials
on the cost and supply of money, it appears to be moving
from one asset class to the next, creating asset bubbles
as it goes and touching base in sequence on stocks, bonds
and real estate.
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