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:: October 2003 | Page 1
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Dear Clients and Friends,
THE STOCK MARKET
After three straight years of stock market declines, it
appears that, finally, 2003 could record positive returns. The
market low touched in March this year was made with a confluence
of bad news about the economy and the impending war with
Iraq. Following the quick military successes, and
fueled by bountiful liquidity courtesy of the Federal Reserve,
stock prices rallied strongly. The S&P 500 rose
15.4% while the NASDAQ Composite climbed 21.3% in the second
quarter; in the third quarter the indexes were up 2.7%
and 10.1% respectively. The largest gains during
this period have been recorded by some of the most speculative
technology stocks. Rising confidence has lured some
investors back into the same types of issues that burned
them so badly only three years ago.
It seems that the Federal Reserve has engineered another "bubble" in
technology stock prices. Day traders that survived
are back, and borrowing to buy stocks on margin has skyrocketed.
Stock analysts have been ratcheting up their price targets
to rationalize purchase recommendations. Investor
psychology has turned 180 degrees since March, when fear
drove some out of the market. Now the call is for
the latest "story
stock" to get back into the game.
For those of us who rely on fundamental valuation for stock
selection, it has become increasingly difficult to find attractive
issues. As stock prices have moved higher and reached
targets based on next year's estimated earnings, the value
discipline is suggesting such stocks be sold, which may result
in a temporary increase in cash reserves above normal allocations.
Experience has shown that at times like these it is important
to protect gains if possible, and be ready to add to holdings
as prices pull back to more favorable levels.
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THE ECONOMY
The last recession officially ended in November 2001. Investors
have anticipated a recovery in the second half of 2001 and
2002, only to be disappointed. Several indicators
now seem to point to realization of these hopes this year,
but concerns remain about the durability and magnitude of
the expansion.
The index of leading economic indicators has been rising,
inventories are low, and industrial production has picked
up. Consumers have been supporting the economy for
some time now, but finally spending by business is growing
too. Economists have revised upward their numbers
for third quarter growth in Gross Domestic Product to about
4.5%. Employment remains the soft spot in the recovery. Jobholders
peaked at 132 million in February 2001; in August of 2003
the number was a bit over 129 million, down 2.1%. The
unemployment rate moved up to 6.1% as the economy was able
to grow with fewer workers. Job creation has become
the major topic for Presidential hopefuls; the administration
is doing everything possible to improve the situation before
the election next year using low interest rates, increased
liquidity in the financial system, tax cuts and deficit spending.
The latest maneuver is to push the value of the dollar down
against foreign currencies to boost exports and slow imports.
It seems to be a risky move that may have unintended negative
consequences as outlined below. The consensus outlook
calls for a gradual recovery into 2004 with housing and auto
production easing back as business spending picks up, profit
margins rise, companies begin adding workers, and profits
increase. If this scenario proves correct, a great
deal of the good news has already been discounted in stock
prices.
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