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Past Commentaries

Current Commentary, Review and Outlook
February 7th, 2003

To My Clients, Friends & Observers:

A gentleman who is not a client recently asked me to forecast the stock market. There is little to gain in venturing forecasts to strangers, so instead I asked him, “What would you do if I told you?”  He was hoping, he said, “to get his money back” after losing a fortune over the last four years. I told him that I manage portfolios, not the stock market, that I couldn’t predict the direction of the next 10% move but I would predict the direction of the next 100% move and that would be up. Not the answer he was looking for, he responded that “it’s all a crap shoot.” I  thought to myself that anyone who perceives investing as a crap game should be reminded that the soaring marble and gilt edifices of the casinos are monuments to the giddy losers who paid for them. The odds are always against the player. Not so in the securities markets.

Yes, there are unfortunate similarities between Wall Street and the casino these last few years. The securities markets are, always have been, and always will be a confidence game to a certain degree. But it is “confidence” in the best sense of the word, confidence in progress and real economic growth. If one insists on calling it a game (which it’s not), then it would have to be the greatest game on earth. The significant difference between markets and cards is that you can be paid in the markets for every hand you are dealt, weak or strong. You can fold a hand and sit out ‘til the next but the pot is progressive. You only forfeit your rights to it when you leave the game.

When I look at portfolios that are paying current yields well above inflation rates, money market rates and short-term deposit rates, I can live with reasonable drawdowns in portfolio value, particularly when the portfolios are outperforming the indexes on the up and downside. These are growth portfolios suitable to their owner’s needs, not fixed income portfolios whose owners require perpetual safety of principal. If one doesn’t require liquidation of principal, then one should patiently ignore drawdowns in valuation, particularly when cash flows from coupons and dividends are sufficient.

Bear markets exhaust themselves finally when the distribution (selling) process is completed. It is completed when new sell orders are lacking, when buyers are compelled to outnumber sellers. Buyers and sellers are constantly looking ahead to future cash flows. What is their present value? We are constantly looking ahead for reasons to sell or reasons to buy, or reasons to avoid either.

The January close was lower than December, an indicator of a lower year ahead with 80% probability. That would give us four successive down years in a row, something which has only occurred once in the last century, a negligible probability on its face. But there are studies that show that the probabilities of extraordinary (improbable) events increase with the length of time they do not occur. Clear?

This much is clear: there is nothing on the horizon from sea-level that suggests faster growth ahead. Corporate managers are cutting, not hiring. They are holding on to capital, not investing it. Consumers aren’t spending the way they used to, and the demographics of an aging population will continue this. Savings rates are up – in spite of historically low interest rates. The cost of oil at $34 a barrel sucks like a leach on our economic physiology yet there is little or no will to drill in ANWR or the Santa Barbara channel, or to develop alternative fuels. Bizarre and stupid behavior. The peace dividend of the ‘90’s is exhausted. The prospect of war is a substantial damper. We’ve returned to a wartime economy and the economic benefits of building weaponry are very shallow. After a weapon is built it generates no other economic activity. It is sunken capital until it is used and replaced. This is not to diminish the importance of military strength. Morally projected, it’s the foundation for global free trade, currency stability, and world peace.

The federal government has been accommodative fiscally although far too aggressive with pork-spending and blatantly recalcitrant with regard to tax cuts. Fed monetary policy has been stimulative, M1 up 2.57% and M3 up 6.54% year over year ended 12/31/03. I do not foresee any rate increases or cuts this year.

Is There A Party Line To Recessions?

This email received at our site at year-end: “Could you tell me if there has ever been a Republican administration that hasn’t had a recession under its tenure?” And the response:

The broadest acceptance of the definition of recession remains two successive quarters of negative GDP as released by the Bureau of Economic Analysis, division of the U.S. Dep’t of Commerce. Let us instead use business cycle contractions. This allows us to go all the way back to the first Republican president (Lincoln), obviates the lack of quarterly GNP/GDP data prior to 1947, and does not alter the results for Democratic presidents.

If we frame the question as, “Has there ever been a Republican president that hasn’t had an economic contraction under his tenure?” the answer is yes, one. That was James Garfield, who served from March to September 1881. We might add Lincoln’s first term with an asterisk. He took office in March, 1861 during a business contraction which reversed within three months to an expansion which lasted the remainder of that term. If we change the question from “president” to “administration” (as requested) we could add William McKinley’s second term, March to September, 1901. During the same period Democrats have had two presidents who completely escaped contractions: Johnson and Clinton. We can safely add Kennedy with an asterisk. He entered office in a contraction which ended a month later.

The business cycle data were taken from www.nber.org.

There is no pattern here and little to conclude. Neither party is better at managing the economy. Both have gotten better over the years. The expansionary “guns and butter” giddiness of the Johnson years and the oil price shocks of the Nixon years led to the devastating, inflationary hangover of the Carter era. Without prejudice, the Clinton years inherited a huge peace dividend, shrinking defense budgets, a bull market in bonds, and oil at $10 a barrel, just three years ago. We will simply not see these conditions again soon and our technological and capital infrastructure is vastly overbuilt. It’s going to take time to use up that excess capacity.

At year-end I predict Dow @ 9,706; S&P 500 @ 1,020; and NASDAQ @ 1,554; Five year U.S. Treasury @ 3.88%; Ten year U.S. Treasury @ 5.12%; Fed funds unchanged.

Best regards,