14 Nov 2003 Lots of Cash

The market continues its sideways movement as the numbers from business and government continue adding to the case that the recovery is real and sustainable.  But everyone, from individual investors to institutional giants, from small businesses to mega-corporations, from the Federal Reserve to the Administration, remains cautious on the future of this economy.

Investors view market valuations as high, or at least, fully reflective of future potential.  Total consumer cash is currently at 3.9 trillion dollars.  That’s 35% of theU.S.third quarter’s gross domestic product.  Even large mutual fund managers are holding more cash than they usually do during stock market advances.

Corporations are sitting on large stockpiles of cash as well.  Microsoft currently holds over 51 billion dollars of cash and securities.  In fact, of our universe of the 1,100 stocks that meet our general investment criteria, 125 have cash positions exceeding 25% of total assets.  Managers, like individual investors, remain cautious and unwilling to take new risks until they see further signs of improvement.

The Federal Reserve has been unusually transparent in its intentions to keep interest rates at current levels to ensure that deflation does not creep into the economy and to promote job growth.  According to a story in this morning’s Wall Street Journal, Fed Chairman Alan Greenspan said the central bank would be more “patient” about reacting to improving economic growth.

William Poole, president of the Federal Reserve Bank ofSt. Louis, said in an interview with Bloomberg that if consensus forecasts of the economy prove accurate, the current environment of low interest rates could “extend well beyond March,” though that depends on incoming data.

This morning the Labor Department released its report on wholesale prices.  During October, prices rose more than expected led by higher costs for food, cars, and light trucks.  Prices paid to factories, farmers, and other producers increased .8%, the largest increase since March of this year. 

Retail numbers fell off in the month of October following the rather blistering pace in the third quarter.  The cash in consumers’ pockets from the summer’s tax refunds and home re-financings is probably sufficiently diminished now to have little or no impact on the spending decision.  The recovery is increasingly at the mercy of job growth.

The third quarter’s growth spurt likely improved the job situation, but sustainability remains the question.  Last week, states received 366,000 applications for unemployment benefits compared to 353,000 the week before; the lowest level since January of 2001, according to Bloomberg.  If sufficient growth in the economy continues, it is likely that favorable employment trends will follow.  But the economy must grow in the 4% plus range to use excess capacity and outstrip the recent spate of high productivity and production efficiencies.

Unfortunately, the manufacturing sector is not exactly roaring back.  Today, the Federal Reserve announced that industrial production rose less than expected in October as auto makers turned out fewer trucks and cars.  The Fed’s gauge of factory production rose .2% and industrial capacity rose from 74.5% to 75%.  Officials pointed out that the index was restrained by a large decline in autos and parts and that other sectors of the economy are faring better.

The U.S.trade deficit widened in September for the first time since March, driven by consumer and corporate demand for cars, computers, and business equipment made in China, Japan, and other nations.  Shipments from abroad increased 3.3% and U.S. Sales overseas increased 2.8%.  These numbers reveal that the global slump is coming to an end.  According to the government and Bloomberg, Americans spent at the fastest pace in six years from July through September spurring the economy to the fastest growth spurt since 1984.

Consumers’ opinions of their futures continued their improvement according to the University of Michigan confidence gauge.  Rising economic prospects and improving job numbers helped boost the index to the highest level in a year and a half, according to Bloomberg.

Our outlook remains positive on the economy, but cautious on the market near-term.  As noted in previous Briefs, the market will likely continue to digest its summertime gains for another month or two.  When more information is in regarding the durability of the recovery, likely in January and February, market appreciation should resume.  We hold significant cash in each of our five model portfolios and look forward to employing it as opportunities present themselves.