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News that retail sales, excluding automobiles, improved by the most in six months sent the market averages up yesterday over 1.7% for the DOW and 2.5% for the S&P 500.  The .7% rise in sales was more than twice what economists had expected.  Treasuries fell and stocks rose as investors gained confidence that the consumer, hence the economy, might just be hanging on. 

Every two years we undergo a peaceful revolution in this country known as the mid-term elections, where one third of the Senate and all of the House of Representatives are elected or re-elected.  If you are a Democrat, the last thing you want to read is more talk about the election, but please bear me out.  There are some vital observations that may have been lost so far in the emotion and hype. 

Roughly three quarters of companies have reported their earnings for the third quarter.  First Call tells us that the actual earnings are running 3.1% ahead of the final estimated earnings for S&P500 companies.  But these earnings expectations have been cut several times by analysts in the weeks leading up to reporting season.  At the beginning of the second quarter of this year earnings growth was expected to be over 16%, but by the start of the Q3 reporting season expectations had been cut to just under 5%. 

We are nearing the end of October – Hallelujah!  EVERY bear market since the end of WWII has ended before November 1st of that bear market year.  EVERY seasonally strong period (November to April) in the second year of the presidential election cycle (like this one) has produced an up market.  And as Don Hays points out, we know that every time since the 1930’s that six-months of Dow weakness equaled or exceeded by the prior six months, is followed by a six-month period producing gains of at least 40%. 

Is the rally of the last few days for real – is the market bottom in place – do stocks rise from here – is the Bear dead?  Earnings drive stock prices in the long run and those reported so far this quarter suggest substantial improvement.  Nokia, for instance, said that they saw earnings stabilize in the second quarter and now believe by third quarter results that the turnaround is for real.  IBM reported an earnings increase of over 10% in a very difficult information technology-spending environment.  UnitedHealthcare said its earnings rose over 53% on cost-cutting and increased premiums.  Numerous others today and the preceding several days have beaten their earnings goals. 

If one watches CNBC or CNN for any length of time he would likely come away thinking that the stock market is on its final legs, and for good.  When things are bad, it seems that those who are best at pointing out how bad things are and could become, get the bear’s share of the spotlight.  Granted, there is plenty of bad news out there, but the good news is not getting through the dense bad fog.  A significant part of the good news is that many of the extremes being reached in today’s stock and bond markets are actually positive signals for better times ahead. 

Having just been in the mountains of West Virginia I was reminded of some very interesting parallels to today’s stock market.  From the mountaintop it seems one can see forever.  The view is spectacular, the air is fresh and clear, and problems seem miles away.  But down in the valleys everything is close and problems seem omnipresent.  Travel can be treacherous on the tight sharp switchbacks.  Just yards ahead around the next curve there may be a ten-ton coal truck barreling down the hill pushing the limits of control. 

The third quarter is drawing to a close and almost everyone in stocks lost money.  European stocks had some of their biggest losses of the past 15 years led by Europe’s largest economy, Germany.  The German DAX lost 32%, the largest since its introduction in 1987.  The U.K.’s FTSE 100 fell 17% for its largest loss since 1987.  France’s CAC 40 fell 24%.  Japan’s Nikkei 225 Stock Average declined 12% and reached a 19-year low during the third quarter.  Hong Kong, South Korea and Taiwan all lost as much as 10%.  Contrary to the trend, Pakistan rose 16% in response to U.S. economic sanctions being lifted.  In Latin America, Argentina gained 13%, but Brazil declined 38%, the world’s worst performance for the third quarter.  At home, the S&P 500 lost 14%, falling to a 4-year low and the NASDAQ fell 16.4% to a six-year low. 

Every year, for the past 20, a group of about 30 faithful Christ Church parishioners go into the hills of West Virginia on a trip to renovate, re-roof, re-floor, re-found, re-wire, and add bathrooms where there were none; but mostly they go to restore the hope that people care.  McDowell County in the southeastern hill country of West Virginia, north of Bluefield, was one of the state’s richest coalfields. 

You know from your July and August statements just how badly the markets mistreated long-term investors.  A few statistics from Credit Suisse First Boston help put the period into even better perspective.  A record $29 billion was removed from mutual funds in July 2002.  Stock funds experienced record outflows, while bond funds enjoyed record inflows.  Net outflows from equity funds in July 2002 were almost twice as large as those during September 2001, and more than five times larger than those during August 1998.  Every style of equity funds was affected by investors’ withdrawals in July.