14 Mar 2003 Mr. Market Can Be Emotional

Hardly anyone would disagree with the premise that Mr. Market has been unusually emotional these past three years.  But the last couple of weeks have demonstrated just how emotional investors can get after a prolonged bear market.  The drone of bad news has been like a vise, applying increasing emotional pressure almost by the hour.  One negative development after another has pounded stock values down and risk-averse investments up. 

But yesterday Wall Street, begrudgingly at first, unanimously decided to view the world more positively – if only for a while.  News that the CIA was making progress with key Iraqi generals in securing their promise of early surrender at the outset of war and talk from the White House that Mr. Bush would be willing to give more time for diplomacy seemed to be just what investors were waiting to hear.  In no small measure, investors’ moods were boosted by the news that young Elizabeth Smart had been rescued from her captors.  The major averages rallied strongly throughout the day.  The mostly ‘old economy’ Dow Industrials finished up 3.5% while the tech-heavy NASDAQ 100 finished up 6.1%.  The dollar had its biggest gain in seven months against the euro.

While the market remains emotional, we continue to concentrate on the economic signs and what they indicate about the intermediate future for investors.  Good news started the week as the government reported that U.S. wholesale inventories unexpectedly fell in January after sales increased, keeping the amount of goods on hand at a record low.  During January, sales rose 1%, the most since November, reflecting more purchases of imported autos, higher priced petroleum and lumber.

The inventory-to-sales ratio, a gauge of how long goods stay on shelves and in warehouses, fell to 1.21 months.  That’s down from 1.28 months in January of last year and matches November’s ratio, which was the lowest on record.  In the short run, the economy may be restrained by low inventories.  Companies don’t want to get caught with inventory that won’t move.  The Iraqi war threat gives them a reason to wait.  But in the longer run, if sales continue, inventories must be replaced, which means manufacturing and business investment will improve.

The trade deficit narrowed in January from its earlier record peak as Americans bought fewer foreign-made goods in a slowing economy while exports increased.  The trade gap of goods and services was $41.1 billion, down from December’s $44.9 billion level.  In 2002, the deficit reached a record $435.7 billion.

Shipments abroad of consumer goods climbed 6.9% in January to $7.4 billion, led by a surge in pharmaceuticals.  Foreign companies bought 2.5% more capital goods.  The Institute for Supply Management’s January factory index signaled a rebound in exports, rising to the highest level since November 1999.

While Iraq remains an obstacle for real economic growth, consumer spending continues to be supported by 40-year low interest rates.  The Mortgage Bankers Association of America’s index of applications for U.S.mortgages jumped 26.7% last week to 1603.1, the highest on record.   A decline in mortgage rates spurred the fastest pace of refinancing ever as the MBA’s refinancing index surged 34.9% to 8920.9.

Predictors may indicate improved spending ahead, but recent history tells a different story.  Yesterday, the Commerce Department reported that sales fell last month by the most since November 2001.  The 1.6% drop was three times the median economists’ estimate and followed a revised .3%increase a month earlier.  Not including vehicles, retail sales fell 1 percent, the largest drop since the terrorist attacks in September 2001.  But you will recall that February was fraught with worries of impending war with Iraq, heightened terror alerts, duct tape buying frenzies, and very BAD winter weather.  We are not surprised that the University of Michigan Confidenceindicator came in at 75 points, the lowest reading in more than ten years, according to Bloomberg.

The Federal Reserve is returning to an easing bias which means rates may be falling again soon.  Declining retail sales, three years of stock declines, and increasing unemployment are making the monetary policy makers nervous.  Maybe now Mr. Greenspan will be more favorably disposed toward the additional fiscal stimulus measures proposed by the President and Congressional leaders.

But, almost in spite of the bad news, yesterday we got a glimpse of how undervalued equities currently are as markets soared on hopes for peace.  Peaceful resolutions to the world’s problems would be wonderful, but investors especially hope for resolution to the uncertainty that surrounds the markets.  The answers for Iraq may come soon. North Korea and other areas may take a bit longer, but our 250,000 troops nearIraqgive that issue the greatest weight by far.

We expect much better market action when the question of military action againstIraqis answered.  The economy has demonstrated remarkable strength and endurance in the face of its numerous trials.  Someday soon (we hope) Mr. Market will be able to focus attention on things like corporate earnings, prospects for future earnings, and on the amazing potential of the global economy in the new age of information and productivity.