14 Jan 2005 New Year – Same Worries

Earnings season customarily brings stock market volatility and this one is certainly no exception.  As oil prices rise creeping toward their record highs and as several major U.S.industrials warn of earnings shortfalls, the good news has largely fallen on deaf ears.  The Dow Jones Industrial Index declined nine of the last twelve trading days for a 3.2% drop from year-end highs.  The NASDAQ is down 5.5% during a similar period.  Investors seem more cynical in January than they did in December when they chased the Dow up 11% for the month.     

Estimates for S&P 500 companies’ earnings growth are at 10.5% for the year, according to Thompson’s First Call.  While down from the 19.4% increase on 2004, the rate is considerably ahead of the twenty-year average of 7%.  Retail sales climbed in December by the most n three months. USindustrial production rose in December .8% making 2004 the best year for output since 2000.  Capacity utilization was also up more than expected in December.

In a couple of speeches yesterday Fed Governors continued their assertion that the economy was strong, strong enough to worry about inflation.  William Poole of the St. Louis Fed said the central bank would eventually drop its “measured” talk of rate increases and raise them faster than the market currently expects.  The Fed’s next meeting is in Early February.

The latest labor report was mixed.  Length of unemployment and the drop in hours worked are in negative trends while temporary employment remained positive even after an outsized gain of 50,800 the previous month.  The drop in the unemployment rate, steady overtime, and the rise in the job leavers rate (people who feel comfortable enough in the job market to leave their current job for better one) provide hope that employment conditions could stay positive.

The major problems facing investors remain and will likely worry us for months and years to come.  In the weeks and months ahead we will learn more about how the government will address budget deficit reduction, Social Security, Medicare and tax reform.  Lobbying and protection of special interests may be just as loud as the election noise of 2004.  One area of concern will diminish somewhat if the Fed raises rates faster than in the past and that’s the dollar’s decline.  As rates rise faster in this country than they do in Europe orJapan, the currency will gain value relative to the Euro and the Yen.

We believe there will be good investment opportunities both at home and abroad.  Generally, large-cap stocks as a group should outperform their smaller counterparts.  Specifically, we think the best performers will be in energy, basic materials, and select industrials and technology.  Abroad, we think Asia and Latin America will be the dominant regional performers, with Japan, Australia, Malaysia, China, Brazil, Argentina, andVenezuelaleading the way.