02 Nov 2001 Patience and Confidence
Just like the Yankees, this market refuses to give up. Down two games to none, the Yankees faced the possibility of a sweep by the upstart Arizona Diamondbacks as they came back to New York for game three of the World Series. But with faith, determination, and more than a little luck, they homered their way back into the series, winning all three of their games in front of the home crowd. In the last two games, the Yank hitters overcame the Diamondbacks in the ninth innings as they capitalized on the weakness of Arizona’s relief pitcher staff.
Just as the Yanks capitalized on the weakness of Arizona’s relief pitchers, patient and steadfast investors have been rewarded by sitting tight through the market’s panic selling in the days following the attacks. In fact, all of our model portfolios are comfortably above pre-attack levels, and their advances have been relatively steady since the lows of September 21st. The Quality, Growth, and Aggressive accounts are up approximately 9%, 21% and 29%, respectively from those lows (individual accounts may differ from model results due to allocation differences, use of margin, timing of purchases during the period, and other reasons).
This October was filled with bad news for stocks, yet the markets were largely up. The usual market fodder of earnings disappointments, layoffs, expansion cancellations were bad enough, but, amplifying the negative mood was the uncertainty created by the constant drone anthrax cases springing up, Pentagon warnings that the conflict would likely go on for years without signs of progress, and most significant, two distinct warnings from Attorney General Ashcroft that the U.S. faced additional threats of further terror without detail. Given that markets really don’t like uncertainty, it’s hard to imagine a tougher time for them than we have now, yet they have advanced rather steadily. There have been some pauses and some significant drops on bad news, but they recover each time – sometimes the same day.
As you know, economic statistics look backward. They tell us (not even very accurately when they are initially released because accuracy is often sacrificed for timliness) what has already happened in the economy. The fact that September was so shockingly terrible, there is little surprise on the part of investors as these bad results are posted. It is expected that this month’s revisions to some of the numbers reported in October’s will be worse as September’s results are more accurately reflected. But those are past indicators, what has already happened.
The Conference Board’s version of consumer confidence tells us what consumers think about future conditions. As might be expected in the wake of September 11th, consumers were shaken. The expectations index fell sharply for the second straight month in October from 78.1 to 70.8.
The expectations index (consumer plans to buy within the next six months) is generally a good turning point indicator, as it tends to lead (predict) troughs in GDP. The gray bars in the chart below indicate prior recessions while the blue line is the expectations index. In each recession, turns in the expectations index predicted economic turning points. You will also notice in the chart below, there was an upward turn before September of this year, hinting that the 2001 slowdown was near an end.
What makes this time different than former recessions is the fervor with which the government is acting to avert a deep or a prolonged recession. We have seen that the Fed’s nine rate reductions have failed to turn this economy around because it has been a business recession so far and not consumer driven. Nevertheless, rate reductions will likely continues as long as unemployment rises. The Fed Funds rate could go as low as 1% by March of next year while unemployment rises to 6 – 6.25%.
Of major importance to the near term future of the economy are the recent declines in long-term interest rates. When the Treasury said they would discontinue further issuance of the 30-year maturity, the bond markets rallied significantly. The 30-year treasury is now trading at 4.94%. It got as low as 4.73% on the news. Low long-term rates are a critical component to improving business investment and keeping consumer spending up. Re-financing home mortgages puts extra money in consumers’ pockets and reduces their monthly mortgage expense. The housing industry benefits as well.
Lower short-term rates keep the automobile industry up. They enable the automobile companies to offer the zero percent financing packages that have kept their sales at healthy levels. Offering such packages aren’t as costly as they might be in a higher rate environment.
The congress is currently hammering out a fiscal stimulus package that will be beneficial to the economy in the coming months. Republicans and Democrats differ over what components of the economy to stimulate, but they goals are the same. There is increasing pressure from the president, from business, and from citizens to act quickly.
Because inflation is low, each of the aforementioned programs can be implemented without worry of making things worse. Both fiscal (congress) and monetary (Fed and Treasury) policy makers have much more latitude than they might otherwise have to reverse this slowdown.
The risks of terror will keep a lid on the equity markets for months or years to come. But it is becoming increasingly evident that the recession factors are adequately priced into stocks. We will likely see more fits and starts as the markets mark time awaiting credible evidence of a bottom, but the worst market action is likely behind us.
Portfolio Changes
Growth Portfolio
Bought Starbucks Corp 10/30
Starbucks purchases and roasts high quality whole bean coffees and sells them, along with fresh, rich-brewed coffees, Italian-style espresso beverages, cold blended beverages, a variety of pastries and confections, coffee-related accessories and equipment, and a line of premium teas, primarily through its Company-operated retail stores. In addition to sales through its Company-operated retail stores, Starbucks sells coffee and tea products through other channels of distribution. Starbucks, through its joint venture partnerships, also produces and sells bottled Frappuccino coffee drink and a line of premium ice creams. We bought the stock because of its superior growth potential and a very reasonable valuation after the market runoff. We look for earnings growth of 25-30% annually.
Bought iShares Nasdaq Biotechnology Index Fund 10/30
The iShares Nasdaq Biotechnology Index Fund seeks investment results that correspond to the performance of companies primarily engaged in biomedical research to develop new treatments and cures for human disease, as represented by the Nasdaq Biotechnology Index®. Because of the significant volatility of individual biotech companies, the index provides us a measure of diversification allowing us to participate in that sector with greater safety. It also offers us much broader coverage of the sector than we could achieve with the limited holdings in our model structure.
