Second Quarter Beats Expectations

The quarter was remarkable on several fronts; the world mourned and buried a beloved Pope John Paul II, oil prices set new record highs (but not inflation-adjusted highs), but failed to derail corporate earnings which soundly beat analysts’ estimates, and corporate managers felt good enough about their futures to book some healthy acquisitions.  But after digesting three months of mixed economic news and promises of higher rates from the Fed, investors chose to be more optimistic.  During the quarter the S&P 500 gained 1.4% while the tech-heavy NASDAQ rose 3%.  The 30 Dow Jones Industrials didn’t fare so well dropping 1.6% during the same period.  Our three models performed very well in comparison.  Your quarterly reports are in the mail and are available on our website at

The quarter began with Goldman Sachs energy analysts suggesting that oil might spike as high as $100.  They suggested that the oil market looked a lot like it did in the 1970s, when supply disruptions led to a “super-spike” in prices to $90 a barrel in today’s dollars.  So far anyway, the predictions are overstated.  Oil started the quarter at a touch over $58.00 and is now at $56.80.  It caused quite a market stir as it reached $60 twice this month.

Another defining characteristic of the quarter were the numerous mega-mergers that took place in virtually every major sector of the economy.  Here’s a sampling:

  • Chevron Texaco made a bid for Unocal at $16.4 billion
  • Adobe Systems  agreed to buy fellow software-maker Macromedia for $3.4 billion
  • GE Commercial Finance bought Bombardier Capital’s Inventory Finance unit for $1.4 billion in cash
  • The NYSE and the electronic trading company, Archipelago agreed to merge ushering in the era of electronic trading at the 212-year-old exchange
  • Time Warner and  Comcast together agreed to pay about $17.6 billion in cash and stock for   Adelphia, the No. 5 U.S. cable operator in bankruptcy since 2002
  • Nasdaq agreed to pay $1.88 billion to buy Instinet owned by the British publishing firm Reuters
  • IBM set a $5 billion   hare buyback
  • Duke Energy  agreed to buy Cincinnati-based utility Cinergy for about $9 billion in  stock, forming a company with stock-market value of about $36 billion and   5.4 million customers fromOntarioto the Carolinas
  • US Airways and America West announced a merger
  • L-3 Communications bought competing defense contractor Titan for about $1.97  billion
  • Bank of America  entered China with a  $2.5 billion bid for a 9% share in China Construction Bank, marking the biggest foreign investment inChina’s banking sector.
  • Pfizer bought Vicuron Pharmaceuticals a maker of drugs to treat bacterial and fungal infections, for $1.9 billion
  • Bank of America this week agreed to buy credit-card issuer MBNA for $35 billion. BOA of  the biggest U.S. commercial bank, in terms of depositors, with 10% of the total U.S.  market.
  • China National  Offshore Oil Corp., aka Cnooc andChina’s number 3 oil company, set tentative plans to launch a hostile bid for U.S.oil  firm Unocal, exceeding the $16.6 billion offer for Unocal made by Chevron earlier this quarter

Earnings for the quarter were quite good with over two thirds of companies beating analysts’ forecasts, higher than the historical average of 59%, according to Thomson Financial.  Companies surprising to the upside beat estimates by an average of 5.2%, compared with 3.1% historically.  All the good news pushed Thomson’s blended earnings growth rate for the quarter to a healthy 13.5%.  At the beginning of the year, forecasters expected growth of just 7.6%.

But according to the Wall Street Journal, estimates for second-quarter growth have eroded, with negative warnings outpacing higher forecasts by more than two to one.  Earnings are now expected to grow just 7.2% in the current quarter, ending a long string of double-digit growth.

The World Bank said the world’s economic recovery has “peaked” and that the speed of the coming slowdown depends largely on the strength of the U.S. dollar. The bank, in its annual Global Development Finance report, predicted a slowdown in global growth to 3.1% this year from 3.8% in 2004, thanks largely to higherU.S.interest rates and a 25% jump in the Euro’s value. Though the bank called a global recession unlikely, it also said the massiveU.S.current account deficit, the broadest measure of trade with the rest of the world, raised the chances that one could develop.

The US Treasury announced that it might bring back the 30-year bond after a hiatus of more than three years.  The announcement sent shock waves through the bond market.  Prices for long-term debt fell sharply, sending their yields higher while short-term issues gained, driving their yields lower. Lately, a lot of government debt has been maturing more rapidly, and the government said it wants to keep its debt load spread out over time. It may also be trying to lock in super-low long-term rates.

Standard & Poor’s cut General Motors’ and Ford’s bond ratings to “junk” status during the quarter.  The downgrades tainted corporates in general as bond investors ran for quality.  The 10-year U.S. Treasury note soared higher, sending its yield to the lowest level in more than two months.

The Nasdaq in general and technology specifically got some extra fuel when Merrill Lynch upgraded the whole technology sector on a short term technical basis.  Goldman Sachs analyst Rick Sherlund boosted his outlook for software makers, and Prudential Equity Group chief investment strategist Ed Keon said he planned to buy more tech.  But others were more skeptical.  CIBC analysts cut their rating on the chip and chip-equipment sectors.  And Thomas McManus, chief investment strategist at Banc of America Securities, said he was skeptical. “We are wary about adding to technology stock positions after a rebound, while the economy is apparently decelerating,” he wrote in a note.

The Federal Reserve raised rates once again yesterday to 3.25% and suggested they may have further to go than the market expects.  Economists currently expect the Fed to go to 4% in the next 12 months, according to a survey released by the Wall Street Journal today.  The Fed’s main concern is to remove the “accommodative” policy to contain inflation without damaging the economy’s growth potential.  The increases show that policy makers have gained confidence in the expansion and are more wary of inflation than of slowing growth, according to Bloomberg News.

The dollar is also showing remarkable strength.  Bloomberg reports that it headed for its biggest quarterly advance against the euro since 2001.  TheU.S.currency has rallied 7.4% this quarter, buoyed by a widening yield advantage over the euro region and faster economic growth thanEuropefor a fourth consecutive year.  The European Central Bank has left its benchmark rate at 2%, the lowest for any of the dozen nations using the euro in at least six decades, since 2003. The Bank of Japan has kept borrowing costs near zero since 2001.  The spread between US dollar-denominated Treasuries and similar European and Japanese government bonds has kept the foreign appetite for both dollars and US bonds quite high.

Our outlook remains positive for continued economic and corporate growth.  Of course oil prices and the degree to which the Fed tightens the money supply have everything to do with the near-term markets, but longer term, the fundamentals are quite good.  We still see excellent opportunities in Asia, the Pacific Rim and Latin America.  We will keep a close watch on Europe for a rebound, but those governments must make major structural changes in labor and tax policies before significant long-term improvement will occur there.

We hope you will have a safe and relaxing Fourth of July celebration.  Happy Birthday USA!