Watch the Earnings and Listen to Management

According to today’s government reports, the consumer has not wilted in the face of higher gasoline prices.  Personal spending was up more than expected in March while personal savings fell to .4%, the lowest since October 2001.  Mitigating the falling savings rate somewhat though is a healthy rise in disposable incomes.  When adjusted for inflation, incomes were up 3.3% last month from March 2004.

Price pressures or inflation are getting toward the high end of Fed tolerance.  The report, which is the favorite for the Federal Reserve policy makers, also showed that inflation rose, but not as much as other recent reports have indicated.  The gauge rose .3% last month and is up 1.7% from March 2004.

Yesterday the government released its preliminary (almost always wrong) report on the growth of theU.S. economy during the first three months of this year.  Gross Domestic Product grew at 3.1%, for the quarter, the slowest in two years as both business investment and consumer spending slowed.  Many expected the economy to slow from its quick pace of last year, but the rate of slowing was unsettling for some and proof for others that high energy prices were finally taking a toll on the economy.

While uncertainty over the economy’s future remains, earnings reports of our companies and those in general have been exceptional.  A chart of the recent earnings releases from companies in our growth and income portfolios appears below.

The earnings performance of our holdings has been exemplary.  On a larger scale, with roughly half of the companies in the Dow Jones U.S. Total Market Index reporting, earnings are up an average of 16% over the same period a year ago.  But stock prices have not risen accordingly for a number of reasons.  In a word it is due to uncertainty – uncertainty about the future of our economy.  Investors wonder if the growth of the past will continue.  Will high oil prices (although falling now) ultimately cause inflation and/or stymie growth?  Will the Fed as they try to contain inflation be forced to raise rates to levels that risk the growth of economy?  Will the European and Japanese economies strengthen in time to begin buyingU.S.exports?  Wil lChina’s and Asia’s economies continue their growth, providing the raw material demand that is sustaining many emerging and developing economies?  The answer to these questions will be provided in large measure (no pun intended) by the moves of the Federal Reserve.  The U.S. economy continues to be the global leader and at this point sustains it.

Most economists believe that the ‘soft patch’ that we currently find ourselves in will not be long-lived.  They see the economy as generally strong across most sectors.  If job growth continues as it has now for several quarters, incomes will continue to rise, the consumer will remain engaged, and business investment will continue.

We plan to pay close attention to what the managers of industry-leading companies say about their future and the future of their industry.  So far, aside from the regulation-driven conservativeness, the tone we are hearing is good.  There are areas such as communications and information technology that show greater softness, but in large the tenor about the future is positive among CEO’s.  We also believe that the price of oil too high relative to supply and that it will continue to drop to a range in the $30’s.  Finally, we think that stock prices will find a bottom in the coming months and that large companies will fare better than their smaller brethren during these uncertain times.