04 Feb 2005 Will 2005 Be As Dreary as January?
There’s a stock market axiom that says, as January goes, so goes the year. According to Bloomberg, since 1950, the S&P 500 has moved in the same direction during the year as it did in the first week 73% of the time. The S&P 500’s drop so far this year marks its worst start since 1990, when it fell 4% in the period through Jan. 20th. The index lost 6.6% that year.
We have suggested and continue to feel that 2005 will be a difficult year for the broadU.S.equity averages, but there will be opportunities in some industries just as others will suffer from the macro challenges that are coming. The Federal Reserve will continue to raise short term rates as they aim for policy-neutral targets. The federal government will likely cut fiscal spending dramatically, both in social and defense programs. But just as policy makers and administrators cut wasteful programs, they will likely reward those providers offering the most effective, productive and/or efficient alternatives. Examples we own include L-3 Communications (intelligence surveillance and reconnaissance), Apollo Group (Univ.ofPhoenix– Internet and distance adult education and training), and Verizon Communications (providing network and data services to the federal government).
Big debates are coming on Medicare, Social Security, and tax reform. And the big uncertainty which is difficult to discount is the continued threat of terrorism. The price of oil is perhaps the best indicator of the level of those fears on a global basis. You can see in the graph below that the trend for oil prices was generally down in November and December of last year, supporting the year-end stock rally. However, the jump in January has had the reverse effect.
Corporate earnings reports are also contributing to the decline of stock averages. Earnings have not been particularly bad, just not as good as investors hoped, dimming prospects that this year’s growth will be as good as last years’. Yesterday, Ebay and Qualcomm disappointed by a penny a share each and were punished with 18% and 19% drops. They helped to set a decidedly negative market tone yesterday. Today, GE reversed the market’s downward trend with better-than-expected earnings and forecast for this year.
As you can tell by recent trade confirmations, we like the economic prospects for Asia, the Pacific Rim, and most notably Japan. We expect to make further specific investments inJapanin the coming weeks. And we are keeping a close eye on China to learn whether the government’s efforts to orchestrate a soft landing in their slowdown of the economy are successful.
One of our main areas of investment focus right now includes energy production, exploration, and oilfield services. We think that high oil prices are here to stay. The $10 to $15 per barrel terror premium may erode or disappear altogether in the coming quarters, but the world’s demand for oil will be unparalleled as the economies of China,India,Pacific Rim and Latin American countries shift into high gear. We think the valuations for many of the leading oil stocks remain reasonable despite their run-up last year.
We think global infrastructure builders and consultants like Caterpillar, Duke Energy, GE, and Fluor will increasingly benefit from the opportunities created in these countries as they build new airports, roads, bridges, and power facilities. Here at home companies like Florida Rock will continue pumping out the concrete as fast as their capacity can provide it.
Technology stocks remain one of the most reasonably valued areas of the market. Because most of these stocks do not pay dividends, their returns come completely from price appreciation. We have pointed out that investors have less confidence in future earnings streams from these companies than they have in past years, so their valuations are much lower relative to earnings. We expect that some careful stock selection and some technology index positions will provide better than market returns this year.
While 2005 may not be a brilliant year for the S&P 500 and the Dow, there remain some bright spots that should provide attractive returns. We will do all we can to identify and own them. For now, that’s it.