News & Insights
A Happy Ending Falling Into Place
The extraordinary economic times of the past few years can now finally be told with a conventional ending. For a time, the boom, bust and recovery story seemed as if it might finish with an unconventional plot twist and an unhappy ending.
Our hero, the resilient U.S. economy, battles back from the body blows of the tech bust, corporate greed and Al Qaeda, and in 2003 delivers a rebounding stock market and gushing corporate profits. But the people anxiously awaiting the arrival of jobs that pay a living wage are left disappointed, as our hero appears to be indifferent to the workers' concerns. But wait! In the nick of time, the economy delivers when the March jobs report reveals that over 500,000 jobs have been created in the first three months of the year. The economy again puts paid to those naysayers who declared "It's different this time."
These good times were purchased at a price. The government has become a profligate spender and
Fed policy has encouraged individuals to do the same. While this has supported the consumer economy, it comes with consequences. The household and government debt decreases policy makers' flexibility during the next economic downturn. These conditions make our government and institutions stakeholders in a more inflationary environment and set the stage for the next act of our economy's story.
What's Next for Stocks
But having successfully closed out this chapter it is only appropriate to prepare for what is next and
remember a recovering economy does not always herald a shimmering stock market. The stock
market rally, already a bit long in the tooth, is likely to grind higher, as we indicated in last quarter's
outlook, with an increased level of price volatility.
The shift from more speculative stocks, such as those in tech and retailing, towards the more reliable
stores of value in the consumer staples and health care areas is likely to continue. Profits, in general
should continue to be excellent, up perhaps as much as 20% from the 1st quarter of 2003, supporting
stock prices, although revenues may only be up 8% on a year over year basis versus 11% in the 4th
quarter of last year. This type of revenue deceleration may justify an emphasis on less speculative
stocks. Quality dividend paying securities seem prepared to outperform the market as a whole.
Small-Cap & Foreign Shares
It is the expectation of higher interest rates that will cause the end of the small cap sector's lead in the
performance game in the coming months. It would be appropriate to take some profits off the table in
the small cap area in the near term.
Our negative outlook for the dollar and the recovery of Japan's economy continue to influence our
recommendation that clients continue to have exposure to the developed and emerging foreign markets.
Bonds & Fixed Income
The outlook for longer-dated, higher-quality bonds is negative. A whiff of inflation and less
accommodative Fed policy is in the offing and so we believe that maturities should be kept short.
Long-term treasuries are still the most at risk as the dramatic increase in bond yields after the jobs
report testifies. Also, the purchase of U.S. government bonds by foreign government has been a
powerful support for bond prices. This is likely to abate in the near term, providing more negative
pressure on bond prices.
Real Estate and Alternative Investments
Real estate investment trusts have been surprisingly strong and have probably moved past fair
value as an asset class. We will probably not add to positions in these except in specialty areas
such as timberland.
The commodities and materials sectors seem ripe for a pullback after their recent strong performance,
but we expect the fundamental backdrop to be favorable for the continued strong performance over
the next year or so. In particular, OPEC's decision to trim production is likely to keep the price of oil
relatively high. Strong demands triggered by a recovering global economy and a rising Chinese
economy coupled with low inventories will provide further support to petroleum prices.
There is no area of the market that seems dramatically under priced, only those areas that are more
attractively priced than others. As portfolios are reviewed we pay particular attention to balancing
our investments from areas that have led to those attractive investment opportunities that have
lagged in this market. This is a reliable way to manage the risk inherent in the capital markets and
at the heart of our process in portfolios where we have asset allocation responsibilities.
The Altavista Investment Team - Spring 2004