News & Insights
A Rarified Air - Cause to be Cautious in 2005
Holiday bows and ribbons are in the trash and the champagne flutes have been put away and we have turned the page on another year. 2003 and 2004 were good years for investors, the first back-to-back positive years since 1998-99, giving investors good reasons to cheer. We remain optimistic and positive on the long-term health of the capital markets but find reasons to adopt a more defensive stance in 2005.
The economy must begin a process of reversing the excesses built up during the "easy money" policies pursued by the Fed since 2001. This necessary adjustment will have the effect of retarding consumer spending and cooling GDP growth a bit. Fortunately, business spending should pick up as corporations find uses for the tremendous amounts of cash that have built up on their balance sheets during the profitable period from late 2002 through today.
The recent run up in stocks has brought the broad market, as represented by the S&P 500, into the middle of a range of fair value. This cyclical bull market we have enjoyed for the past 2 and 1/3rd years is close to the post WWII average in length. We believe that profitability of big American companies is set to slow after more than doubling over the past three years as interest rates and wage costs rise. This makes us a bit cautious this year. If the market rises another 10 percent, it will be trading at over 20 times 2005 earnings, fairly rarified air for a market that is set to experience slowing profit growth.
Within the diversity of opportunities represented by the stock market there are still some attractive sectors and companies. We believe that energy and commodities will continue to benefit from a global expansion in manufacturing, particularly in Asia. Food and agricultural stocks should fare better than the market as a whole. The volatile technology sector stands to be a beneficiary of increased business investment, and the valuation of these generally expensive issues is not nearly as obscene as in the recent past.
With inflation rising sharply off of the almost historic low recorded in 2003, it is difficult to work up enthusiasm for bonds of any stripe. We continue to believe that the duration of bond portfolios should be kept shorter than the market. Our estimate is that the 10 year Treasury should yield between 5% and 5½ %, up from its current 4.3% level.
We continue to find the foreign markets attractive for their relatively modest valuation. They also serve as a bulwark against the effects of a weaker dollar.
Real Estate & Alternatives
REITS, which have provided stellar returns over the past five years are now fully priced and so we approach them with more caution than in years past. Agricultural, energy and industrial commodities have done well during the last two years and we believe they still remain attractive as an investment, although we caution that the path they chart may be a volatile one.
The Altavista Investment Team - Winter 2005