HCMI Client Letter - May 3rd, 2001
April 2001 was the best month for stocks since
December 1991 (right before allied forces took back Kuwait from Iraq.) As
we wrote several times this Spring, not only were we not selling stocks but we
were putting cash to work - our equity exposure is currently 90%, the highest in
years. Clients were well rewarded with an average gain of 9.1%, slightly
ahead of the S&P 500's 9.0% gain. We're not out of the woods yet; the
average client remains down on the year but losses have been cut in half or
better and we're fairly optimistic about the rest of the year's
results.
The first week of April saw terrible selling as we
projected in our April 1st client letter.
There were margin calls and mutual fund redemptions which forced sales, and many
investors had to raise cash to pay taxes on gains from 2000. We took the
unusual step of advising our clients who had taxes due (particularly from
exercise of stock options) to pay the taxes by taking a margin loan against
their account; we will close out these margin loans shortly now that the market
has rallied. As we noted in a recent column on stock market valuations risk
is greatly reduced from a year ago. Also, markets were completely
surprised by an inter-meeting cut in Fed Funds two weeks ago. A
particularly benign inflation report gave the Fed leeway to move prompted,
we think, by the bankruptcy of several telecommunications companies and the fear
that a domino effect would knock down more if the Fed didn't boost confidence by
dropping rates
What's next?
There is evidence that the economy is not as weak as
analysts had feared. The most recent GDP report put growth at 2.0%, about
double economists' estimates. As we pointed out earlier, the economy is in
much better shape with low inflation, low unemployment and low interest rates
when compared to previous recessions in 1991-2, 1982-3 and the early
1970's. However, corporate earnings are in a recession (will decline for
at least 2 quarters.) Analysts 3 months ago had estimated first quarter
earnings to grow 5.3%, yet final results are indicating a decline of
6% to 7% with 81% of companies reporting. Earnings growth looks negative
for Q2 and Q3, possibly only turning positive again in Q4 (information from
FirstCall.)
The short term outlook for technology companies is
bleak. After an orgy of capital spending in 1999 and 2000 (combination of
Y2K spending and Internet building) new investment has slammed to a stop.
There are many traditional companies building out Internet strategies now, but
many are able to buy up secondhand equipment at bankruptcy auctions, even on
E-Bay. However, we believe that the worst is over
for technology stocks (stock prices generally anticipate company
fundamentals by 6-9 months.) The healthy 35% surge in the NASDAQ over the
last 4 weeks was a combination of short-covering and bottom fishing. Some
clients have asked us whether the opportunity to invest there is over. We
say no, the 35% rise in many stocks still leaves most 50% off all-time
highs. Emerging technology companies like TheGlobe.com and VA Linux
will either go bankrupt or be bought out at pennies per share.
Companies like Sun Microsystems, Oracle, EMC and Cisco will continue to
gain at the expense of competitors. We continue to invest selectively in those
companies with solid revenues, decent cash flow, and a secure market
niche.
Strategy
We continue investing 25% of our clients in
technology, financial services, healthcare, and "slow but steady" stocks.
The "slow but steady" group includes companies such as Real Estate Investment
Trusts (REITS), energy stocks and consumer non-cyclicals whose stock prices are
generally less correlated with the S& P 500 and therefore smooth out overall
returns. We expect May to be flat even though markets are expecting
another 25BP cut in Fed Funds on May15th, perhaps even 50BP. June will be
rocky as pre-announcements proliferate. Stocks should be higher again in
July.