HCMI Client Letter - July 1st, 2001

After 4 negative quarters in a row, the S&P 500 gained 5.7% but remains down 6.9% following a loss of 9.1% in 2000.  The last time the S&P 500 had two negative years in a row, a fairly rare event since 1945, was in 1973-4.  Since economic conditions are substantially better now compared to that period, we expect the S&P 500 to move into positive territory by year-end.

Market conditions looked pretty grim the first week of April as fund redemptions, selling of stocks to pay for taxes and margin calls pushed stocks to multi-year low.  We stayed with our strategy, did not liquidate positions and were rewarded with a handsome rally over the following 6 weeks.  Stocks slumped again in June over worries about corporate earnings.  However, negative pre-annoucements were light compared to March and December, which indicates to us that regular earnings reports, due out after July 5^th, will be better than expected.  Accordingly, we are investing our cash balances in stocks.

Bullish factors for this quarter:

• Price of energy falling as consumers reduce consumptions – this trend will show up in reduced inflation rates in upcoming PPI and CPI reports.
• Stock market volatility down by a third, sellers appear to be sold out.
• Major averages in a trading range with strong support at Dow 10,500, S&P 500 1,100, NASDAQ 2000.  We believe the next major market move will be to break out of the trading range, not break down.
• Investor focus turning to prospects of higher earnings in 2002 which should compare favorably to 2001’s mostly negative growth.

Bearish factors for this quarter:

• Fed likely near the end of further reductions in the Fed Funds rate.  Yields on US treasuries have moved higher over the last 4 months, which means that little benefit from recent cuts is passing through to consumers.  (Mortgage rates, for example, are priced off 10-year treasury yields.)
• Capital spending (manufacturing facilities, technology etc.) not likely to resume at rates seen in 2000 due to widespread capacity excess.  Corporate bankruptcies and defaults likely to continue at higher than average rates through year end.

Our strategy is as follows:

Maintain our stock allocation of 25% each to technology, healthcare, financial services, "slow but steady" stocks.

Review and rebalance those accounts which have drifted away from our core strategy.

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