HCMI Client Letter - May 3rd, 2002
Dear Clients and Friends,
US stocks have been pretty much straight down for 9
weeks in a row. The S&P 500, just about breakeven on the year on March
31st, is now down 6.3% on the year, falling 6.6% in the last month. The
average HCMI client is down 6.0% on the year. As we wrote in our last
letter, we moved to fully invested in March, so it's somewhat discouraging
to see the worst month for stocks since the September 11 terrorist
attack.
What's going on?
Usually a strengthening economy leads to improved
corporate profits, which leads to a stronger stock market. Typically the
stock market anticipates the economy by about 6 months. So under normal
circumstances, the stock market should have been rising steadily since last
fall. The terrorist attack knocked this pattern off balance, but then
we saw a big rally through year end as Al Qaeda was routed. Stocks peaked
the week of January 7th, fell sharply through early February as earnings failed
to impress, then regained the losses through March. Earnings again failed
to impress in April. The fact that earnings declined 12% was not a
surprise (earlier estimates had been for a decline of 15%); however, corporate
managements have provided little guidance about earnings for the rest of the
year and the lack of information makes investors very nervous.
Stock analysts, as tabulated by First Call, estimate that earnings will grow 7.4% in the second quarter and in
excess of 20% for the third and 4th quarters. A gain in Q2 2002 would be
the first positive quarter after 5 quarters of negative growth. However,
stock analysts are some what in disrepute right now after the excesses of the
"Internet era" so investors don't seem inclined to believe those
estimates. We think it's perfectly logical that earnings should be higher
later this year based on recent economic reports such as last week's GDP
which showed growth at a substantial 5.8%. However, in the current
pessimistic environment, investors dismiss the good GDP report and focus on
today's jobs report which showed unemployment at 6%. The unemployment rate
rose, not because jobs were lost in the economy (payrolls actually rose) but
because more people are looking for work. This is explained by
unemployment benefits for those laid off after 9/11 expiring and also because
people who might have been discouraged from seeking work when the economy had
its brush with recession last year, are seeing a pickup and therefore starting
to look again.
Other investor worries:
The fear of another Enron type
bankruptcy
The fear that accountants (e.g. Arthur
Anderson) can't be trusted anymore
The fear that institutions in general (e.g.
the Catholic Church) can't be trusted
The fear that the stock market, as a wealth
generating mechanism, is permanently impaired
The fear that Al Qaeda will launch another
successful attack on US soil
The fear that Mideast violence will spill over into
a broader conflict
The fear that the US will attack Iraq by year
end
The fear that oil prices will go to
$40/barrel
At what level does rational concern become
irrational panic (the flip side of the 90's rational optimism becoming
irrational exuberance?) When we look back over the post war era, we are
reminded that the US was eyeball to eyeball with the Soviets for over 40 years,
through multiple proxy wars, civil wars. We lost a war in Vietnam, lost a
president to Watergate, almost lost another to Monicagate, underwent a painful
metamorphosis from a manufacturing economy in the 70's to a service economy in
the 80's, endured oil boycotts, soaring inflation and unemployment.
Through all this, the economy continued to grow, and with it the stock
market. So the current environment, while not the feel-good times of the
late 90's is pretty benign. Therefore, we're sticking to our strategy,
focusing on companies with solid revenues streams and good cash flow to get
through the current hard times, and staying fully invested.
As always, please contact us with your questions
and concerns.
Yours sincerely,
David Edwards, President
Heron Capital Management, Inc.
(800) 99-HERON
http://www.HeronCapital.com