HCMI Client Letter - June 4th, 2002
Dear Clients and Friends,
After a sharp one week rally in May (mostly driven
by short-covering,) US stocks resumed their downward trend and are now at or
below lows for the year and below the levels of September 10th (prior to the WTC
attack.) The S&P 500 is down 9.7% on the year and the NASDAQ is down
19.9% on the year, with nearly all the losses contained in the last two
months.
Investor worries include:
The potential (although tiny) of a nuclear exchange
between Pakistan and India
The apparent regrouping of Al Qaeda in rural
Pakistan and Kashmir
Increasing doubts that corporate earnings will
return to positive growth in Q2
Continued doubts about the quality of corporate
accounting (with Tyco likely to follow WorldCom and Global Crossing into
purgatory)
The US Dollar declining against the Euro and Yen,
which makes foreign investors less interested in holding US Dollar assets
(although it also increases the value of overseas profits translated back into
US revenues)
Rotten technicals (stocks open higher, close lower,
day after day and week after week)
Investors are mostly ignoring:
A slew of economic reports showing that a "double
dip" recession is unlikely
Price of oil falling as war fears in the Middle
East ease
Interest rates stable near 35 year
lows
Strong consumer confidence and spending despite 6%
unemployment rate
The next series of earnings report are due starting
the second week of July which means that pre-announcements of earnings
shortfalls will start appearing over the next 4 weeks. According to
FirstCall, which tracks earnings actuals vs. estimates, earnings warnings and
downward revisions are running lower than average, while earnings upside
surprises are running higher than average. In aggregate, this means that
corporations are doing a little better than expectations.
Earnings for Q2 are expected to rise 7.3%, the
first gain in five quarters. The Q2
earnings turnaround will be led by the consumer cyclical, technology, and
financial sectors. Technology is expected to go from a decline of about 30% in
Q1 to a gain of about 33% in 2Q. The financial sector is expected to go from a
gain of 6% in 1Q to a gain of about 18% in 2Q. The consumer cyclical sector is
expected to go from a 1Q gain of 3% to a 2Q gain of about 29%. In
expectation of this earnings growth, we fully invested our clients in March and
have so far not been rewarded in the slightest. We have simply left new
cash arriving April and May uninvested; since other fund managers and investors
are doing the same, there is a complete absence of buyers.
Given current interest rates and earnings
expectations, the S&P 500 is fairly valued at about 1100; the current level
of 1035 represents about a 6% discount. We don't know when the current
bearish psychology will break (a stand down of the Indian/Pakistani armies or a
major breakthrough in the war against al Qaeda would be very helpful).
However, all conditions indicate stronger economic growth, therefore higher
corporate profits, therefore a stronger stock market, so we will sit tight with
our current investments.
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