HCMI Client Letter - September 3rd, 2002


 
Dear Clients & Friends,
 
After 5 months of losses, the major US averages eked out small gains in August.  However, from the scary lows of July 23rd, the averages are up about 15% and up five of the last six weeks.  In July, a record $52.6 billion was withdrawn from US equity mutual funds and nearly double the amount withdrawn after the 9/11 attacks last year (overall, about $4 trillion is held in US equity funds.)  As we commented to a number of clients in the last few weeks, hundreds of thousands of investors are liquidating their life savings at firesale prices for no good reason.
 
Economic reports over the last 4 weeks have been mixed.  Consumer confidence is down and back-to-school sales, second only to Christmas sales in importance, were weak.  Housing starts and sales, however, remain strong reflecting generational lows in mortgage rates.  Cars sales also remain on track to set records in 2002.  The single most positive report was last week's durable goods reports, which jumped a record 8.7% in July after falling 4.1% in June.  Durable goods include aircraft, factory equipment and telecomms equipment, stuff usually purchased by businesses to expand capacity.  Since the sharp decline in business spending caused the 2001 recession, this recovery in spending bodes will for 2003.
 
There have been no new corporate accounting scandals in recent months.  Of the 691 US companies required to attest to the completeness and accuracy of their accounting statements, only 16 were unable to do so.  These 16 include companies already under investigation such as Enron, Dynergy and Adelphia Communications, or companies that are in bankruptcy such as Consolidated Freightways and Worldcom.  The full list is at http://www.sec.gov/rules/extra/ceocfo.htm - companies not in compliance are checked "other."
 
S&P 500 earnings in the Q2 finished with a small gain of 1.4%.  The estimate for growth in Q3 is currently 8%, and for Q4 is 30%.  Given current yields of under 4% in the ten year treasury bond, this forward projection of growth implies that the S&P 500 is undervalued by 30%.  September is typically the toughest month for stocks as we get into pre-announcements for Q3 and we typically see the highest number of analyst downgrades (clearing the decks for upgrades in the following January.)  October is also tough as mutual funds capture tax losses (by selling stocks down on the year) prior to their fiscal year end of October 31st.  So much about this year has been unusual that we can hardly guarantee that the next two months will follow the usual pattern.  On the first trading day of September, US stocks are down sharply on trading losses overseas (including a 19 year low in Japanese stocks) and some comments on lower revenue at bellwether Intel.
 
The single biggest wild card is the likelihood of war with Iraq.  Much chatter in the media and government about whether such a war is the "right thing to do."  Pragmatically speaking, given the call-up of armed forces reserves, the prepositioning of troops and materiel in neighboring countries such as Turkey, Jordan and Bahrain, and the fact that factories are on triple over-time producing the kits for "smart bombs," is seems that the Administration has already decided on such a war, perhaps in January-March 2003 when temperatures in the mostly desert country are bearable.  The price of oil rallied over $30/barrel last week despite reasonably high inventories and the likelihood of an OPEC production increase shortly.  In our opinion, the US has been at war with elements within the Middle East for over ten years, we just hadn't realized it yet.  So we regard war with Iraq as taking the conflict back the Middle East, rather than waiting for another attack on US soil.  We don't doubt that the US would prevail, with or without support from allies, but nobody knows how much such a war would cost in terms of US military lives, civilians killed on the ground and total dollars (nobody ever knows in advance when it comes to military conflict). 
 
So we're still sitting on the cash we have on hand, looking to get past pre-announcement season and watching the conflicts unfold in the Middle East.
 



Yours sincerely,
David Edwards, President
Heron Capital Management, Inc.
(800) 99-HERON
http://www.HeronCapital.com

Last updated on September 3rd, 2002