For the year, the S&P 500 declined 23.4% and the NASDAQ declined 31.5%.  2002 marks the third year of declines in the major averages, the first three year decline since 1939-41 (the commencement of World War II.)  From the peak in March 2000, to the valley of October 2003, the S&P 500 declined 49% and the NASDAQ declined 78%, the worst declines since 1973-4 (OPEC oil boycott, resignation of Nixon, surging inflation, surging unemployment, collapse of US manufacturing.)  On only two other occasions in US stock market history have stocks declined 4 years in a row - 1929-32, start of the Great Depression and 1861-4, the American Civil War - so it seems unlikely (though not impossible) that the US market will be lower a year from now. 

Given that the United States dominates the world economically (produces 25% of world GDP with 5% of the world’s population) and politically (the only remaining super-power,) and with S&P 500 earnings set to grow 10-14% in 2003, one would project that US stocks would be doing better.  However, investor sentiment can overwhelm fundamental realities on the upside (as we saw in the late 1990’s) and on the downside (as we saw over the last three years.)

There was a decent rally through Thanksgiving off the October 9^th lows, but half the gain was given up in December.  In most years, stocks rally into the year-end, but this year, concern over the impending war with Iraq left investors sitting on their cash.  Critical dates to watch are January 27^th, when the UN inspectors make their first full report, and January 31^st, the next new moon when US attack aircraft, already invisible to Iraqi radar, will also be invisible to the naked eye (therefore providing a likely date for commencement of the Air War.) 

Between now and month-end, about 120,000 US combat troops, supplemented perhaps with some British troops, will be lined up in Kuwait, Qatar, Turkey and on carriers in the Persian Gulf.  Regardless of what the UN inspectors report, it is highly unlikely that the US will call off the invasion.  Securing Iraq achieves several objectives 1.) eliminates the threat of the unpredictable Iraqi leader, 2.) allows the US to establish an anti-terrorist base right in the heart of the Arab world, 3.) dispels Al-Qaeda assumptions that the US is unwilling to project force and sustain losses to achieve security, 4.) gives the US access to the second largest reserve of oil, thereby the leverage to control world oil prices.  The consensus analysis is that the Iraqi military forces will fold within a matter of weeks, if not days.  However, so much can go wrong in a military conflict that we’ll just have to wait and see how this war turns out (hence, the hesitation of investors to put money to work in stocks.)

Other recent geo-political developments include the descent of Venezuela into near civil war.  Venezuela is the world’s 5^th largest oil producer; disruptions in production there caused oil to surge to $33/barrel recently.  North Korea has decided to take advantage of US focus on Iraq to abrogate previous treaties regarding nuclear production.  Critics of US foreign policy have called on the Bush Administration to abandon the war with Iraq and move forces to the Korean Peninsula, thus demonstrating no knowledge of how much time, energy and planning goes into such exercises.  North Korea will be dealt with, but not until after the situation in the Middle East stabilizes. 

In the United States, it’s been over 6 months since any new accounting scandals have come to light.  We said earlier this year that corporate excesses have a way of being self-correcting; it appears indeed that any companies with doubtful accounting polices have worked overtime to fix them prior to an SEC investigation.  Christmas retail sales showed the smallest growth in about 20 years.  Despite the doom and gloom, S&P 500 earnings are expected to grow 12.9% in the 4^th quarter, a nice rise over Q3’s 6.8% gain, Q2’s 1.4% gain and Q1’s 11.5% loss.  GDP grew smartly at a 4.0% rate in the Q3, 2002 and is estimated to grow 1.4% in Q4 2002, 2.4% for all 2002 and projected to grow 2.6% in 2003.

Bullish factors for this quarter:

Our strategy is as follows:
We harvested tax losses in December and are sitting on the cash for the time being.  If the war with Iraq is short, with minimum casualties, we would want to move new cash into stocks pretty quickly.