The S&P 500 gained 14.9% in the 2nd quarter and the NASDAQ gained 21.0%. For the year, the S&P 500 is up 10.8%, the NASDAQ up 21.5%. Overall, the stock market turned in the best performance in the last 4 ˝ years, lifting the averages and the value of clients' assets to the best levels in a year.
Several factors contributed to good stock market performance
· US, British and coalition forces completed the military conquest of Iraq by mid April
· Fed policy remains supportive, with rapid money supply growth and a (mostly unnecessary) 0.25% interest rate cut
· Government bond yields remain near 45 year lows, contributing to strong demand for housing and allowing consumers to free up cash by refinancing their mortgages.
· The market was due for a rebound after the hammering received in 2002.
Even after these gains, the S&P 500 remains 36% below its all time high, 42% below fair value given current yields and earnings expectations, and the NASDAQ remains 68% below its all time high. However, investors remain very skeptical of stocks as an investment, preferring, for the time being, real estate and money market accounts. Cash flowed into stock mutual funds in May, slowed to a trickle in June, and $5 trillion remains in money market accounts.
Earnings growth for Q1 was a solid 11.8% with energy producers on the strong side, hotels and airlines on the weak side. Earnings growth for the rest of the year is forecast at 5.3% for Q2, 12.7% for Q3 and 21.3% for Q4 (the later numbers are usually revised downward as the year progresses.) Even so, annual growth should be at least 10%, which compares favorably to 2002 +0.1% and 2001 –17.3% (all numbers from First Call.)
Economic reports are coming in stronger. Consumer spending held up through the recession, war with Iraq and rise in unemployment, primarily because the refinancing wave has allowed homeowners to extract equity from their homes. This stimulus should slow as rates stabilize or go higher. Business spending is starting to pick up a little, particularly in the technology sectors as hardware installed during the run-up to Y2K and Internet spending needs to be replaced. IT directors are very choosy about seeking “low cost –quick payback” solutions, which means that a lot of companies with crummy products won’t survive.
In international news, Al Qaeda struck against Western targets in Saudi Arabia and Morocco, though more Muslims were killed than Westerners and Al Qaeda lost a large group of recruits either in the attack or in subsequent arrests. Pressure remains on Al Qaeda to deliver a big attack (Texas authorities were alerted to possible 4th of July attack) and we worry in particular about the second anniversary of 9/11 (major Al Qaeda attacks typically occur about two years apart.)
Iraq is proving as difficult to police as East Central Los Angeles (complete with drive-by shootings, unsolved murders, robberies and looting.) Although the majority of Iraqis appear to welcome the removal of Saddam Hussein, there are plenty of Baathist party officials, foreign troublemakers and religious zealots to stir up trouble. US fatalities are currently running 5-8/week – this number needs to drop to zero quickly (similar attrition rates eventually forced the Russians out of Afghanistan.) About 2/3’s of the “deck of cards” is in custody, and an Iraqi scientist revealed a cache of machinery and documents to enrich uranium for bombs; the search for WMD proceeds.
The Syrians and North Koreans are on their best behavior for now. The Iranians are struggling to suppress a student insurrection, which threatens the theocratic government. Ironically, it was students who installed the mullahs a generation ago. Iran is also under pressure to divulge whether its scientists are progressing towards nuclear weapons. Pakistan was rewarded this week with cash and the forgiveness of some old debts for its support of anti-terrorist efforts.
The Bush administration is investing a substantial amount of political capital in the “road map to peace” between Israelis and Palestinians. A cessation of hostilities in the West Bank and Gaza strip deprives al-Jazeera of the images that inflame Arab sensibilities. The Palestinians have a lot to lose if the cease-fire is violated by Hamas, Hezbollah etc. The Israelis will simply declare the Palestinians as untrustworthy and go back to expanding the settlements and demolishing the Palestinian economy. We’ll see what happens over the next three months.
Our strategy is as follows:
We’re nearly fully invested and will invest our remaining cash by mid-July. We continue to monitor international developments, US economic reports and investor sentiment. Solid stock market gains in the coming quarter might allow us to declare the bear market over.
Yours sincerely,
David Edwards, President
Heron Capital Management, Inc.
(800) 99-HERON
http://www.HeronCapital.com