HCMI Client Letter - April 18th, 2005

Dear Clients and Friends,

Last week's sell-off bears some comments:

• It was the sharpest weekly decline in two years
• Adding to declines of the previous 5 weeks takes the averages back to the levels of last November, thus giving up all of the 2004 year end rally
• Stocks fell despite a precipitous decline in the price of oil, from $58 to $50
• Stocks fell despite a rally in the dollar
• Stocks fell despite interest rates easing back to 4.25% in the 10 year
• Stocks fell despite increasing merger activity
• Stocks fell despite earnings coming in a little higher than expected (8.6% vs. 8.1%)
• Stocks fell despite the unemployment rate falling to 5.2%, the lowest rate since the 9/11 attacks
• Stocks fell despite being undervalued 20-30% by the Fed Model

What's going on?  There are times when investors succumb to "irrational exuberance," as we saw in 2000.  Other times, investors succumb to "irrational despair," where bad news is bad news (IBM missed it's earnings report!) and good news is bad news (falling treasury bond yields forecasts recession!)  We believe that investors are "fighting the last war."  In 2000, investors continued to bid up stock prices even as S&P 500 earnings growth went sharply negative.  Now that earnings growth has fallen from plus 20% in 2003 and 2004, to the low teens for 2005, investors are determined not to get caught out again and are dumping stocks wholesale, even when the earnings reports are good (as we saw with General Electric last week.) 

These are the important things to remember:

• Even with oil in the $50/barrel range, inflation remains at extremely low levels
• The current economic expansion is only two years old.  The previous expansion was seven years, the post war average is five years, there's plenty of slack in the economy and economic growth is expected in the 3.5% range for 2005
• Economic growth worldwide, excepting Europe and Japan, is robust
• Earnings growth for S&P 500 companies is expected to accelerate later this year