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Year 2003 Commentary


Time Heals Many Wounds


After a difficult 2002, this year did not start out much better as we experienced continued volatility through the first quarter.  However, with April Fool’s Day upon us the markets finally decided to make their stand and began delivering solid gains for the remainder of the year. Much of the emphasis behind this performance was due to interest rates at 40 year lows and the White House passing a $350 billion economic stimulus package that reduced income, capital gains and dividend tax rates.


One year ago fear emanated from the stock market and Wall Street. This situation created tremendous opportunities. However, the time to be fearful was when others were greedy (1999) and the time to be greedy was when others were fearful (2002). This was easy money; unfortunately, the environment of easy money is over.


Going forward, we continue to see decent, but not stellar, stock market opportunities of 7% or 8% per year over the next ten years. And while the market currently appears to be fully valued, this may not be so bad when compared to alternatives such as fixed income and cash. Furthermore, it’s a possibility that an increase in interest rates could act as an anchor upon big gains in the equity markets—despite the fact that we continue to see good Gross Domestic Product figures and corporate profitability. Therefore, we remain cautiously enthusiastic about the equity markets.


Certain technology stocks showed us that they still have life and, sadly, that investors in these stocks can still be quite foolish. Over the past year stocks with negative earnings increased in price by 60% whereas stocks with actual positive earnings only gained 17%. I suppose some investors have already forgotten the lessons of 2000—2002. To quickly summarize, the only reason an investor should own a company is to share in its earnings. This is difficult to do if a company has no earnings. Investors have already bid up companies with poor earnings so much that they are now, in many instances, more expensive than they were in 2000. In fact, the stocks in the Nasdaq 100 are trading for 38 times 2004 earnings. Certainly not a bargain by anyone’s valuation. Given this, we remain leery of the tech sector and prefer that people leave their gambling needs in Las Vegas.


We also look for investors to move out of cyclical and small cap stocks into more defensive large cap companies. Health care and consumer staples continue to be some of our favorites. To enhance that strategy we favor companies with strong international exposure, as we anticipate that the US dollar will continue to show weakness against other currencies.


Much has been publicized about the decline in the dollar. There are two sides to this discussion. A weak dollar is positive for US based companies with lots of international production. A weak dollar is also positive for US based companies exporting their goods and services, as they are more affordable in the international market place. It also means that goods and services produced abroad are more expensive for American consumers. It just depends upon which side of the argument you are on.


After several strong years of consumer spending leading our economy we expect business spending to provide leadership in 2004. Consumer savings rates are extremely low while business spending is picking up. We now have record low inventories in proportion to domestic and international sales. Additionally, corporate productivity in the third quarter climbed at its fastest pace in 20 years. This led to corporate profits rising 30% in the third quarter, which was the best year-over-year growth in profits in 19 years. Furthermore, corporate spending will continue to benefit from the 2002 and 2003 tax packages. Despite the phenomenal increases from corporate America we should not expect them to continue at this torrid pace. They are simply making up for lost time.


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The economy as a whole, as measured by Gross Domestic Product, has continued to stabilize and strengthen. After growing at a 3.3% annual pace in the second quarter, third quarter GDP grew at a blistering 8.2% annual rate (its fastest pace since 1984). While these are good numbers, no one should expect the third quarter figures to continue. For 2004 we project that GDP will increase in the 4% to 4.5% range (versus 2.9% for 2003). If GDP records a 4.5% increase it will be its best number since 1984.


In the past year, as predicted, we saw interest rates on the key ten year US Treasury jump by 11.5% as yields increased from 3.8% to 4.25%. While we expected an increase in market rates, the Federal Reserve challenged our position by lowering the short-term Fed Funds rate to a meager 1% in June (its lowest level since 1958). While much of the justification for this move was out of concern over deflation, we did not see this as a valid concern and time has validated our position.


The Fed Funds rate will most likely remain at 1% until the June 2004 meeting. In the second half of 2004 we think the Fed will increase short-term rates from the current 1% to 1.75% or 2%. However, the Fed will not raise rates until they are convinced that inflationary pressures are prevalent and, more importantly, that the employment picture is consistently improving.


Even if the Fed does increase short-term rates the overall interest picture will provide a difficult environment for fixed income investors. Expect cash equivalents to produce paltry returns. Longer term fixed income investments will not be much better. This continues to be a great situation to borrow money and a poor one under which to invest for income.


In addition to employment statistics, a few other factors will affect interest rate scenarios and Federal Reserve decision making. For the time being there is still a fair amount of untapped industrial capacity that needs to be utilized. Furthermore, raw material prices need to be observed closely. Oil has been consistently above $30 per barrel and gold has broken through the $400 per ounce barrier. Several other raw materials, such as steel and copper, have seen large price increases. All of these give some indication that inflationary pressures are mounting.


However, in analyzing the multitude of components that factor into inflation and strength of the economy the one that intrigues us the most continues to be employment. So far, the weakest area of this economic recovery has been job creation. Despite this, new claims for unemployment are now at their lowest level since January of 2001. We continue to expect moderate improvement in overall employment. Additionally, decisions by the Fed to increase interest rates have historically been more closely linked to the labor market than any other aspect of the economy. Not surprisingly, strength in the labor market will be a major plus for the Bush re-election effort.


It is also worth noting that 2003 was the third year of the Bush presidency. While the third year is typically the best year in the presidential cycle, the fourth year is also usually positive. The Dow Jones Industrial Average has increased in an election year 16 out of the past 24 elections. The fourth year of a presidency has delivered double digit returns on the average. The incumbent typically does everything they can to get re-elected. Going into the election we have an improving economy, low interest rates, declining unemployment and the 2003 economic tax package. If these strategies work as anticipated, expect Bush to be re-elected in November.


Finally, if you are interested in receiving the most recent update to the Sather Financial Group, Inc.’s Form ADV please let us know and we’ll have one mailed to you in March. If you have any questions or comments please drop by or give us a call.


We wish you good health and prosperity in the coming year and thank you for your continued support.


Sincerely yours, 


Dave Sather, President



Last Updated on Friday, 06 March 2009 14:38