Second Quarter Newsletter—July 1, 2004
To Our Valued Clients and Friends:
I. Nowhere fast again!!
II. Auto and home sales
III. Disappointing job growth, but continued improved earnings
IV. Politics
V. How are our mutual funds doing?
VI. The remainder of the year
I. Nowhere fast again!! - You may recall that at the beginning of the year I suggested that the second year of a rebounding market usually provides only modest investment returns. In our first quarter letter, I reported that the markets had changed little from the first of the year and while the first quarter experienced substantial volatility the Dow Jones Industrial Average changed by less than 1%. Now that the half-year mark has arrived I report that the Dow has changed less than 2/10 of a percent during the second quarter, resulting in the Dow Jones Industrial Average being down 1.1% for the first six months. Nowhere fast!
In reviewing other investment indexes, you may observe that the broader market appears to be slightly stronger than the capital weighted indexes. As an example, the Russell Value and Growth Indexes were up 3.3% and 2.3% respectively.
| Investment Indexes | 12/31/03 | 3/30/04* | 6/30/04* |
| Dow | 10,321 | -.9 | -1.1 |
| P 500 | 1095 | +1.3 | +1.5 |
| NASDAQ | 1973 | -.05 | +2.1 |
| Russell Value | 569 | +2.1 | +3.3 |
| Russell Growth | 462 | +.004 | +2.3 |
| REIT Index | 99.27 | +9.09 | +2.14 |
| *cumulative change since 12/30/03 | |||
There were places to make money in the first half of the year, please note our mutual fund report, and there was certainly one place to lose money. Ten year treasuries, which yielded 3.67% this time last year, ended on June 30th yielding 4.66%, and this is after the bond rallied over the last two weeks bringing the yield down from 4.9%. A bond purchased last year, yielding $367 per $10,000 would have to be discounted to $7,875 to provide the same yield that the 4.66% ten year treasury bond does today. A 21% loss in a single year.
The increase in interest rates affected both bonds and real estate investment trust and caused major concerns in the market during the first half of the year.
II. Auto and home sales - New home sales slowed only slightly due to the increase in interest rates. Housing starts and refinancing continue to be strong and as a result I believe that the housing industry will continue to be sound, although not duplicating the past several years of growth, due to historically low interest rates.
Automobile sales are another matter. Increased oil prices and buyers exhaustion will result in substantial declines especially in the SUV area. This morning General Motors reported a 30% decline in the second quarter for SUV sales. The Cadillac Escalade was hit hardest with a 42% decrease in sales over the previous year.
An increase in oil prices along with the discontinuation of mortgage refinancing may “pinch” the average consumer’s spending habits for the remainder of the year. Although gas prices have declined during the past several weeks the average American is still paying 40 cents a gallon more than this time last year. As a result, it is understandable why SUV sales have dropped. (Higher gas prices will probably hurt retail sales at the “Wal-Mart and Target” level - watch these companies’ sales reports for continued weakness compared to previous years sales.)
(Look for some real bargains in the SUV market later in the summer. Substantial incentives will be used to sell down the bulging inventories of SUVs that are on most lots today. While there may be a shift to hybrids and smaller cars do not look for profits in the automobile industry to continue to rise as these smaller cars do not carry the profit margins that SUVs have over the last five years.)
III. Disappointing job growth, but improved earnings - Last Friday the market began what may be a modest decline over the next week because of disappointing job growth. The analysts were expecting job growth of over 200,000 for the month, but the number appeared to be only about half that figure. I believe it is inappropriate to expect the economy to replace the 1.8 million jobs that have been lost during the recession quickly. As I have mentioned earlier, some of these jobs have made their way overseas, but the increase in productivity of the American worker has resulted in a lack of need to replace all of these jobs. As a result, although we must continue to be sympathetic to our fellow Americans who are out of work, as investors, we must focus on earnings.
During the first half of the year 76% of reporting companies exceeded earnings expectations. This improvement in earnings has not been properly priced into the market. A 12-month estimated earnings per share projection places the Dow Average price earnings ratio at 16.6. This price earnings ratio of 16.6 is on the low end of the 52-week moving average, which topped out at 19.5. I believe this suggest that the market is approximately 10%-15% undervalued in light of current interest rates and projections of corporate earnings.
I have grown fairly optimistic in regard to the remainder of the year, but believe that the market will continue to trade in a relatively narrow range. Although corporate earnings have improved the uncertainty of Iraq and the presidential elections will continue to dampen enthusiasm for the market. We will continue to see a few high flying companies, which have created astronomical price earnings ratios, periodically disappoint and the headlines surrounding those disappointments will result in momentary downdrafts. Nevertheless, dollars committed to more value oriented sectors will continue to have the capacity for upside growth while providing downside protection through low price earnings ratios and sound dividend yields.
IV. Politics - The presidential race appears to be a toss up based on national polls. Nevertheless, I believe that there are several issues to be debated, and the manner in which they are addressed between now and November may result in the current polls being incorrect. Iraq will continue to dominate the headlines and the sooner Iraq gets pushed onto the second page the better for the Bush administration. Healthcare is an issue that is a sleeping giant in America. If the Democrats continue to hammer on the need for more affordable healthcare I believe they will receive mid-America’s ear. While the Democrats plan for healthcare is ambiguous at best the Republicans offer no clear position on an issue that is affecting millions of Americans.
The economy is a toss up, while the gross national product of the country is growing at over 4.4%, which is excellent, job recovery, as mentioned above, simply isn’t going to happen. The combination of job concerns and Iraq could sink the current administration. Do not be surprised if it’s not Kerry by 5% in November.
(Please do not interpret this as endorsements except that we all need to vote our conscious in November. With over 45% of Americans not voting in the 2000 election I only wish there was a candidate that would inspire the electorate to get out and vote. I believe that the only reason that the country appears to be divided into oppositeends of the political spectrum is that many “middle of the road” Americans feel disenfranchised and simply can not get excited about either candidate. We are left with the die-hard right and left and that is all that we hear on the news.)
V. How are we doing? - While the Dow Jones Industrial Average was down 1.1% for the first half of the year, I am pleased with the performance listed below that represent the major mutual funds in our Thoroughbred no-load mutual fund program. Please note that I have divided funds based on their investment category, such as balanced, growth, value, etc. Then I compared their performance not with the Dow Jones Industrial Average, but with the Lipper investment mutual fund index that reflect that specific investment sector. With very few exceptions I am pleased to report that our selections have doubled, or even tripled the Lipper average return for each specific sector.
VI. The remainder of the year – I believe the remainder of the year has potential. I have committed all of our idle cash into either balanced funds or value oriented securities and mutual funds. I believe the market has the potential to increase in value by approximately 10% in the second half of the year and I would not be surprised to see the Dow Jones Industrial Average slightly north of 11,000 at year’s end. This would place the Dow at the lower end of our projection for the year 2004. While there could be downdrafts in the market between now and December, caused by events in Iraq, disruption of oil supplies, or some unforeseen terrorist activity I believe that having the price earnings ratio of the Dow Jones Industrial at only 16.5, relatively low interest rates, along with what appears to be controlled economic growth will do much to protect investment downside. Do not be overly concerned about a momentary downdraft. Focus on a two-year investment horizon which I believe looks attractive.
Let’s see what the next 90 days brings!
Warmest Regards,
M. Brooks Clark
*Clark Financial Advisors is registered with the Securities and Exchange Commission (SEC) as a registered investment advisor and annually files an ADV with the SEC, as required. The ADV II form provides background on the firm and its principals. If you would like to receive a copy of this form please contact Jennifer Gibbs via email at Jennifer@clarkfinancialadvisors.com to receive a copy. You may also return this page of the letter with a note signifying your request for a copy of the ADV II filing for Clark Financial Advisors.
