Last September, we issued a commentary entitled Beware of Politicians (enclosed for your review).
In summary, we anticipated much choppiness for the markets as the calendar neared the election. We also voiced concern about the bond market and the role of Fannie Mae and Freddy Mac in the country’s monetary picture. All in all, we projected a stronger market with the Dow at or near the 10,000 mark by year-end. Actually, we were a little shy as the Dow hit 10,500 but our basic thesis continues on target.
Currently, we’re entering the emotional part of the political process and fully expect the stock market to be more volatile as it becomes transfixed on weekly poll results and events in Iraq.
There are also some new concerns that are becoming more and more evident to investors and worthy of our comment:
One concern is the reappearance of inflation, which is the catalyst for the recent interest rate hike conducted by the Federal Reserve Bank. We believe that this concern over a new inflation trend is unwarranted. The inflation that is rearing its ugly head is a commodities-related inflation that can easily be explained by the ramp up in ordering to facilitate the needs of an awakened global economy. Dollar based commodities, in particular, have surged in price to also reflect a weakened dollar over the last year. A slowing economy, which is becoming more evident, will go a long way toward stabilizing commodity prices. A stronger dollar, which we expect, will help reverse last year’s price increases and bring us back to “square one” with respect to this inflation issue. The true root of all enduring inflations is “too much money chasing too few goods,” which usually coincides with an overheated economy. This is clearly not the case today.
Another, and perhaps more serious, concern is the prolific desire to regulate Corporate America. Not a day goes by without some announcement about a new S.E.C. or Justice Department investigation of a public company. A news release of this nature simply torpedoes the stock price and leaves it in limbo until things are finalized. The fear of such an investigation has brought a “paranoia” to corporate chieftains who are reluctant to discuss their corporate outlook with anyone, whether it be good or bad. The lack of information is also evident in the Wall Street analytical profession as analysts and money managers find themselves subjects of increasing regulation and prosecution. All in all, this erosion of confidence in our capital markets stemming from this issue is accelerating with no end in sight. All of this is the result of a few bad apples in the likes of Enron and WorldCom. In an effort to purge our economic system of greed and dishonesty, we have created a mindset that could ruin our wonderful free market place. More and more politicians are embracing this trend as they hope to influence a naive public. Yes it’s election year, and we should expect political grandstanding, but this is dangerous stuff…enough already!
The rise in corporate earnings should continue, but at a slower rate. The economic cycle is intact and simply shifting gears. We see little risk to this being derailed over the next few months.
Lastly, the outlook for the election is cloudy and accordingly, we can expect markets to focus on the present– rather than the future. One simply can’t see the future from this point in time, and as everything ultimately hinges on the politics of the country, we simply must wait this phase out.
Uncertainty is certainly a negative for Wall Street. We therefore expect more short-term unwinding (the Wall Street verbiage to describe this unwinding is “correction”) of last year’s tax cut rally. We expect this correction to be mild due to the strong underpinnings of the economy and by the end of the year, we expect an upward bias to reassert itself taking us somewhere near Dow 11,000 by year-end.
To use an analogy framed by my son, Harlan B. Cadinha, “The financial markets should continue to see sunny weather along with intermittent scattered regulatory and currency showers with a small chance of terrorist and General Election rain.” Should the barometer begin falling, we will let you know.