Quarterly Letter to Clients October 1999

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Quarterly Letter to Clients

July, 2000

Indices at quarter-end (June 30, 2000):

Dow Jones Industrials: 10,447.89 2nd Q'00 -4.34% YTD: -9.12%

Standard & Poor's 500: 1,454.60 2nd Q'00 -2.93% YTD: -0.91%

The inclusion of Microsoft and Intel in the Dow Jones Industrials has not stemmed the erosion of this venerated market index. For a year and a quarter now, the market has been flat. We are left wondering if Microsoft will turn out to be one of the "Dogs of the Dow".

On April 20, 2000, the Wall Street Journal referred to Qualcomm as a "blue chip". Well, call me an old fogy, or what you will, but I cannot help but believe that the name of an internet company and the term "blue chip", when written side-by-side, constitute an oxymoron—at least at this point in time.

Generally, in the early evening, after the markets close, I go out to play tennis. Very often, people at the various clubs at which I play ask me "how did the market do?" For years I have replied by recounting the movement of the Dow Jones Industrial Average, which was the answer everyone expected. They all knew what I was talking about and what it meant.

Lately, though, people have been asking "what did the NASDAQ do today?". And what is really striking in this turn of events is the profile of the questioners. They are not the young hotshots that you might expect. Rather, they cut across all strata of society, with a generous sampling of people well into their retirement years.

Many of these folks took significant hits to their net worth in the mid second quarter. The pundits among them have been saying that the year ’00 is turning out to be pronounced "uh-oh". They are learning lessons that I learned in the late 60’s. But I was young and didn’t have anything much to lose. A year ago these people were gloating, and now, though I feel their pain, I find myself secretly smirking at their comeuppance.

The situation has given me ample occasion to quote "The Money Game" by Adam Smith (nee George Goodman): e.g., "if you don’t know who you are, this is an expensive place to find out." The book is an excellent read, and as applicable today as at any time in market history.

I am once again indebted to the Dow Jones publication "Barron’s" for the insight that 81.5% of NYSE stocks, 72.4% of NASDAQ stocks, and 59.7% of the S&P 500 stocks are below their 1997 highs. You can easily infer that we have been in a bear market for the last three years, the averages notwithstanding.

Let me put this in a different way: if, in 1997, you had invested in a basket of NYSE stocks, today, after three years of double-digit gains in the DJIA, eight out of ten of your stocks are likely to be lower. If you think my business is easy, you are mistaken.

I hope the Fed remembers that higher interest rates are inflationary.

With oil at a level near double the prices that prevailed less than a year ago, and with mortgage rates sharply higher than 18 months earlier, it is my personal opinion that the Fed is very near, or at, the end of its program of raising rates. We currently have a prime rate of 9.5%. I cannot see Alan Greenspan pushing through a rate rise that would force that number to double digits. Especially in a presidential election year.

If twenty-five basis points is the maximum boost from here, then what next? And what are the ramifications should the rate increases halt? Even more important, what would be the reaction if rates were to head down?

Without too much rumination, you could posit a soft market into the early summer, as the players sort it all out, with a classic summer rally to follow later. I believe that this is the likely scenario. I will go out on a limb here, and say that it is my opinion that we are very close to seeing the Fed actually reverse course and lower rates. I would not be surprised to see such a move by the end of this year. I believe it is a good time to buy bonds.

Jim Pappas