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Quarterly Letter to Clients

July, 2001

Indices at quarter-end (June 30, 2001):

Dow Jones Industrials:  10,502.40      2nd Q'01   +6.31%   YTD:  -2.64%

Standard & Poor's 500:  1,224.42        2nd Q'01   +5.52%   YTD:  -7.26%

Six large rate cuts in the first six months of the year show us that the Fed is serious about keeping the economy going.  Early in the second quarter, after the fifth half-point cut, the market finally accepted that conclusion, and the Dow rose from its depths around 9100 to trade over the 11,000 mark for the first time in what seemed like a very long time (it was actually about 8 months).

The bloom quickly left the rose, though, and financial markets calmed down.  The Dow gave back about 700 points of its gain before the final rate cut.

Through it all, our accounts continued to do nicely.  Having sidestepped the outrageous prices of the recent bubble, we held our own during the market contraction that followed.

The market is waiting, not very patiently, for the economy to catch up with it.  It may be a longer wait than many people believe.  A record number of companies warned of earnings shortfalls in the first quarter, and another record number is expected for the second quarter.  For the last 18 months we have been range-bound, with an apparent top around 11,200 and a nominal bottom in the area of 9800.  While we have sometimes worked past those bounds, we have also had occasional frightful falls to punctuate this otherwise dull and uneventful stock market.

My suspicion is that we are likely to see a pattern much like that of 1966-1982, with a rolling, stumbling, sideways movement marked by several severe, albeit brief, downturns.  Yes, I did say 1966 to 1982.  Sixteen years.  I can make a cogent argument for a movement of this sort  lasting for such an extended period.  It goes something like this:  The market goes up for 15 to 20 years, then goes sideways-to-down for 15 to 20 years, and the pattern then repeats.

As evidence I submit market history: 

The latest bull market began in 1982 and ran until 2000, an 18-year phase.

From 1966 to 1982, stocks were sideways-to-down, the above-mentioned 16-year period.  

From 1948 to 1966, eighteen years, we had a very strong market.

In the 19 years from 1929 to 1948 the market struggled to get even.

Prior to 1929…well, you get the point.

So it is not far-fetched to predict a sideways-to-down market for the next 15 years.  Witness Japan over the last 12 years.  So much for the so-called “V-shaped” recovery, or even it’s cousin, the “U-shaped” recovery; maybe we should be thinking "L".

But experience has shown me, time and again, the folly of trying to predict the market.

Can you prosper in a sideways market?  Yes, it’s just not so easy.  How do you make money from this point on?  Just like always:  you presume that the economy does not fall off the cliff and that we do not have a national or world-wide catastrophe (war, famine, drought); you make an educated guess as to the prospects for a few companies; you examine their balance sheets to confirm that they have the capability to survive and grow; and you try to buy those companies at reasonable prices.  You give them time to grow; you invest more when their stock prices are low; and you continue to search out new ideas.

Some will be clunkers, some moderate winners, a few will be giants.  All will take time.  It should be the bottom line that you focus on, not the individual issues.  Remember that only hindsight is accurate; we would avoid the clunkers if we knew which ones they were, but we don’t.  The best we can do is make an informed guess, not stretch too far out on the limb of risk, and be patient.  Also, today’s clunkers are often tomorrow’s darlings.

If a company warns of an earnings shortfall, do not panic.  It may, in fact, turn out to be a buying opportunity.  Focus on the company’s position three, or five, or even ten years out rather than on short-term successes or disappointments.

The goal should be consistency.

I have lived through all types of markets, and I know that my strategies work.  I cannot say that a given year will be profitable, or that a particular security will prove to be a good investment.  But I can say that I am consistent in my approach and in my results.  And that, remember, is the goal.

Jim Pappas

copyright © 2001 JPIC