New Page 1

Back to Quarterly Letters || Previous Letter || Next Letter

Quarterly Letter to Clients

October, 2003

Indices at quarter-end (Sept. 30, 2003):

Dow Jones Industrials: 9,275.06 3Q'03 +3.22% YTD +11.19%

Standard & Poor's 500: 995.97 3Q'03 +2.20% YTD +13.19%

Recently, after trading hours I tuned the TV to the stock market channel. There was a news bar running across the bottom, and one item said that the Fed was worried about deflation. The immediate next item said that consumer prices had risen in the latest month. I would have to surmise that the individual Fed governors are not the ones taking the family car to the gas station.

Someone else must be writing their health insurance and property tax checks as well.

Yes, lots of items have been going down in price, due to competition, production moving offshore, efficiencies gained, and lower interest rates. But other things spiral higher, and they are big items like housing and gasoline. Has your telephone bill been going lower lately, or your cable TV bill?

We also have a Federal budget deficit (and attendant debt) that is rocketing upward to unprecedented levels. We will do what we have always done to worm our way out of this: we will inflate our currency. It is a systemic problem for which I see no other solution.

It is for these reasons that I don’t believe that the Fed is serious about deflation. In my opinion, the Fed wants an environment of moderate inflation with low interest rates and is jawboning to achieve this. They are buying time.

The press is telling us that business is turning up, albeit without adding jobs. We are all aware that jobs are being outsourced and often sent abroad. For years manufacturing has been leaving the U.S. for lower-wage countries. Now, with advances in communications, even service jobs are going offshore.

For the company cutting employees and eliminating manufacturing facilities, productivity appears to rise. The bottom line improves as the cost of labor and overhead decreases. But often, the top-line (gross sales) is declining.

This leads me to ask if business improvement is a matter of top-line growth, bottom-line growth or both? After all, how long can you have sales declining and profits increasing?

Early in the third quarter stocks ran higher, shrugging off the pressure of sharply rising interest rates and oil prices. But late in September, those worries caught up with investors, and the markets gave back some of their gains.

The interest-rate move had its requisite effect on bond prices, which were marked down sharply. That move proved to be temporary, though, and as rates stalled and fell back a little, bonds quickly rose again. Even with the gyrations in rates we remain at very low levels in the larger picture. Rates have been trending down for more than twenty years now, and I fully expect them to continue at these low levels for the foreseeable future.

Both stocks and bonds appear to be fully priced. This does not necessarily mean that they are going down, but it may be difficult for either asset class to rise in price from these levels. It is my expectation that the markets will mark time until there are definite signs of real improvement in business. And by that I mean both top and bottom-line growth.

September and October are generally the weakest months for stocks, and those months are largely behind us. The year-to-date has been more than satisfactory. And the month that is usually the strongest, December, lies just ahead. But we also have underlying problems which must be overcome in order for the markets to make any real headway.

It is the sort of market that will reward the intelligent, careful buyer. Thus, at the moment, I am content to let cash build up and await better buys.

Jim Pappas