Quarterly Letter to Clients October 1999

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Quarterly Letter to Clients

October 1999

Indices at quarter-end (September 30, 1999):

Dow Jones Industrials: 10,336.95 3rdQ'99: -5.78% YTD: +12.59%

Standard & Poor's 500: 1,282.71 3rdQ'99: -6.55% YTD: +4.35%

In the final few weeks of the quarter, the Dow Jones Industrials dropped by over 1000 points, or something in the neighborhood of 10%. Somehow I feel that Alan Greenspan may be sleeping more comfortably now. Consumer confidence arguably follows stocks, ergo, we might see a slowing of the economy, ergo, no inflation, ergo, no reason to raise rates. Some, of course, will doubtless see this as a bullish scenario.

Back in the real world, stocks have stalled, and we are seeing some rotation out of the large, household-name companies into the middle-tier and smaller companies. The Internet stocks, not long ago the primary focus, are now somewhat blurred. We have seen former market angels turn earthward (witness Coke, Gillette, Rite-Aid, Avon, Maytag, and Raytheon) on earnings-related warnings. International companies have been hurt by the sharp fall in the dollar vs. the yen and other currencies. As I write this, the average stock is down 20% from its high, and bonds are negative for the year-to-date.

In some measure, all of this is because of interest rates, which Mr. Greenspan has nudged upward twice this year, albeit ever so slightly. Higher rates trending downward are much better for stocks and for bonds than lower rates trending upward. This latter case is what we are now experiencing. Couple this with oil prices that have doubled in less than a year, and it is easy to see why the market is nervous.

In the 1970's we had an economic condition known as stagflation; low growth and high inflation. Why then is it so hard for us to accept the fact that the opposite condition can exist? In today's economy we have solid growth combined with low inflation. We have full employment and still enjoy a currency that is the de facto world standard. In short, the economy is as good as it can get.

But now, after several strong years, fear is evident in the market. People do not believe that the current good times can persist. So can the good times continue to roll? Is this consolidation or a topping process? I pointed out to a friend recently that while the economy and the stock market certainly correlate over the longer term, in the near to intermediate term there often is no correlation at all.

Business, while perhaps slowing, still appears to be robust. But the market is also a psychological place. While I am not comfortable predicting the market, here is what we can say for certain: we know that the market will go down, then go up, down, and up again. We do not know how far up or down or for how long a period of time each move will last. But we do know that over the longer term the trend is up and always has been. We know one more thing: you are almost always better off staying in and riding out the downswings.

Thus my position now is to remain in those securities which I expect will produce good returns regardless of the direction of the market. Certainly the stocks we own will follow the overall market direction, but I anticipate that their moves to the downside will be less than that of the indices, while their upside is substantial. And our bond and convertible bond holdings will continue to give us cash flow along with some possibility of capital gain. The strategy is to protect and preserve your assets while seeking competitive returns. Never lose sight of this goal.

Jim Pappas