Brimmer Financial Newsletter
Second Quarter, 2003
Finally, after waiting for good news with the patience that would try a saint, equity investors were rewarded with a really good quarter. The three months just ended produced the best stock market performance since the fourth quarter of 2001. In the last three months the Dow Jones Industrial Average gained 12.4%, the S&P 500 index tacked on 14.9%, and the NASDAQ posted an impressive increase of 21%. The mood of the investment community has been improving for most of this year. With each passing month more companies have reported improving sales and profits. Optimism is overcoming pessimism. Over the last six to nine months, improving financial results have encouraged more individuals and professional money managers to add to their stock holdings.
The laws of supply and demand are still in force. More money chasing a relatively fixed number of shares in the market results in higher stock prices. (There have been few new stock issues coming to market of late and a number of companies continue to buy back their own shares. Thus, the number of shares available for purchase is relatively unchanged). This kind of price inflation is welcome news. A higher stock market enhances the national wealth because the majority of us in the workforce and many retirees are also in the shareowner class (mutual funds and stocks in 401k's, IRA's, retirement plans, etc). We all hope to graduate with honors.
The economy and financial markets can be compared to gardening. Now the cold hard winter is over. The ground is tilled, fertilized and planted. The sun is shining and there's enough rain to grow the flowers and vegetables. A vast field of cash on the sidelines earning next to nothing in money market funds waits for more equity planting. Drizzly interest rates favor equities over short-term bonds and cash. Fertile new tax changes have lowered the cost of capital. Sunny legislative warm weather encourages small businesses to spend and invest in capital goods. Investors, the happy farmers if conditions hold, will enjoy lower taxes on their dividends, a growing economy and a prosperous investment harvest. They already enjoy huge increases in their real estate as a result of 45-year lows in interest rates, substantial mortgage refinancing (that puts millions in the pockets of consumers) and a dearth of non-real estate investing over the past three years. If the share crops have been poor over the last two years, at least the farmhouse has gone up in value.
The seasons are turning. Now that real estate has risen in value, it may be the asset group that stalls, allowing stocks to move ahead. If the economy does indeed turn up because of tax and low interest rate incentives, then interest rates and consumer price inflation will rise along with wages. When this occurs I hope you are mortgage-free or have already refinanced to a low interest, short as you can (10 to 15 years), FIXED rate mortgage. I don't think I'll ever see mortgage rates this low again. My goal for all of my clients is that they all become debt-free and have enough income to be financially independent.
The federal government has done everything possible to set the stage for future growth. Since the government can't hire everyone in the country to work for the government, most of the gains in the economy must come from the private sector. It may seem counterintuitive to lower taxes so that more taxes can be collected. But it's worked in the past and should work now. By lowering income taxes each taxpayer enjoys more take-home pay and is more likely to spend, which improves the overall economy, creates or sustains jobs and increases the amount of tax collected eventually by the government. More money circulating in the economy creates more taxable events such as sales taxes on goods, income taxes on wages, capital gains taxes on sales of assets held for investment and excise taxes on assets like cars and fixed capital equipment. The faster money circulates throughout the economy, the more taxes local and national governments collect.
The Congress with President Kennedy lowered taxes as it did with President Reagan and again with President Bush. Prior to The Reagan years the top income tax rate was about 70%. Each tax reduction resulted in a number of years of sustained growth. I expect that this recent tax incentive will have a similar effect. It could be mild or better than expected if peace breaks out in the world.
It has become necessary to stimulate the U.S. economy for a number of reasons, not the least of which is that the number of manufacturing jobs lost in the U.S. to foreign, cheaper labor is significant. Our unemployment rate is still at 6%. A rate of 5% or less is considered a reasonable unemployment rate because there are always people moving between jobs. Also, there are millions of undocumented foreign workers in the U.S. who aren't counted. We have had trouble competing with the low wages of companies in the emerging nations of the world, especially those in Asia. They are able to produce goods of high quality, ship them across thousands of miles of ocean and still earn a profit because their labor costs and health care costs are much lower than ours. Eventually, workers in China and other low cost producer countries will develop a large middle class. These workers will then demand higher wages and a better living standard. Their low cost advantage will some day be lost to other emerging nations and/or improvements in productivity in the industrialized nations. Until then, our producers must run faster just to stay even.
People do what they believe to be in their own best interest. Politicians, if nothing else, are serious students of group psychology. They know that voters will re-elect them if they deliver on their campaign promises. But in reality, government entities have a rather small number of tools to change human behavior (which is how they try to manipulate economic conditions). The Fed can increase or decrease the amount of money in circulation. Congress can increase or decrease tax rates on everyone or on certain groups (high income, middle income, low income). Congress can pass legislation that encourages or discourages certain behaviors. They can fund research and development in science and technology, add more money for this program, less for that one, and pass tougher laws to punish criminal behavior so as to discourage lying, cheating and stealing. The national government can, to a limited degree via the Federal Reserve, raise or lower certain interest rates. And of course, politicians can also argue with each other and try to reduce complex problems into 20-second TV sound bites.
The historic record over the last century indicates that a low inflation, low interest, high cash environment favors equity investing. It seems to me that our government has done just about everything possible with the tools it controls to encourage and stimulate the economy to grow. It's up to the American people now to respond . If we do, then a growing economy is the logical outcome.
More than 30 months passed from the market highs of March, 2000, to the lows of October, 2002, before the market turned upwards. The Dow Jones Industrial Average is almost 2,000 points higher now than it was in October, 2002, when it hit a low of 7,197. The signs of a healthier financial and economic environment are everywhere. Of course, no one has tomorrow's newspaper. We can't predict when the top or bottom of any market cycle will occur. But we can use knowledge and wisdom gained over the years to help us deal with events as they occur and as we plan for the future. Investing requires time, attention and care, just like gardening.
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