Fourth Quarter 2003 Review

A good time was had by all. The last three months of 2003 capped a positive year with gains in all major sectors of the stock market. The Dow Industrials added another 12.7% in addition to the earlier gains of the first three quarters. The S&P 500 Index as well as the NASDAQ boasted gains of over 11%. Investors, encouraged by positive readings from the economy, continued to bid up the prices of stocks across the full spectrum with small, mid-sized and large firms enjoying higher prices. Even a number of battered and beaten technology stocks left the ICU and Rehabilitation Units and are making a good recovery. They may not see the highs of March, 2000, for some time, but at least they're up and taking nourishment.

At year's end the Value Line Index estimated the median Price/Earnings (P/E) ratio of its universe of 1700 stocks at about 19 times earnings. This means that the average stock price is 19 times higher than its earnings per share. At the high point in March of 2000 this number was about 20 times earnings. At the market low in the fall of 2002, the average Value Line P/E was approximately 15 times earnings. The present higher valuation indicates that investors are now more optimistic about future earnings than they have been for a couple of years. Said another way, investors are buying with the conviction that the future earnings of their companies will justify the prices they are paying today.

There is no guarantee that the market is correct in its pricing. Any number of negative events could dampen enthusiasm for stocks. A look back at the historical record suggests that the average down (bear) market lasts about 18 months. Our most recent bear had a lot more stamina. It ruled the market for some 30 months, from early 2000 to late 2002. A painful combination of stock market bubble bursting, terrorists and corporate malfeasance fed the bear a bountiful banquet of bad news for months. Happily, since last October, the bad news has gradually given way to more upbeat assessments of the economy and the world.

The most recent report from the Institute of Supply Management (ISI), considered by many economists to be the most accurate economic prognosticator available, announced a surprising 20-year high index number of 66.2, suggesting a gross domestic product (GDP) growth north of 7%. The New Orders report posted a 53-yr high of 77.6 and the production index jumped to 73, indicating that manufacturers are enjoying higher order volume. This news seems to contradict the widely held opinion that U.S. manufacturers are not doing well. In fact, things appear to be improving in this sector. But improvements in manufacturing can be both a blessing and a curse. Higher productivity helps a company become more profitable, but often creates a lower demand for new employees. Increased productivity results in more work per person per hour. One important contributing factor for these hourly gains can be seen in technological advances which have kept employers from needing as many new workers as in prior recoveries. Computer-guided robots weld auto body parts together and perform any number of tasks on the factory floor of many industries. These jobs were once performed by workers. Fewer people do the work formerly done many in the manufacturing sector.

The news media have recently focused on unemployment as a drag on economic growth. In fact, new hiring usually lags the other indicators in a recovery. Over the last decade, according to a report from the Labor Dept., some two million manufacturing jobs have left the U.S. as firms outsourced production to China, Mexico and other emerging nations. But during the same ten years, 2.8 million new jobs were added in staffing all types of schools and colleges. This is an increase of some 28% in gains in education over losses in manufacturing. As is so often the case, the devil is in the details. With U.S. employment hovering around 100 million, there are a lot of details.

The U.S. Labor Department's website offers a snapshot of the economy. The data is collected, reported and then adjusted after a few weeks to reflect more fine tuning of the information. For Nov. 2003, the unemployment rate was 5.9%, not high by historic standards at this phase of an economic recovery, but still not low. Inflation and interest rates continue to roam around in very low single digits. These 40-year low interest rates may be heading up some time in the middle of the year, assuming the economy continues to grow. As a reminder, if you have not yet refinanced your high-rate home mortgage, you should consider doing so now. Rates may never again be so low. Contact your local mortgage lender and inquire about the practicality of refinancing. I've often told my clients in person and in print to set a time table and plan to become debt-free. Owning a debt-free home at retirement time offers a special sense of security and peace of mind. There are cases where it may not be possible or beneficial to pay off the mortgage, but in most cases I believe debt-free is the place to be.

The U.S. economy is strengthening. Investors are more confident. Earnings are growing across a broad swath of companies. The stock market has been going up for over a year. Patient investors are finally seeing plus signs on their portfolio statements. The fourth quarter was good to us.

A number of stimuli have had an effect on the markets. Both low interest rates and low inflation certainly favor the stock market. High interest rates draw money away from stocks and into CDs and other fixed investments. The tax changes in mid-year 2003 favor certain qualified stock dividends with a lower income tax rate. Companies are now being pressured by their owners, the shareholders, to increase their dividend payments. For decades, dividends have contributed roughly one-half the total return to investors. Many of my clients have been reinvesting their stock and mutual fund dividends for years. It's interesting to see how the number of shares accumulate over the years. The Federal Reserve has been accommodative with regard to the money supply. There's plenty of cash in reserve in the nation's banks and money market funds, even at these low rates. Banks are eager to lend. Lower income tax rates increase the outflow of money into the hands of consumers. The pent up demand for replacement of machinery and equipment is starting to show up in the orders companies are placing for capital goods. All of these factors are positive for the securities markets.

As always, bull markets climb a wall of worry. There are any number of unsolved problems and concerns that dampen the outlook, at least in the near term. A large Federal budget deficit is one. We have long been a nation with an overhanging debt. It seems large now because of how many zeros there are in the federal debt number. Consider this: During the final years of World War II the U.S. had a debt that was between two to three times larger than our current debt in proportion to the nation's economy. During the 1950s and 1960s much of this debt was paid down, only to increase again during the inflationary 1970s and 1980s. America has never been out of debt since the Great Depression of the 1930s. That hasn't stopped us from growing our economy. Debt hasn't stifled our entrepreneurial spirit. Debt must be measured against the backdrop of the country's total output. If all the Federal debt were paid down, as attractive as that might sound, what effect would that have on the economy? Interesting study question. I agree that we as a nation are too deeply in debt when personal, corporate, state and federal debts are totaled. I personally would like to see American households reduce personal debt. There's a saying among financial practitioners: "Many of us are just a few paychecks away from homelessness." Not a pretty picture, but good motivation to own your own home debt-free as soon as possible.

What keeps America free from the bleakness of widespread poverty are liberty, opportunity, a free public universal education system, the rule of law and ultimately our Constitutional guarantees and our national will to enforce the rights so clearly delineated in our founding documents. We also enjoy a number of social safety nets to protect us from certain misfortunes of life. Political issues in the coming election year debates will focus on how we will allocate our federal and state treasure, where we will raise the money to do the things we vote for and how we will evolve as a political body, just as we have since 1789.

From now until mid-April we'll be gathering up little slips of paper, organizing tax folders and fussing over the myriad details of a not-so-simple tax system. Another reminder- because of the mid-2003 income tax law changes, be aware that some of your securities will be reporting later than usual or may even send a second, "corrected" 1099 tax report. Expect some confusion. Gather up as much information as possible and get to your tax preparer, but also be aware that you may not want to file early if you own a number of securities. We also have been making an effort all year to organize the cost basis information for your securities. Let us know sometime well before April if there is any missing information in your cost basis file.

Certain dividends qualify for lower tax rates based on a formula that involves how long you've owned the stock, etc. Again, don't throw away any of the information you get from your securities. This is another good reason to become computer friendly. Most companies now have very good web sites with lots of information about their stocks. Spin-offs and stock splits are often carefully noted on these sites.

One of the many market disciplines often discussed and seldom followed is the issue of when to sell. Sir John Templeton has been often quoted as saying he sold a security whenever he found a better bargain. Buying a stock or any investment is a lot more interesting and exciting than setting a predetermined point at which to sell the security. After all, if it's doing well, why sell it? Also, there's the issue of paying tax on the capital gain, which kept many investors from selling in 2000 and 2001. I suggest that as the market improves, the reasons to set selling prices have not evaporated. One of the best, though not perfect, devices is the good-until-canceled stop loss order. A stop loss order creates a sell order that will be executed when the specific stock drops to a specific price. There are exceptions to this simple explanation, but this is the main idea. By gradually moving the stop loss price up as the stock goes up you set a sell discipline that is unemotional. We have an article here in the office on the topic of stop loss orders. I'm encouraging all of my clients who hold individual stocks to get a copy of this article from me or read it on our web site. Selling is tougher than buying.

Let me remind you about our web site: www.brimmerfinancial.com. On this site we briefly discuss the basics of investing and financial planning, offer a schedule of local seminars, post past quarterly newsletters, articles and information, and invite you to contact us.

I'd also like thank all of our clients who have referred their friends and family members to us over the last year. We appreciate your confidence and have enjoyed working with our newest clients.

Over the coming months many of you who have not had an office or telephone appointment for some time will be getting a note asking you to call to set up a time so we can discuss your specific questions and review your portfolio. The last three years have been trying, to say the least. Much time has been spent here discussing the many negatives of a down cycle. Now, with a brighter market environment in place, it's important to review where you are financially, your goals, any changes in your life that need to be addressed and any questions that need an answer.

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BRIMMER FINANCIAL
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