Market Commentary – January 2003

Despite fair strength in recent months, and what appears to be a January effect in the most beaten down stocks, I think the evidence is that the bear market remains in force. If so, in another month the length of the decline will match the 1929-1932 bear market, though it is much milder in severity. That mildness may not be good, for despite the long decline stocks remain high priced. In the spring the bear market would enter its fourth year, which would raise the question, are we in a Japanese style decline, now in its thirteenth year? The situation in Japan supposedly could not happen here because their monetary authorities fiddled while Tokyo burned. In reality, Japan did react, but failed to stem the tide. As to the idea that we would move more decisively, by going along with the speculative boom, the Fed failed when it might have had enough influence to make a difference. Fed inaction is a primary reason we are in this pickle in the first place, and subsequent moves failed to lift the economy, indicating that its influence may have been forfeited. Now the administration is proposing added tax cuts where the major benefits go to the rich, who don’t need stimulus. There is a pattern here - the same kind of inadequate action we criticize the Japanese for. The Japanese seemed to do everything wrong, and we may be following. The recklessness disregard for deficits just might worsen our situation. Has anyone noticed that the dollar is off 25% against the Euro? The few who have claim that is great! But if we defend the dollar, interest rates go up, and if we don’t, there could be a run on the dollar. Our new belligerent foreign policy could add to the pressure. Crazy stock markets, like Japan’s in the late 1980s and ours in the late 1990s, have always been followed by severe declines. When you dig yourself a deep enough hole, it isn’t easy to get out. We are also following the Japanese model in the absence of a severe recession that clears the slate for recovery and prompts more decisive action to help the economy. According to government statistics, we barely had a recession, and the economy advanced all of last year. As I have noted before, there is something fishy about this data, and it has the effect of generating complacency. Far from being cheering, then, the benign economy suggests we are following Japan’s lead. Another similarity is ongoing high stock prices. The Japanese market continued to be recommended for years after the downturn because prices were cheap compared to earlier levels and investors were unwilling to accept that the Japanese miracle had ended. As a result, Japanese stocks remained extraordinarily high when earnings retreated along with prices. The same pattern prevails here, and hope springs eternal because of the belief that somehow our economy is invulnerable. A value myth has been created by the assumption that earnings will quickly return to 1999 levels, even though there is no sign of that happening. A recent earnings rebound is only as measured against 2001 levels that were loaded with inventory and downsizing charges. As for the nuts still buying high technology stocks, they too remind me of the true believers about Japan in that they refuse to face up to the evidence that times have changed. The present tech rally, like the others over the last three years, appears almost orchestrated by traders, rather than based on fundamentals. I suspect that traders start the rallies in hopes of rekindling memories of 1999, and they succeed temporarily as shorts cover and momentum players jump aboard. One of the foremost reasons for thinking the bear market will extend is the recent action of tech stocks. The circumstances that make me believe the bear market is not over fall into three categories: 1) an absence of the kind of give-upsmanship you would expect after such a long decline, 2) the failure of stock prices to reflect the reality of a slower economy and slower growth prospects, and 3) our changed circumstances internationally as reflected in a weak dollar, hatred of the Bush policies all over the world, and diminishing industrial might. We could have a decent rally if the economy picks up a bit, but the great bull market is over, and our circumstances have changed. Ultimately the bear will work its way out, though, either in another severe decline or a lengthy period of relatively flat prices. Most of the best thinkers believe we will have such a flat phase, but that good money can be made, as in the 1975-1981 period preceding the market takeoff in the summer of 1982. However, compared to 1975 there is a serious problem. Then stocks were extraordinarily cheap, today they aren’t. Part of the fast start in 2003 arises from the Bush proposal to make dividends tax free, a move estimated to lift the market 10 to 20%. I would accept that number, and more, if the tax freedom for dividends had gone to corporations, for then they would have been strongly influenced to raise dividends (there is no real influence in the present proposal, other that stockholder pressure), reported earnings would rise meaningfully, and the new system could have been used to straighten out balance sheets. Such a policy would have been highly stimulative, though difficult to pay for without some offset in higher personal taxes, which probably explains why Bush chose short term political expediency and feeding his fat cat friends. As to how much boost the market may get, the S&P-500 yields 1.7% and the overall market less, so a big payoff is unlikely. On a tax adjusted basis, only about ½ of 1% is added to already low dividend income, not enough to make much difference. The very rich with substantial dividends would be a huge beneficiary, but between the low market yield and a goodly portion of dividend payments already being tax free, it is hard to see much boost to the economy. Even conservative economists see little help, other than a better tone for consumer spending out of the assumed rise in the stock market. The Bush proposal is not drawing much support, and he is undoubtedly following a strategy of asking for more than he expects to get, so the plan will be trimmed to a 50% exclusion, or more likely a dollar exclusion like $5,000 to $10,000 (which would get him off the hook about favoring the very rich). While the overall affect is helpful to the stock market, it is not apt to be decisive. The economy is what counts, and at the moment it seems to need more direct help. A bear market, however, is not without hope. For instance, a 1.7% dividend is not enough to lift the overall market much, but far higher payers are out there. Not many stocks yield 4.5% or more, where you get a meaningful plus from a non-tax status, but they are out there. In addition, while stocks in general remain overpriced, low priced special situations have been available all along. These led to our great year in 2001. I blew 2002 by becoming overconfident, but we still suffered only a small decline in a generally terrible year. I am less optimistic than two years ago, however, because extreme bargains were far more numerous then. Still, there are attractive, if not extremely attractive, stocks, and the changing environment will produce special opportunities as the year unfolds. With a little luck, and a better ear for trouble, we could have another good year even if the bear market continues.

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