April 25, 2003

Follow The Money...

As the U.S. military consolidates its positions in Iraq, investors are patiently awaiting some realistic reason to add to their equity positions. During the past several months, the Investment Company Institute data show that there is no rush to add to equities at this time. In February the outflow from equity funds was $11.11 billion after a $371 million outflow in January. Despite our military success in Iraq, analysts are uncomfortable with reports of unfavorable domestic economic data. Corporations continue to curtail capital spending and are unwilling to reverse the staff downsizing implemented during the past few years. In fact, the latest data indicates that unemployment applications increased in late April. Growth in the business sector remains elusive at this writing.

On a year-over-year basis, layoffs in the manufacturing and service sectors continue unabated. The search for “undervalued” stocks remains a challenge. From the standpoint of value, the S&P 500 is currently trading at a price of more than 31 times current earnings – not a level many would refer to as “cheap.” The following chart illustrates this fact. With corporate earnings continuing to decline, few knowledgeable observers look for a new bull market to arise in the coming months. From our vantage point, we concur that prudence is one’s best guide at this time, rather than greed.

As the chart illustrates, at 20 times earnings, an overvalued ratio on a historical basis, the S&P 500 should trade at approximately 560. At fair value of 15 times earnings, the S&P 500 would trade at 420. Consequently, a drop of 50% to 55% in the S&P 500 should not be considered an impossible event.