July 24, 2002

SIGNS OF THE TIMES

The market downturn now underway is different from those of the past two or three decades. We believe that the perfidious actions of some corporate executives has worked, along with other factors, to transform what could have been a cyclical downturn and correction into a secular downturn that well could last for several more years. The developments that fostered this transformation have been widely reported (and sometimes sensationalized) in the media during the past four to six weeks.

From its all time closing high of 1553.11 during the week ended March 24, 2000, the Standard & Poor's 500 stock index has declined approximately 49% from its peak. The breath of the index encompasses upwards of 75% of the total stock valuations of publicly traded companies in America - not an inconsiderable sum of loot. Early in this process of readjustment, approximately $7.0 to $8.0 trillion of the savings of the American people have evaporated and along with it, the savings, the hopes, the dreams and aspirations have also been abandoned. From the giddy heights of "over exuberance", equity markets are slowly grinding their way back toward reality, or as a Broadway ditty from an earlier era described it - we are beginning to experience the cold gray dawn of the morning after.

Those of us old enough to remember a bear market find the ever hopeful and positive comments of CNBC hosts and their guests (for the most part) rather amusing. Off the bottom, rallying at the close, and closing above the lows of the day, have become euphemisms for disasters offered by apologetics. Despite their belief in market miracles, we can conjure up little prospects of a reversal of this bear market anytime soon. The wealth, savings and confidence that have evaporated will not be easily replaced - the process will take years. At this writing, it appears that the sheep have not finished being shorn.

Turning to the market, one overhanging problem facing the market is the rather large discrepancy between the historical price-to-earnings ratios and those that exist today. The chart below shows the present ratios as opposed to those existing at past periods of market valuations stretching from the early 1970s through the close of 1994. Beginning in 1995, excess exuberance led to the bubble market, which has yet to be fully unwound. The chart below shows the level of distortions existing at this time.

Chart provided by (c) Decision Point

Were the S&P 500 stock index to return to the levels the prevailed in the past, the index would trade at 500 with a 20 times earnings ratio, about 370 with a 15 times earnings ratio and about 250 with the ratio at 10 times earnings. The danger to the market is that investors might well reevaluate the amount of current dollars that they are willing to pay for a $1.00 in corporate earnings. This is especially true if earnings on the S&P 500 stocks continue to decline. The previous chart is updated through July 19th for the latest data.

We expect that the final capitulation will develop during a period of substantially lower volume, stagnant prices, and a return to price-to-earnings ratios of 10 to 15 times earnings. Also, the return to reality will be accompanied by mighty oaths of crazed investors, forever swearing off common stocks echoing through the canyons of Wall Street and the Main streets of America. Then, our buying opportunity will have arrived.

July 5, 2002

Market Misery

Take heed investors ... the one-day market rallies are just that one-day market rallies in a bear market. In our opinion, the markets will likely drift in a downward direction until noticeable improvements in capital spending, corporate earnings and the employment picture are evident. From a historical perspective, the market, as a whole, is still overvalued in terms of price/earnings ratios despite the massive price declines to date. With the S&P 500 index currently trading at a P/E of 40.04 (see chart below), the index could decline to the 400 to 600 level in order to bring stock prices into a "fair value" range as determined by the historical P/E range for the index over the past thirty years. In other words, stock prices could decline another 50% from here. Of course, earnings (the denominator of the ratio) could increase to bring the historical ratio into line with historical levels, but this seems unlikely given the economic environment at the current time. Further commitments to the market should be very selective and limited.

Chart provided by (c) Decision Point