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October 2, 2003
Issue 6

 In This Edition

Here Comes October……..
In this newsletter we would like to provide our outlook for the balance of 2003.

  • Tidal Wave of Stimulus
  • Bear's last "At Bat"
  • Expectations for Stocks, Bonds, Currencies, and Interest Rates


Tidal Wave of Stimulus


In our first newsletter in July, we posed the following rhetorical question: “What would happen to the U.S. economy when 21st century productivity takes full advantage of 1950’s level interest rates?” Given the Fed’s stubborn commitment to low short term interest rates, we are about to find out. Historically, the Federal Funds rate has been well correlated with GDP. When the economy picks up, the Fed typically increases rates in an effort to keep the economy on an even keel. At this time however, we see the Fed keeping the Funds rate at 1% while second quarter GDP was 3.3% and the expectation for second half GDP is >4%. Looking to recent history, during the 1990-91 recession, the Fed took an accommodative stance, pegging the Funds rate at just below 4%. At 1% today, the current Fed looks more like the backyard barbeque enthusiast who uses an entire can of lighter fluid just to make sure the flame is lit.

In addition to the Fed’s stimulus, we also have significantly lower Federal Tax rates as additional stimulus. Some of this relief is certainly offset by higher individual State property and use taxes, but the impact of 15% dividend and long-term capital gains tax rates is still significant.

Bear's Last "At Bat"


Now that the broad markets have moved well off of their October lows, the bears are all but out of negative data to sponsor their cause. They continue to focus on the employment data, but this is a lagging indicator. With surging productivity and GDP expectations moving well above trend by year end, payrolls should begin to expand.

It is important to recognize that the current unemployment rate has not risen to anywhere near the levels seen in the last recession. In fact, the employment rate of the early 1990ís did not decline to the current level until 4 years after the recession.


Expectations for Stocks, Bonds, Currencies, and Interest Rates


We continue to be optimistic on the U.S. Economy. Broad equity markets have risen well off of their October 2002 lows, with the Dow up 28% and the Nasdaq up 61%. Meanwhile, the 10 year U.S. Treasury yield is amazingly unchanged at 4.05% despite its extraordinary volatility. It is fair to ask what portion of the strong equity returns reflects an oversold situation last fall versus an improving economy of this year. However, we are clearly in an environment which favors equities.

The bond market has continued to enjoy unsustainable flows from different factions such as mortgage-backed securities traders as well as Asian central banks (supporting a stronger dollar through open market purchases). In the absence of such activities, we should see higher rates and a lower dollar.


 Market Highlights

  9/30/03 8/29/03 6/30/03 3/31/03 12/31/02
DJIA US 9275.06 9415.82 8985.44 7992.13 8341.63
S&P 500 US 995.97 1008.01 974.5 848.18 879.82
Nasdaq US 1786.94 1810.45 1622.80 1341.17 1335.51
EAFE Int'l Equity 1103.39 1072.14 1025.74 868.55 952.65
5 Yr Treasury 2.865 3.494 2.41 2.71 2.74
5 Yr AAA Muni 2.300 2.820 2.17 2.50 2.59
10 Yr Treasury 3.932 4.427 3.52 3.80 3.82
10 Yr AAA Muni 3.670 4.080 3.30 3.75 3.72
30 Yr Treasury 4.857 5.190 4.56 4.82 4.77
30 Yr AAA Muni 4.680 4.890 4.50 4.66 4.69
EUR Currency 1.1686 1.0908 1.1425 1.0899 1.0488
JPY Currency 110.36 116.65 120.06 118.67 118.69
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