October 3, 2006

 

      Several events suggest that the 3^rd quarter of 2006 could be pivotal for the economy and financial markets.  For the first time in over two years the Federal Reserve held a meeting without raising overnight interest rates.  In September, the hedge fund Amaranth Advisors imploded after a leveraged position in natural gas futures lost over $7 billion.  That proved to be the "canary in the coal mine" for the energy markets which saw huge losses for the quarter:  oil -15%; natural gas -29%; and unleaded gasoline -30%.  Despite the criticism heaped on the oil and gas industry the past few years, we should tip our hats to the people and companies that produce, refine and deliver these vital products for what has been accomplished in the wake of Hurricane Katrina.  It has only been 13 months since Katrina and Rita ravaged the energy facilities in the Gulf of Mexico and on the coast, but today, most production is back on-line and supplies are plentiful.  The best evidence of this is the price action in the energy complex since Hurricane Katrina:  oil -10%, unleaded gasoline -41%, and natural gas -67%.

 

STOCKS:  Buoyed by the fall in energy prices and the pause in rate hikes from the Fed, the major stock indices posted gains for the 3^rd quarter:  the Dow Jones Industrial Average +4.7%; the S&P 500 +5.2%; and the NASDAQ Composite +4.0%.  There was significant rotation in the market away from small cap, natural resource, energy, and cyclical stocks toward large cap and stable growth companies.  The best performing sector, however, was technology, +8.2%, which is counterintuitive to a "slowdown" scenario.  The message might be that the economy is more resilient and durable than some expect.   

 

 BONDS:  After 17 "measured rate increases" from the Federal Reserve, the bond bulls finally got the pause they had been anticipating.  The result was a relief rally with prices moving up and rates moving down across the yield curve.  But this respite from rising short term rates may be transitory.  The Federal Reserve's key inflation metric, the Personal Consumption Expenditure (PCE) Deflator, currently +2.5%, is well above their comfort zone of 1-2%.  We maintain a defensive posture toward bonds.

                                          Ashby M. Foote, III 

 

MARKET COMMENTS:  A column by Ashby Foote appeared on National Review Online's website on 14 September 2006.  Please click on the link below to read his thoughts.

     National Review Online Artlicle: September 2006

September 13, 2006 - 

     Conference update:  September 7th and 8th were spent at the Morgan Keegan Equity Conference in Memphis, TN.  It is always a good opportunity to see some new companies and sense the current sentiment of portfolio managers from across the country.  The rough patch in the market the past three months also meant that many of the stocks were trading at reasonable prices.  Some themes we picked up: 1) Companies in the industrial sector felt very good about the economy and had positive outlooks for the rest of 2006.  2) Everyone except the energy companies welcomed the recent slide in oil and natural gas prices.  3) The biggest concern of the 5 trucking companies that presented was the serious shortage of qualified drivers.  This is, no doubt, an indicator of an overall tight labor market.  Our thanks to the folks at Morgan Keegan for hosting another excellent conference.      Ashby M. Foote, III 

22 August 2006 -

      There is quite a divide today between the outlook of the demand-siders and the supply-siders views of the year ahead economic prospects.  The former see the glass as half empty with all the juice from tax cuts and home equity extraction exhausted.  I happen to side with the supply-siders like Wesbury, Malpass, Forbes etal and believe that the economy still has plenty of legs for the next 12 months.  The tax cuts and their extension until 2010 is a powerful force for continued capital formation but in the current "Fed centric" view of the world they lost in long shadow of Greenspan.  Also below many radar screens is the dynamism found at the grass-roots of the economy that is using cheap new technology to fashion new businesses and new business models.  Consider this anecdote from "An Army of Davids" by Glenn Reynolds: "There are over 724,000 people in the U.S making a living by way of E-Bay, while WalMart, America's biggest employer, has a work force of 1,100,000."  This example is further supported by the Bureau of Labor Statistics Household Survey employment data over the past 4 years which has consistently reported better job growth than the companion Establishment Survey, which started up a year later and has grown at 1.5% versus 1.9% for the Household.  Both are samples but it is the Establishment numbers that get the headlines.  The critical flaw of the demand side view is the exclusion of creativity in the wealth creation process.  While supply-siders can't predict what will be created they at least are prepared if not anxious to be surprised.                               Ashby M. Foote, III

24 July 2006 -

     Some comments on Qualcomm(QCOM):  we don't normally comment on individual  stocks, but, because of the recent sell-off,  here are some observations on what we feel is the best positioned technology company in the world:

17 July 2006 -

     The stock market got some good economic news today with the release of Industrial Production for June (+.8%), twice the expected +.4%.  That may not seem like much, but combined with April and May it represents the best quarter since the 4th quarter of 1999.  It was highlighted by strong output at mines, factories and utilities.  Capacity Utilization, another widely followed statistic, also hit a six year high at 82.4%.  Both are further evidence of continuing strong economic conditions.            Ashby M. Foote, III

MID-YEAR 2006 INVESTMENT UPDATE

July 7, 2006

    The 2^nd Quarter of 2006 was rough on stocks and bonds.  The honeymoon for new  Federal  Reserve  Chairman Ben  Bernanke  came to  an a brupt  end and before  the quarter  had  closed,  both stocks  and  bonds  had  thrown  major tantrums over the uncertainty of Federal Reserve policy.  The economy continues to do very well, especially in the old economy industrial sector as typified by Caterpillar Tractor.  Caterpillar has been the best performing Dow Jones 30 stock for the past 1 year (+54%) and 5 year (+181%) periods.     

STOCKS:   Stocks  got whipsawed in  the second quarter  and what had been the best  performing sectors got hit the hardest.  Corporate earnings continue to hit all time highs  both in  total profits  and in profits  as a percentage  of Gross Domestic Product (8.5%).  The end result is stocks trading very cheap to current earnings.  The current P/E on the S&P 500 is 16.1, which equates to an earnings yield of 6.2%.  Our outlook is for higher equity prices by year-end.   

BONDS:  Interest rates moved higher across the yield curve during the quarter.  The only winners in the rate hiking cycle have been certificate of deposit and money market investors who are finally seeing yields reach levels that would be considered normal.  We still expect more rate hikes and maintain our defensive posture on bonds.

                               Ashby M. Foote, III                                                         

June 16, 2006 -

A Wild Week for the Market:

     After 5 weeks of pain and agony the stock market bounced back with a vengence this week, gaining 315 points from Wednesday's low to Thursday's close and then breaking even Friday.  The catalyst for the turn around was a culmination of comments from members of the Federal Reserve that getting inflation under control was their number one priority.  Encouraging for stocks is the continuing good data on the economy and a number of raised earnings expectations from companies like Best Buy, Nucor and Qualcomm.  The drop in commodity and precious metals prices is an indication that the risk of runaway inflation, which had spooked the markets, is receding.  With short term rates still below their average level for the past 22 years of 5.5% there is no reason to expect a slowdown in the near term.              Ashby M. Foote III  

-- The following guest commentary by Ashby ran in The Clarion Ledger on June 2nd, 2006.  Please click on the link below to read his thoughts.  As always, your comments are appreciated.

   Clarion Ledger Commentary:  June 2006

16 May 2006 -

Ben Bernanke's First Test

It has now been 100 days since Ben Bernanke was sworn in as Fed Chairman and gold has rocketed up $146 or 25%!!  The market is giving the new Fed Chairman a test unlike anything he administered at Princeton.  While I applaud his goal of more transparancy, he still has some work to do on style.  Passing monetary policy info through Mario Bartiromo at Saturday evening cocktail parties can generate global nausea faster than the avian flu.  How was Alan Greenspan faring at the 100 day mark?  He was trying to clean up the debris from the massacre of Black Monday that had collapsed the market on October 19th, 1987.  He took the chairmanship in August 1987.  In some eerie ways, the volatility and political harranguing over tax-cuts and currencies is reminiscent of that time.  The trigger for Black Monday was Treasury Secretary James Baker, speaking in Germany, threatening a lower dollar to address the trade deficit.  It was as bad of a policy prescription then as it would be today.  Greenspan and the Reagan brain-trust had a meeting of the minds and pulled the economic cart out the ditch in 1987 - lets hope Bernanke's test result and any remedial training is less painful. Ashby M. Foote, III

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FIRST QUARTER 2006  INVESTMENT  UPDATE

April 5, 2006 

    The 1^st Quarter of 2006 was excellent for stocks but very difficult for bonds.  Numerous economic data points surprised on the upside and confounded the skeptics.  Here and abroad, the fundamentals for prosperity and wealth creation have rarely been better.  Our economic model, which continues to forecast a strong and durable expansion, performed very well for the quarter.  Client equity portfolios enjoyed double digit returns easily surpassing the returns of the major U.S. stock indexes: S&P 500 +3.7%, Dow Jones Industrials +3.7% and the NASDAQ Composite +6.1%.

BONDS:   The bond market suffered a reality check in the 1^st Quarter with interest rates rising across the maturity spectrum, as hopes for an early end to Fed tightening dissipated.  The Fed, with Ben Bernanke as its new Chairman, increased rates twice to 4.75%, the highest level for fed funds in almost 5 years.  The end of this extended rate hiking cycle is closer, but the action of gold and commodity prices suggests the potential for more rate hikes ahead.  We maintain our defensive outlook for the bond market and expect higher bond yields by year-end.

EQUITIES:   The best performing sector in the 1st quarter was Telecom +13.4%,  and  the  best  performing  industry  was  Steel  +50%.   The industrialization of the world¡¯s most populous countries is a strong tailwind for the global economy.  The biggest beneficiaries so far have been energy, and other industrial commodities.  Corporate profits are growing faster than the economy and in the 4th quarter reached 11.5% of Gross Domestic Product (GDP), the highest share since 1966.

OUTLOOK:   Stocks, at 15 times forward earnings, remain cheap relative to bonds.   Conditions  for  economic  activity  remain  positive  with  falling unemployment, reasonable interest rates, and modest inflation of 2 to 3%.  One item to watch, which will impact the markets, is legislation to extend the 2003 tax cuts on dividends and capital gains.  Failure of the extension would present significant risk for U. S. stocks.

                                    Ashby M. Foote, III          

-- A Guest Editorial by Ashby on state franchise laws and the proposed merger of AT&T and BellSouth  appeared in The Clarion Ledger on Saturday 25 March 2006.  Please click on the link below to read his thoughts:

      Clarion Ledger Editorial:  March 2006

     Clarion Ledger Column: February 2006

-- The lead story in The Clarion Ledger's "Business" section on Sunday, January 8, 2006, featured Ashby and some other local investment professionals.  Use the three links below to read the story and related 2006 outlooks for the market:

Links to Clarion Ledger Article:  January 2006

             Link 1       Link 2      Link 3

2005: A BRIEF OVERVIEW

 "An exciting year for weather, a boring one for financial markets."

 January 6, 2006

The Economy and the Markets

    2005 turned out to be a very good year for the economy in the U.S. and abroad even though U.S. stock indexes were little changed for the year.  When one considers the economic headwinds of rising short-term interest rates, $65 a barrel oil and the cataclysmic headwinds of a record hurricane season, that is quite an achievement.  It is a credit to the flexibility and dynamism of the U.S. economic system that it can sail through such storms and keep right on percolating at a growth rate of 3.5 to 4.5 percent.  It is worth remembering that economic growth is the norm not the exception.  So just because we have had 3 good years does not mean a downturn is just around the corner.  Matter of fact the macro-economic conditions around the world are the best they have been in 50 years.  Rising commodity prices have been a boon to the developing world and that combined with capitalistic reforms in countries like India, China and the old U.S.S.R. have really ramped up global economic growth.  This is great news for the many U.S. multinationals that export to these markets.

Bond Market Outlook

    The Federal Reserve continued its rate-hiking regime during 2005 and still isn¡¯t finished.  We expect two to three more quarter point increases in 2006.  The signals from commodity prices suggest there is some inflation on the horizon.  We continue to maintain a defensive posture towards bonds.

Stock Market Outlook

     GDP grew at close to 4% for 2005 and S&P 500 earnings grew by 11% but despite those strong fundamentals, stocks were little changed for the year.  The good news is most of the Federal Reserve¡¯s rate hikes are behind us now.  We expect the expansion to continue, earnings to grow by 7 to 10% and stocks to rally nicely to close the yawning earnings gap between stocks and bonds.  At year end the earnings yield on the S&P 500 was 6.7% versus 4.5% on the 30 year Treasury bond.  A gap that much in favor of stocks has only been seen twice in the past 20 years and both turned out to be excellent buying opportunities. 

                                                Ashby M. Foote, III    

The following column regarding Hurricane Katrina and its destruction of the Mississippi Gulf Coast appeared on The American Spectator website in late November:    

    American Spectator Column:  November 2005

Market Comment: October 2005

From September 12 through October 12 the Dow Jones Industrials, S&P 500 and NASDAQ have all dropped close to 5%, which is cause for investor concern and a good signal to reassess the economic fundamentals.  There are always plenty of things for investors to worry about ¨C the financial media motivated to sell advertising makes sure of that.  The talking heads on CNBC and other media outlets keep discussing the market's lack of leadership, what with energy very extended, financials at a 52 week low and tech now lead by Google and Apple faltering. The biggest worry of all though seems to be about the
consumer finally running out of dough. My explanation for all this is that the "DEMAND SIDE VIEW" which is dominant among the media and Wall Street today doesn't capture the full dynamics of the Reflation
and tax-cut lead recovery we are now two years into. It is no coincidence that David Malpass and Brian Wesbury, two of our favorite supply-side economists, have been two of  the most prescient economists in the country over the past 18 months in predicting stronger than consensus economic growth. Those who follow GOLD as an important barometer and have seen it rise from $254 to $470 are not surprised to see oil, gas, copper and steel rise dramatically and stay at high levels. Strategists and analysts using the demand perspective on the other hand, extrapolate backwards for 5, 10 or 15
years and keep waiting for those commodity prices to collapse as they did during the two decades (the 80s and 90s) of DISINFLATION. It is also not a surprise
to the supply-side perspective that the banking industry would be challenged by REFLATION or that short term rates would revert to historical norms. What makes these times especially interesting is that just about everyone on Wall Street has spent all or most of
their careers in a period of disinflation. Today's monetary conditions are dramatically different than those of the 80s and 90s, probably closer to those of the 1950s. Reflation is great for the developing world where natural resources are a bigger part of the economy. Which gets us back to rising commodity prices -
some of the rises are speculation but much of the rise is simply demand shocks from increased global growth. This is entirely different from the supply shocks of the 1970s when the OPEC cartel cut back on the supply of oil. 
Some summary thoughts:

 We have been through a very unique period the past 5 years - one of the worst bear markets in that past 60 years in conjunction with a brief spell of deflation.  The deflation was fine for consumers with a fixed salary or
retirement income but it squeezed business profit margins.  In response to that deflation threat, the Federal Reserve took short term interest rates to historic lows.  Now that threat is past and rates are returning to normal
levels.  I think rates still have further to climb.  Stocks have now enjoyed three years of good earnings growth and even though the market is still a ways from its 2000 peak, the earnings of the S&P 500 are much higher than
what they were in 2000.  In other words, stocks are very reasonably priced to earnings today at a 6%earnings yield.  The global economy is also doing extremely well, probably the best since the 1950s.  There will always be things to wring our hands over - from hurricanes to wars to budget deficits.  The challenge for investors is to look past the noise and focus on the long term health of the economy.  Right now the fundamentals of the U.S. economy are very sound with low unemployment, low taxes, lots of job creation and a good environment for creativity and innovation.  As the bear market of 2000 - 2002 recedes, investors will again turn to equities as a good way to build nest eggs and generate income streams.

We welcome any questions or feedback.

Ashby M. Foote III   13 October 2005

THIRD QUARTER 2005 MARKET COMMENTARY

STORM CLOUDS

When the biggest natural disaster in U. S. history wallops your state, the dissection of government statistics on housing starts, employment gains and GDP revisions becomes a rather meaningless exercise.  KATRINA and RITA are the only story of the 3^rd quarter, and for Mississippi, the main story for several years to come.  The fact that the stock market gained over 1% in the month following Katrina is a testament to the underlying strength of the U. S. economy.  Also remarkable was the price action in the energy markets.  Oil, which has been on a seemingly inexorable rise this year, peaked on August 30 at 69.81, the day after Katrina¡¯s land fall and is now 10% below that peak.  Natural gas on the other hand, subject to a different set of supply and demand dynamics, rocketed to new all time highs of $15.00 per million BTU.

BOND MARKET

Rising short-term interest rates, courtesy of two quarter-point rate hikes by the Federal Reserve, took a toll on bonds with rates rising across the maturity spectrum.  Even though these increases were negative for bond prices, they pose little threat to the economic expansion now enjoying its third year.  It is reasonable to expect GDP to grow by 4% in 2006.  We expect at least two more rate hikes in the upcoming months and maintain our defensive posture towards bonds.

STOCK MARKET

The stock market shrugged off the headwinds of rising short-term interest rates and rising energy prices to post a 3.1% gain for the quarter.  The best action came from companies that dig or pump stuff out of the earth, be it oil, natural gas, copper, iron ore or coal.  It didn¡¯t hurt that hurricanes Katrina and Rita shutdown oil and gas production and also created fresh new demand for building materials.  The stock market¡¯s resilience in the face of rising rates and rising tides is a reflection of rising corporate earnings.  S&P 500 earnings are expected to reach $74.02 for 2005, a 10% increase from 2004, and hit $78.80 in 2006, another 6% increase.  The S&P 500 currently trades at a very reasonable 6.2% earnings yield.

Below is a recent interview on the economic impact of Katrina published in the Metro Business Chronicle and an editorial that appeared in the Clarion Ledger.  We welcome any comments or questions. 

Ashby M. Foote, III                                 ashby@vectormm.com         7 October 2005

 POST KATRINA THOUGHTS 9/16/2005

It has been 18 days now since Huuricane Katrina hit the Gulf Coast and 17 days since the world realized how devastating it was.  The action in the markets in the 12 trading days since 30 August has been quite remarkable considering Katrina would have to be considered a "worst case" scenario by anybodies measure.  Since 30 August oil has fallen by $5 a barrel a 7% drop, the Dow Jones Industrials has risen by over 200 points a 2% gain and the S&P 500 gained a similar 2%.  There are several take aways from such resilient action in the face of one of the worst natural disasters in America's history.  One is that the stock market was already trading at low valuations reflecting concerns over a number of glass-half empty concerns.  Oil on the other hand was trading at historic highs and was enjoying a fare amount of speculation. 

In the weeks ahead the nation's attention will turn from rescue and relief to rebuilding and renaissance.  The markets have already bid up the prices of many of the companies and industries that will benefit from the massive rebuilding ahead.  It is a rare opportunity to re-invent a major American city.

Ashby M. Foote III, 16 September 2005

SECOND QUARTER 2005 MARKET COMMENTARY

THE ECONOMY

You wouldn¡¯t know it by watching the stock market, but the economy continues to percolate along at a very healthy pace.  1^st quarter GDP has now been revised up twice to 3.8% and it looks more and more like 2005 may see economic growth of 4% and S&P profit growth of 8%.  S&P earnings have now surprised to the upside in 7 of the last 8 quarters. 

GLOBAL OUTLOOK

China, India and their combined population of two billion, is surely the biggest economic story for the decade ahead.  Their embrace of capitalism and march from developing to developed economies will be a major influence on the world¡¯s financial markets.  This is a big change from the last 25 years where the U.S. economy was the primary engine of global growth.  Both India and China are already enjoying rapidly rising standards of living.  If they continue on the current track, their global influence both as producers and consumers will only increase.

STOCK OUTLOOK

The stock market slogged through another difficult quarter despite continued robust earnings reports.  For the quarter ending 6/30/05, the S&P 500 edged up 1.37% and for the twelve months it gained just 6.24%.  The earnings yield of the S&P 500 at 6.5% now exceeds the 4.36% yield on the 30-year Treasury Bond by 2.14%.  A spread that favorable to stocks has only been seen twice in the past twenty years. 

BOND OUTLOOK

The bond market has demonstrated a remarkable resilience over the past twelve months.  In the face of overnight rates rising from 1% to 3.25%, and a 15% rise in the Commodity Research Bureau (CRB) index, the yield on the 30-year Treasury Bond has fallen from 5.29% to 4.19%.  Such contrary action has been a boom for bondholders, but warrants increased caution in the months ahead.  We continue to be defensive in bonds and expect rates, both short and long, to be higher by year-end 2005.

Ashby M. Foote, III                                 ashby@vectormm.com         11 July 2005   

 -The following column appeared in the April 2005 issue of the Metro Business Chronicle:

The "Sweet Spot" or puzzling data?

by Ashby Foote
Guest Columnist

It has been just over five years since the great bull-run in stocks ended and the current message from ¡°Mr. Market¡± is a puzzling one. Chalk it up to the litigious and legislative clattering and cluttering of Sarbanes, Oxley and Spitzer but stocks look cheap.

Valuation
Since March of 2000 earnings of the S&P 500 are up 25%, revenues are up 16%, dividends are up 18% but market valuation, which is what counts most to most investors, is still off 19%. When it comes to value, everything is relative, so how are bonds now versus back then? In March. 2000 an investor could earn almost 6% on a 30 year treasury bond; today it is only 4.74%. An easy rule of thumb for comparing asset classes is to compare earnings yields: as noted before, the yield on the 30 year treasury is 4.74% while the earnings yield on the S&P 500 for 2005 earnings is 6.44%, a whopping yield gap of 1.70% in favor of stocks. Back at the market peak the yield gap was just the opposite over 2% in favor of bonds. Applying this metric over the past twenty years, S&P 500 earnings have only been this cheap versus bonds four times: November 1988, September 2002, February 2003 and today, April 2005. There are three ways for that gap to revise to the mean: earnings can drop dramatically, bond yields can rise sharply or stocks can rally strongly, or lastly a combination of all three.

The "Sweet Spot"
For the twenty years from 1982 through 2002 the economy enjoyed steadily falling inflation rates and steadily falling interest rates but that ended with a scary spell of deflation and a 1% fed funds rate. Under those falling rate conditions the "sweet spot" for profitability was at the end of the supply chain that interfaces directly with the consumer, such as retailers and financial services. During those two decades the end of the supply chain dramatically increased their share of the economy's profits and market capitalization. But conditions have changed and a two-year screen of increasing profitability now indicates that the sweet spot of profitability and pricing power has moved to the front end of the supply chain. Over the past two years the S&P 500 is up 36% but there is a big divergence among the nine sectors in the index. The be