PERFORMANCE ANNOUNCEMENT

As Of: September 9, 2003

What Bear Market?

Perspective changes everything.

      The following chart is an accurate representation of the trajectory of the Standard & Poor's 500 stock index for the past fifteen years (1988 to the present). Does this look like a bear market?

Sure looks like a powerful upward trend!

      Any investor who has participated in the market drop since 1999 is likely to say we have been in a bear market, not a bull market, but the chart is undeniable. Since anyone who invested in the decade from 1988 to 1998 should still be profitable, it is hard to take seriously those who whine about economic collapse and the three year drop in the stock market. Most recently, we have had a powerful market rise for six months without any significant pullback or "correction". It appears that we are simply continuing the upward trend of a 15 year bull market. Overlaying the actual price history of the S&P 500 on the above chart tells the story of an acceleration of prices in the late 1990's that was corrected from 2000 to 2003. The past six months shows a return to the long term trend.

Now we see the full story. But it still looks like a bull market.

      Indeed, a longer term perspective seems to indicate that things have been going pretty darn well for the past fifteen years. (Actually, if we ignore the hiccup of the October, 1987 crash, stock market investors have been doing exceptionally well since 1982.) So what is all the fuss? The stock market simply rose at an unrealistically fast rate during the technology bubble and then corrected; but we are still on the track of a long term exponential rise (note the line is not straight up, it is accelerating in an upward curve).

      It appears there is really only one question to ask. The short version of the question is: "Is the current rally sustainable?" The longer version is: "Is the current rally a resumption of a decades long rising trend in the market, or is it simply a rally in a bear market that started in 2000?" My answer is that the rally is both a resumption of the longstanding upward trend and a rally that is not sustainable. Long term trends are hard to kill. The stock market took a kick in the head for three years, but the long term trend still wants to persist. There is every reason to expect that the trend will continue unless and until it is overwhelmed by structural changes in the economy which will no longer support the trend. So it becomes necessary to look and try to find structural changes that will derail the economy.

      The best reason I can give to explain why the current rally is not going to be a sustainable trend is because 2003 does not feel the same as 1993, or 1995, or 1998. The Dow Jones Industrial Index is at higher levels than in 1998, and the S&P 500 Index is at the same or higher levels also; but the economy certainly doesn't feel the same. We have gone from government surpluses to a budget deficit. We have watched private debt increase at record levels along with bankruptcies. Corporations are laying off workers and growing profits by cutting costs. They are not growing revenues. The U.S. dollar has dropped on the foreign exchange markets, but all the major governments seems to have adopted a weak currency policy. The result has been that gold has risen in price to its highest levels since 1996 (a hint that something isn't right with the world). The shadow of terrorism has swept across the land, and with it, an unknown cost that is yet to be paid. The cost of trying to protect our air travel system, our nuclear plants, our water systems, our harbors and borders, our rail systems and cargo ships, our electric grid and our computer systems is unknown. Whatever the cost, it will come out of corporate profits and individual's income. And worse, it isn't known whether a tremendous expenditure to harden our systems against attack is a futile effort with little or no payback. Many corporations have woefully underfunded pension plans, and rising health care costs are also putting a dent in corporate profits. The list of negatives goes on, with issues of fraud affecting investor confidence, and accounting changes making financial statements almost indecipherable by the average person. Hardly the stuff to support rising stock prices.

      I suspect that the markets are in denial, and are failing to consider the increased risks and attendant costs that have been introduced in recent years. It doesn't make sense that fixed income investors will accept low single digit returns on anything but the very safest bonds; and it doesn't make sense that stock investors will accept 25 to 45+ price-earnings ratios on stocks that can't prove strong financials and strong forward growth rates. The government (through low interest rates, pumping up the money supply, and tax reduction legislation) has provided a short term stimulus; but this is like feeding candy to a child for dinner. It may satisfy the hunger for a short period, but it does not provide real sustenance. Worse, the recent low interest rates which prompted a rash of residential refinancing has effectively encouraged a lot of people to pitch their tents in a flood plain. It is only a matter of time before an economic storm wipes them out.

      I believe the structural changes are big enough to overwhelm the old trend and eventually cause a whole new valuation paradigm in the investment markets. Failing a single event that shocks the markets into a sudden change, it is most likely that the long term trend will die slowly. There will be lots of down days followed by strong rallies; but in the end, the people who sell on the peaks will take money from the people who buy on the dips. So Where is the bear market? It is quite possible that the real bear market hasn't started yet. The past three years were just the appetizer. The long term trend has yet to truly break down.