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February 4, 2003

Ron Watkins writes:

 The current "economic" uncertainty and the impending war -- are the two prevailing media and corporate rationale describing the reactions in the markets. Other factors such as improved corporate governance and new regulation (to prevent further Enron debacles) -- all combine to create an investing environment riddled with fear and uncertainty. The masses sell, buy, move assets around -- ignoring completely a fundamental rule of success "Constancy to Purpose".
Some points:

* World conflicts/war -- while tragic -- creates spending and demand for products and services far beyond "weapons". The need for food, clothing, shelter and other resources increase. Patriotism increases, sentiment grows positive, and these effects are long lasting. It has every single time (without exception) provided the seeds of expansion.

* The requirement for basic goods and services does not stop. We still eat, drink, pay our mortgages, make repairs, brush our teeth. 

* Economic doldrums in many ways is a boon for the next boom. Companies are forced to improve efficiency and effectiveness, eliminate waste and invest more carefully. 

* Companies continue to innovate -- in fact the pressure to innovate, motivated by desperation, is often stronger than when motivated by inspiration.

* The global marketplace continues to expand and open.

Well run companies, producing required goods and services to a growing population -- will continue to grow, expand, improve profitability. We are now able (for the first time in a few years), to buy the stocks of these companies at historically low valuations. 

This is a time of great opportunity -- IF -- wise decisions are made.

* Interest rates are at historic lows and there is even talk of lowering rates a little further. Japan for the first time in history has implemented a "negative" interest rate.

* Rates offered by debt/bond instruments are low -- remember that as interest rates rise, the price of those instruments fall.

* Real estate maintains significant appreciation in stark contrast to the published sentiment and economic confidence.

* Business Inventories are at historic lows, improvements in the supply chain allow this, as well as reduced expansion plans....yet figures from the purchasing managers report show slight increases in orders.

All of these factors create an "environment" which we must look at as a whole in order to make wise decisions. 

The markets as a whole have traded in a "range" from 7800 - 8800 for quite some time now -- and the effect of this is twofold.

1) It facilitates the transfer of wealth. Many have sold, or will "sell", lock in and accept their losses. The sell, to someone willing to buy at this price. What happens next? the reverse scenario. Prices will rise, and the new owners (who have purchased recently) will sell at various price points....to whom? to those now deciding the time is right to buy. Which side do you want to be on?

2) It creates pressure on both sides of the range. That is..the longer the market trades within a range, the greater the pressure "build up". There is a point just above the high of the range...where "paper" or orders (to buy) accumulates. There is a point just below the bottom of the range where paper accumulates to sell.

When (not if), when the market breaks out of this range, the greater the pressure (to buy) fuels a long, often rapid appreciation of prices.

Now one could say that the market could also explode to the downside in similar fashion -- so we have to consider factors which might effect the direction in either way.

Of a random selection of the top-rated growth companies -- throughout their history -- shows that their historical P/E ratios average around 24 to 25 times earnings. Today they are at 19 - 20. Considering the economic impact of those companies, the market (as indicated by the Dow) is "free" at a Dow of 6800. It would be fairly priced (historically) at a Dow of 12000. It would be expensive (given "today's" earnings, sales and economic impact) at a Dow of 14000.

So, in my opinion -- the downside risk is minimal. Nothing is ever free, so it is unreasonable to think the market would ever approach that low water mark. 

We cannot predict interest rates, we can't predict world events, we can't predict the direction of the stock market on any given day. We can however predict that the population will continue to grow, and that growing population will demand and need products and services. Well run companies will provide them and those participating in the ownership of those companies will be rewarded appropriately.