“The market be nimble, the market be quick, the market jump over the 10,000 point stick”

(a parody on an old nursery rhyme)

Yes, it will happen, and likely in the next four months. It has been an amazing market when you consider that the performance of only ten companies contributed over 38% of the gain in the S&P 500 during 1998. Fifty percent of the companies comprising the index did not advance in price at all in 1998. Yet the psychological factors driving this market dictate a move to higher levels. As we said before, we are witnessing a stock market mania, particularly in areas such as the Internet stocks, which has created an environment of speculative euphoria. How long it will go on is anybody’s guess. Ours is that as long as there is liquidity around we will see higher stock prices.

This is the year that managers will have to be nimble and quick. There is much lurking in the wings that could cause a repeat of the August to October period in 1998. Last year was the year of global financial crises. It started in Asia, spread to Russia and then cropped up in Brazil. And it’s continuing. Despite the intervention by Mr. Greenspan and IMF bail-outs, very little improvement has taken place in the economies of any of the aforementioned nations. At present we may well have a powder keg on our hands with the internal situation in Brazil. After the IMF agreement of late 1998, it was expected that the country’s currency would regain credibility and the outflows of cash would stop. Well it has not, so Brazil’s recovery may be in trouble.

There are some bright spots however. Recently we have seen signs that some of the hard hit Asian economies are bottoming. South Korea has started reforms and seems to have turned the corner, as have a few other lesser developed countries in that region. Unfortunately, the mainstay of the Pacific, Japan, is still in crisis. This nation is still trying to recover from the bubble economy of the late 1980s. Japan is rich and will not go bankrupt, but their problems are many and will not go away quickly. To recover, they must export their goods to someone. Most of Asia is not importing which leaves the good old US of A as the importer of last resort. Half a world away in Europe, weakness is beginning to develop. The German industrial production yearly growth rate is approaching zero. The economies of both France and England are slowing and the lowering of interest rates during 1998 by their respective Central Banks has not seemed to help.

Here in the U.S. ever expanding liquidity and strong consumer confidence have been the driving force behind the market. No longer are P/E multiples and dividend returns a concern to today’s investor. We have entered the era of the “day trading” amateur investor. Market momentum is their watchword and, in some cases, their speculative activities have caused one day of trading to exceed the total capitalization of a company. According to some Wall Street estimates “day trading” accounts for as much as 12-15% of total daily NASDAQ volume.

The root of investor confidence may lie in the fact that the U.S. now has the lowest jobless figures in 40 years. At year-end the unemployment rate was a seasonally adjusted 4.3%. For 1998 as a whole, unemployment averaged 4.5%, the lowest since the 1969 figure of 3.5% achieved during the Vietnam War. No wonder the consumer is confident. With such an abundant job market he can always earn his way out of debt (New job= more money). Couple this with the fact that the U.S. economic figures have shown a persistent tendency to surprise on the upside. Two keys to future market activity may well be the unemployment numbers and consumer confidence. The labor market indicators to watch during the coming months are the Manpower Survey of Hiring Intentions, the Small Business Hiring Plans and, of course, Initial Unemployment Claims.

For the past two years, we, along with many other managers have predicted a slowdown in economic activity. Will it arrive in 1999? We have been very closely monitoring the earnings forecast for the S&P 500 published by First Call. Over the past year these predictions have started out as double digit growth forecasts, quickly moving to high single digit growth and then by quarter close, tumbling to one-to-two percent growth. At the beginning of January, First Call’s 1999 projection was for 10% earnings growth for the S&P 500 to $44.41. Our call is for growth of somewhere in the 3-5% range. When the entire world is, as described above, in an economic slowdown we cannot be far behind.

Inflation is no longer a problem in the U.S or worldwide. It’s the building deflationary pressures that could well be our problem in 1999. The Producer Price Index was down by 0.1% for 1999 which followed a drop of 1.2% in 1997. This is the first back-to-back yearly decline on record. We have seen what has happened in Japan when their consumer began to retrench by spending less and increasing their savings rate. In the U. S., we are witnessing a negative personal saving rates which suggests that Mr. and Mrs. Consumer may soon slow their spending spree, reduce the amount they are putting into the market, and begin saving more in a conventional manner, i.e. saving accounts. The stock market has been volatile over the last two years. This roller-coaster environment may cause the investing public to take a realistic look at what makes a company worth more a year from now than it’s worth today.

As we have elaborated above, there are major problems out there in the wings. But the market will only climb a wall of worry and we have many reasons to worry. In the short run the market will go higher, but with less exuberance.

Gordon B. Lamb
Jeffrey M. Campbell

January 13, 1999