Amid mounting evidence that the U.S. economy has bottomed, the markets made impressive moves during the week of February 25th, with the DOW gaining 400 points (4.40%), the S&P moving ahead 48 points (4.41%) and NASDAQ adding 78 points (4.50%). These types of strong moves, if sustained, serve as a foundation for further gains if the economic strength continues, and if corporate profits return to their former vibrant selves. However, there is still much work to be done, and investors must be reminded that the path to recovery will likely be slow and steady, rather than overnight. For the year, the Dow Jones Industrial Average is up 3.5%, but the S&P 500 is still down 1.4% and the beleaguered Nasdaq Composite Index is down 7.6%, despite the gains made on Friday.
Upgrades to our Large Cap Growth & Income models during the past two weeks have served us well, as we have participated in much of the gains in this area. We have also maintained our positions in Small/Mid Cap Value, an area that has continued to outperform the overall market. However, our models still urge caution in the volatile growth area, holding significant defensive positions in the S&P 500 and in the NASDAQ. While it is unproductive to be defensive on a strong day like Friday, it is important to note that for the year we have avoided much of the continued weakness in the NASDAQ, and are slightly trailing the S&P 500. We have been quick to add to positions that we believe offer additional upside, and we will continue to monitor and adjust accordingly. It is and always will be our goal to participate in approximately 80% of the gains of the market, and to avoid approximately 80% of the losses. Over the past two years, this goal has served us well. Once the trend has identified itself and is becomes clear that solid foundations have been established, we will more assertively enter the growth areas of the market.
On the economic front, evidence that the recession may be short-lived continues to flow from Washington. Economic conditions have rebounded sooner than even the relative optimists like us had expected. The best evidence for this is the near-record 26.2% decline in initial unemployment insurance claims (four-week average) from the 505,750 peak on October 20 to 373,250 on February 23. Since most past recessions ended soon after unemployment claims peaked, the recent recession has ended or all but done so. Rises in stock prices and commodities prices add support to this view, and so do most economic statistics reported since December. We still believe that the economic rebound’s pace will surpass expectations in 2002. High debt burdens and other factors will restrain Real GDP’s rise but the extent to which policies have turned stimulative promises a much more robust pace than the 2.3% recorded after the 1990-91 recession. We doubt that the Federal Reserve will raise rates until this fall and expect that low inflation will hold bond yields down even as economic conditions improve. Based on how the stock market has behaved after severe shocks and economic recessions, the stock market should rise in 2002 and 2003. Valuations and Enron-related concerns have restrained the market’s advance in recent weeks but those concerns should fade as the faster-than-expected upturns in economic conditions and profits prove sustainable.