Capital Markets Perspective June 2003
Capital Market Future Performance
There is reasonably accurate information on all criteria effecting the
investor except the future performance of capital markets, and the
underlying economic factors which influence capital markets. Nevertheless,
there are known factors about the economic environment, the capital
markets and their sectors. When these are evaluated as a mosaic, guidance
is provided on prudent investment decisions. Currently, we consider the
following germane factors to consider in making investment decisions:
- Stock Market Valuation
Having declined markedly from their highs, and considering the
extremely low return on taxable fixed income, stocks currently do not
seem as extremely overvalued as in the late 1999. Particularly those
stocks with yields above the rate of money market funds. This speaks
only to relative valuation. Absolute stock price valuation based on
yields and P/E rations is near historic highs.
Index investing, which proved so successful for 25 years, and is
firmly grounded in finance theory, needs to be reconsidered in the
current environment. Large cap stocks are at high valuation levels
relative to the market, and there is substantial market volatility. We
believe current stock selection should be oriented, without
sacrificing growth prospects, toward dividends, value, and a strong
balance sheet.
- Manufacturer Pricing & Capacity Utilization
There is excess capacity. Producers are unlikely to be able to raise
profits, nor report higher earnings per share. There seem to be few
factors for an immanent increase in demand, which would provide the
ability to raise prices.
- Deficit Spending and Balance of Trade
The federal government has embarked on the creation of a significant
deficit. Deficit spending is a traditional and necessary response to
economic malaise. One side of creating the deficit is tax cuts. The
structure of the cuts is believed to benefit primarily those in upper
income brackets. The tax cuts may not increase consumption. They will
shift the tax burden for ordinary consumers to States and
municipalities. This will increase the deficit while providing only
moderate demand stimulation. If the deficit becomes overly large, it
will cause inflation, and reduce foreign investment.
The balance of trade deficits have reached an all time high, and
continue to grow. While the timing of any affect on capital markets
the trade deficit may have is unknown, it is a time-bomb with the
potential to cause havoc. Currency risk is an aggravating and
corollary factor. While a declining dollar may not directly affect
investors, it will prove to be a disincentive for foreign investment
in the U. S., and cause the trade deficit to increase.
- Foreign Competition
Industrial production has been lost to Asian producers. This trend
will continue, and place continued earning pressure on selected
sectors of the U. S. economy. One of our tests for any investment is
the 'Asian factor' i.e. are the firms we buy susceptible to foreign
competition.
Based on the factors above, we currently estimate the returns for these
sectors:
SECTOR ESTIMATED RETURNS
|
Fixed Income
|
Money Market
|
Corporate Bond
|
Municipal Bond
|
High Yield Bond
|
| Return-base |
4% |
7% |
6% |
9% |
| Year 1-5 |
2% |
5% |
6% |
7% |
| Year 5-10 |
5% |
8% |
7% |
10% |
| Year 10-15 |
4% |
7% |
6% |
9% |
Equities
|
S&P 500
|
High Dividend
|
Real Estate Trusts
|
Master Ltd Partnership
|
| Return-base |
10% |
8% |
7% |
12% |
| Year 1-5 |
6% |
8% |
6% |
10% |
| Year 5-10 |
11% |
8% |
7% |
12% |
| Year 10-15 |
10% |
8% |
7% |
12% |
Background
As long-term investors, creating and managing diversified portfolios,
Davidge & Co., first, and foremost addresses individual client
requirements. Decisions are informed by these criteria:
- Future cash and income needs such as college or retirement.
- Tax considerations, including the evaluation of current and
prospective tax laws.
- Individual client risk preferences and assets.
- Assessment of capital markets future performance.
|
Home
