Fourth Quarter, 2000

On January 3, one day after a major manufacturing index fell to its lowest level in 10 years, the Federal Reserve instituted a surprise lowering of the discount and Fed Funds rates by ½ percentage point each. This was the first time since 1991 that the Fed eased by more than a quarter-point between regularly scheduled meetings. The NASDAQ over-the-counter (OTC) market surged 14% the same day (its largest one-day gain ever), and other market indices also registered impressive gains.

On January 8, just three business days later, both the S&P 500 Index and the Dow Jones Industrial Average had given back all of their gains from that impressive one-day rally. Only the OTC market managed to hold onto a modest gain over its January 3 low. Clearly, our stock markets have been in a deep funk, with the current stream of troubling economic news continuing to pound down stock prices in most industries.

One of the lessons learned from studying the history of Federal Reserve rate increases and reductions is that once a course of action is undertaken, the Fed continues moving in that same direction with additional interest rate increases or reductions, as the case may be, until the desired economic results become clearly measurable. Thus, we believe it is quite likely that the Fed will cut the discount rate and perhaps the Fed Funds rate again one or more times before the economic downturn plays itself out. These actions are very bullish for the financial markets. Any re-emergence of inflationary pressure during this process will create a huge dilemma for the Fed, however. Should it fight inflation or recession? It is likely that financial markets may experience enormous volatility for the next few quarters while these contradictory forces vie for supremacy.

We believe that the Fed’s January 3 rate cut marks the beginning of the future economic turnaround. Furthermore, today’s worrisome economic conditions have prompted President Bush to move with renewed vigor on his campaign promise for a broad-based tax cut.

The combination of an expansionary monetary policy by the Fed and a fiscal policy calling for tax relief will eventually cause the economy to begin a recovery, perhaps as early as the third or fourth quarter of this year (barring other unforeseen shocks to the system.) The stock market, it should be remembered, is a discounting mechanism and when the pessimism associated with the current bad economic news begins to subside, investors will begin to look ahead to late 2001 or 2002, and the bull market will reassert. The stock market has a well-documented history of rising in advance of an economic recovery and so the worst of the market’s poor performance may soon be over.

Accordingly, we have begun to gradually increase stock market exposure for those clients utilizing our tactical asset allocation services. We are beginning this process in a modest way now, in spite of an increasingly negative current economic environment and extremely high stock market volatility, because it’s not possible to tell in advance when market psychology will switch back to optimism from its present pessimism.

This is a time when one’s investment philosophy guides the decision-making process. We manage your investment portfolio from a long-term growth perspective. Today many stocks are attractively priced and we believe actions are being taken to improve long-term growth opportunities. Short-term traders may disagree with this approach, preferring instead to wait for clear signs of a turnaround from either the market itself or the economy before jumping back in. We welcome your thoughts on this question.

Good riddance to the year 2000!

The OTC market ended the year with a decline of almost 40% - the worst 1-year return since the Great Depression. This market has now given up all of its gains for calendar year 2000 and has declined back to the level it last saw in June 1999. All three major stock market indexes posted losses for the first time in 10 years. Also, 47 of 62 primary markets around the world dropped for the year in dollar terms. When our domestic stock market sneezes, the rest of the world’s stock markets catch a cold.

Last year was the first time since 1990 that bonds outperformed stocks. Our decision to maximize client bond holdings as far back as 1999 has benefited accounts in this regard.

During 1999 and early 2000, it had been "common knowledge" that the technology sector was virtually immune to the business cycle. This thinking was largely responsible for the continually rising P/E levels of the majority of the tech sector stocks. It was the growing economic slowdown precipitated by six Fed rate increases last year that instead proved just the opposite. The truth is that the tech sector is one of the most cyclical areas of the economy. We have used the significant pullback in tech stock prices to reposition client accounts for strong growth ahead of the next recovery. We continue to gradually shift money into stocks that are profitable leaders in their respective fields of expertise, and most client portfolios continue to have an overweighting in the tech sector.

For now, we’re keeping a vigilant eye on the Fed, the Congress, and President Bush’s unfolding policies for dealing with the slowdown. We believe our new President is strongly "pro-business" and client accounts are now appropriately positioned for current market conditions and future improvement in the economy.