Stocks on steady climb

Stocks continued their steady climb last week with the DOW rising above the 9000 resistance level and staying there. In fact, most indexes have risen above their 200 day moving averages based on the equity markets interpretation of the improving economic picture.

Even though significant advances have been made, our research still shows the S&P 500 is undervalued by 15% relative to our fair value estimate of 1150.  All the major global markets were up last week by over 2% with the German DAX and Japanese Nikkei leading the rise at 4.6% and 4.1% respectively. The volatile tech index NASDAQ, is now up 22% for the year to date, having risen 7 out of the last 8 weeks. The performance makes it the best performing major market index for the year. The S&P is up 12% year to date and the DAX 8.1%. All the major market indexes are now in positive territory on a year to date basis. Of particular interest to us at Investments International, is that Equity Mutual Fund cash in flows, our investment specialty, have risen dramatically and totalled USD 1.5 billion in the United States over last week. Bond funds also saw a good inflow for the week, hitting USD 2.4 billion in the USA. We note that economists forecast US GDP growth in 3rd and 4th quarter this year to be 3.5% and 3.7% respectively, more or less in line with what the bond market is indicating the growth should be via its yields.

 However, the equity markets are ahead in valuation of such growth to the bottom line revenues of companies, indicating that either the US equity markets are optimistic or that the economists predictions are conservative. At this point, we believe that, factoring in the expected United States Federal Reserve rate adjustment downward and the effects (which have yet to be seen) of the Bush tax stimulus plan, the US economy will outperform economists expectations in the 3rd and 4th quarters. Last week, economic news from the US included worse than expected weekly initial jobless claim’s, which rose to a 5-week high of 442,000, up 16,000, in the week ending 31st May. The overall unemployment rate rose slightly to 6.1%. Employment remains the weakest link in the economic recovery. Better news came from the manufacturing sector, with the Institute of Supply Management reporting an improvement in its Manufacturing Index, during May, from 45.4 to 49.4. The Services Index  rose from 50.7 in April to 54.5 in May, more than what economists predicted. Key economic news from across the pond came from the European Central Bank when they cut short term rates by 50 basis points to 2.0%. ECB President, Wim Duisenburg, also hinted that further cuts were likely to help the economic recovery. The Euro responded accordingly falling to less than 1.17 on the US Dollar. The Central Banks in Denmark and Sweden also lowered rates last week.

The Bank of England left the UK overnight rates at 3.75%, thus the Great Britain Pound jumped to a three and a half year high, breaking the 1.66 mark against the US Dollar. Also in England, the Confederation of British Industry disclosed that retail sales had their best month in six months with over 40% of retailers stating sales were up in May. US Corporate governance issues were in the press again last week and early this week with Sam Waksal, President of Imclone getting sentenced on Tuesday after pleading guilty to insider trading charges. Also as a part of the Imclone scandal, Martha Stewart was formally charged for insider trading and lying to SEC investigators on the sale of USD 228,000 of Imclone stock the day before an unfavorable announcement was to be released on the Companies cancer drug application. Looking forward, we continue to believe that diversified growth oriented investors should consider value based equities as a core position with a view to developing holdings in small and mid size capital growth type companies. Sectors we feel will outperform in the near to medium term are Health Care, Financial Services, Consumer Discretionary and Technology. e-mail:darcy@investments-intl.com