As a life long Green Back Packer fan I’ve learned a lot from studying one of the greatest coaches, of any sport, Vince Lombardi. One thing the legendary coach was noted for was “Lombardi time.” If a meeting was scheduled for 9:00 then Lombardi time was 8:45. In his opinion, showing up 15 minutes early demonstrated initiative and commitment. That philosophy has always sounded good to me, and it is one I try to follow. Invariably, in today’s hectic world, if an individual follows this schedule he ends up having plenty of time for reflection. Given what is going on in the world today more time for reflection might be a good thing.
Because we are up to our eyeballs in challenges…. There are five forces holding back the equity market thus far in 2004. In the next few paragraphs I’ll identify these challenges and share my sense of what might happen going forward.
Number one – High oil prices… Last week I paid $2.29 for a gallon of premium gasoline. I watched hopelessly as the digital display in dollars raced by in a blur while the gallon indicator crawled at a snail’s pace. Although oil prices may move higher through the peak summer driving months, I do believe that prices will trend down in the second half of this year, as the supply and demand imbalances correct. Moreover, global economic growth should moderate in 2005, which will further ease the pressure on oil prices. In a nutshell, I think we are close to the peak in oil prices.
Number two - Quagmire in Iraq… Plain and simple, Bush needs a break in Iraq. Finding Osama bin Laden would do the trick, and there are rumors that an all out effort to find him before the November election is underway. Even so, whether U.S. Special Forces capture him before the election is anybody’s guess. The point is he will be found or eliminated at some point. The outcome is a foregone conclusion, only the timing remains uncertain. Meanwhile, my gut feeling is that the situation in Iraq will improve before November. Admittedly, I can’t back up this feeling with any empirical evidence, but the Bush Administration knows what’s at stake. It is clutch time, and my bet is they will pull it off.
Number three - Election uncertainty… Historically, a republican in the white house is viewed more favorably by the financial markets but the effect is usually short-lived. With the latest polls indicating a very close race the cloud of uncertainty is unlikely to lift until election time. Still, when the outcome is known the market will discount it fairly quickly, in my opinion. Ultimately, the final result will not be a long-term driving force for the equity market.
Number four – Higher interest rates… The bond market has already discounted that the FED will raise interest rates at its next meeting in June. In fact, over 100 basis points of tightening are already priced into the bond market. Higher interest rates typically depress equity valuations, which is one head wind the market has been battling of late. Longer-term, the more significant issue is what higher rates do to the prospects for earnings growth in 2005. At this stage, despite the fear of inflation and higher interest rates, S&P 500 earnings are expected to increase 18% in 2004 and close to 10% in 2005. From a strategic perspective, bears point to this deceleration in earnings growth as a reason to be cautious. My sense is that once the other challenges are behind us 10% earnings growth in 2005 won’t look so bad. Moreover, nearly one company in three is projected to produce faster earnings growth in 2005 than in 2004. In my view, there is a growing possibility of an earnings driven rally in the equity market, which may be lead by companies that buck the trend by accelerating earnings growth next year.
Number five - Threat of a terrorist attack in the U.S… Alarms bells are ringing loud and clear at the Department of Homeland Security. One Washington insider predicted an 80% chance of an attempted terrorist attack in this country prior to the election. It’s virtually impossible to forecast where and when an attack might occur, or how “successful” it might be. Nevertheless, there are two predictions I am willing to make regarding a future terrorist strike. First, the citizens in this country will rally around our political and military leaders in the event of a terrorist attack on U.S. soil. Second, the support for our leaders will be in direct proportion to the level of devastation caused by a terrorist attack. In my view, if the terrorists want Bush to lose the election the last thing they should do is give the voters a reason to rally around our beleaguered President. An attack on our soil will only strengthen our resolve to finish the fight. As Coach Lombardi said, “It’s not whether you get knocked down, it’s whether you get up.”
Collectively these five challenges may seem particularly formidable. But examined separately, it is possible to envision a better market environment in the second half of 2004. To begin with, I think we have seen the worst in terms of oil prices and the predicament in Iraq. Next, the presidential election makes for interesting press, but it is not a long-term market driver. Meanwhile, higher interest rates are largely priced in to the market already. Lastly, the threat of a terrorist attack is something with which this country has to endure, but freedom and our way of life will prevail. “To achieve success, whatever the job we have, we must pay a price.” - Vince Lombardi
