The movie Eve’s Bayou is about life’s intriguing misperceptions, false
hopes and misdirected innuendos. You don’t have to see the movie to
understand the analogy to the stock market. Once you discount the
voodoo incident—and perhaps agree that voodoo economics is a misnomer
— you may realize the need for a reality check in the stock market.
Facts are much better than all the noise.
First, the United States is experiencing an economic slowdown, the
recognition of which occurred ever so quickly at the end of 2000. The
machinations of this slowdown are now unfolding. Currently, there are disagreements about the
depth and breadth of the slowdown, but there is general consensus that the U.S. economy is headed
for a hard landing — 0-2 percent gross domestic product (GDP) growth for 2001— rather
than a recession, represented by 2 quarters of negative GDP growth. Just as we had global growth
from 1996-2000 (despite the 1998 Asian setback), we now see global slowing, the first such coordinated
slowing since the 1970s. The reality is that slower growth must, by force of the global
interconnectedness of economies, affect the bottom line of corporations everywhere. The correlation
between economic growth and profitability is at stake. The reality is that profitability, or the
lack of it, lags economic growth in almost all cases. When economies slow, profitability falters.
When economies grow, profitability returns, often slowly.
Second, in the stock market, profitability means earnings. At the end of the first quarter, consensus
estimates went negative for the year (-0.5 percent). This is the first published indication that
we are experiencing a profits recession. More hopeful is the fact that 2002 estimates were revised
upward to 17 percent, but this trend needs vigilance to make sure we do not have a prolonged
downturn in corporate profitability. In short, the economic recovery cannot happen quickly.
Third, despite the economic and earnings downturn, there are pockets of fundamental earnings
strength, but none of these pockets are in "popular" sectors, like technology-media-telecommunications
(TMT). The focus should be on energy, basic materials, consumer staples, financials and
utilities. We face this quandary on a daily basis, given that we have a sharp focus on natural
resources and gold while at the same time holding fundamental analysis in high regard. When
applied to the S&P 500, the facts are hard to fight. TMT sectors are collapsing fundamentally
while the defensive sectors — especially staples, financials and utilities — are gaining ground.
Investors thinking that interest in these latter sectors is a result of disappointments in TMT may
be proved wrong as the economy continues to falter. The growth in energy earnings continues to
impress. Wall Street, we believe, is late to realize the strength of underlying fundamentals in this
sector, especially as oil and gas prices stabilize in the face of strong discrepancies in supply/demand
equations.
And fourth, we remain sanguine about America’s ability to return to profitability. Despite the pervading
negativity, there are indications of future strength. Consumer confidence appears to be
holding up. Auto sales are not off as sharply as one might assume. Beneficial policy decisions are
lining up: a tax cut, lower interest rates, possible repeal of the death tax and a lower capital gains
tax.
Finally, we are well positioned to respond quickly to market rotations, whether or not they are to
deeper value or to higher growth. We suspect that the market is aligned more to the former than
the latter in the foreseeable future.
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Investment Professionals 
