Letter - January 2003

 

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ZIGZAG

If the world would only stop for a few days there would be no problem getting this report out on time. Three times, we have had to "stop the presses" when overnight news destroyed our line of thought. Although we have in our thinking a bullish bias, we were not prepared for the explosive performances (up) of the stock market in the first week of trading in the new year. Investors are so starved for good news that they are prepared to overlook negative economic data. However, we believe (near term) the market will be under the influence of political events rather than economic ones.

On the political front, there are five roadblocks, which could destroy investor's hopes. In Venezuela, a six-week general strike against the government has cut that country's oil production from three million barrels a day to 300,000. Although OPEC has said it would step into the breech, the loss of Venezuelan oil (which counts for 15% of our imports) has caused a spike in the oil price from the mid-$20's to the low $30's. This could not have come at a worse time for the American economy, which is struggling to gain upside momentum. A fuel price increase is the last thing the airlines need.

The four other problems are Iraq, the Israeli-Palestinian Conflict, North Korea, and bin Laden. If someone could bring in bin Laden's scalp, it would be worth 1,000 points in the stock averages. As for resolving the others, let us hope that President Bush can pull off the hat trick. Today, our outlook, not only towards investing, but also towards our daily life, is influenced by political events over which we have no control. On the New York Stock Exchange, volume has fallen sharply, as buyers and seller prefer to sit out the "dance." No wonder, for the market is swinging like a pendulum. Tax cuts one day, President Kim the next.

There is light at the end of the tunnel (!) coming from a votive candle lit in the hopes that Fed Chairman Alan Greenspan's old fashioned economic religion still works. Its dogma being that low interest rates and a plentiful money supply can deliver us from economic purgatory. With patience, it has always worked in the past. However, today we are faced with a new devil, the declining dollar. This should help American exporters, but could be a depressant on our financial markets as foreigners decide to repatriate their money. The withdrawal of funds should be gradual though, as the underlying strength of the American economy and the stability of our political system keep our country the world's "safe haven." Keep your eye on the gold price, and take that European vacation sooner than later.

Most bulls and bears agree that October saw the bottom of the bear market, but opinion is divided on where we go from here. We also believe that the bond market topped out the last week in December, so probably the bond party is over. This should again favor investors seeking income as interest rates rise. Consumer spending, which has been the life support of the economy the last two years, appears also to have peaked. Although stocks are not cheap on earnings multiples, stock prices have come down drastically. Low multiple stocks should prove profitable, affording a margin of safety. So, for starters, we list five stocks, which should out-perform the market in 2003.

CANNED VEGETABLES and fruits are not as exciting as PC's. However, the canned food business is stable, in fact so stable that there has been mass exodus from the business. In fact, today, there are only three major canners left: SENECA FOODS ($15), DEL MONTE FOODS ($8), and Chiquita ($14.70). After many years of intense competition, the lack of same is now permitting the above to raise prices…. and profits. Selling at less than ten times earning, the first two are our picks. They could even, possibly, turn into growth stocks. Downside risk, almost nil.

CIT GROUP ($20). This old-line commercial lender was sold last year in an IPO by owner TYCO at the fire sale price of $23. Since then, the shares have declined even more as loan quality concerns have dogged the company. Nevertheless, at 6.8 times estimated 2002 earnings of $2.93 and a 15% discount to its book value of $22.49, the stock looks cheap to us. A better economy resulting in improved asset quality should expand the earnings multiple significantly and, if you can ever buy a financial stock under book value do it.

NVIDIA ($12.50). This maker of advanced video semiconductor chips for PC's and video games such as the Xbox, sold by Microsoft, has seen its share price collapse in the last year from $70 to as low as $7, as a result of a delayed new product launch and the bear market. However, the company has remained profitable throughout the downturn with earnings estimates of $0.70/share for the year ended January 2003. A new product launch early this year coupled with economic recovery should make NVIDIA a strong performer.

MARATHON OIL ($21.50). Oil and gas stocks look especially well positioned to gain in 2003 when higher oil prices may prove less vulnerable to decline than widely expected. The world supply balance is tighter than it has been for decades, while the stock price for a well-established producer like Marathon Oil is little more than half its commodity value. In addition to making most of its profit from producing natural gas and oil, Marathon is a major supplier of refined products in the U.S. Midwest where profits have been down from two years ago, but now are on the rise again. The smallest of the "major" oil companies, Marathon is also an attractive target for acquisition by a giant. The $0.92 dividend (4.25%) helps make the waiting worthwhile.

PREFERRED STOCKS are the stepchildren of the financial world, neglected. However, their price stability has well served farsighted investors who included them in their IRA's and pension funds. When ten year treasuries were yielding 3.57% in mid-December, Public Service Electric & Gas, New Jersey's largest utility, issued, at par ($25), a 8.45% cumulative preferred stock, callable in 2007. It is only rated BBB, but its parent stock trades on the NYSE at $30 with earnings estimated $3.50/share for 2002. (Our experience is that the rating services are too severe on Preferred stocks). Anyone interested in income should consider this group. Ask us.

 

Philip Herzig


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