Round Trip

Last Friday the market fell by over 200 points amid cries from Wall Street analysts that earnings and revenues were light. Citigroup, GE and other heavy weights had small earnings or revenue miscues of one sort or another. I said it was too early to bury stocks for 2006 on the basis of so few earnings reports, especially when hundreds of reports were due out this week. Just as I guessed, the earnings reports this week have been good to great and stocks have retraced most of last Friday's loss. A few companies have again been a bit light in revenue, but as Mike Hull, our president, said, "The light revenue might be coming from companies holding back a bit of business for next quarter, especially if they already their earnings in the bag." Today's GDP report came in at growth of 1.1%. That was under the estimate of 2.8% for the quarter and will be the subject of the media's worries this weekend. Let me say again. I would not get too hung up in this number either. It will be revised two more times, and I believe it will end up higher. In any event, auto sales were the biggest contributor to the weakness, and I believe that is due to the hangover effect of the "deep discounting" all the domestic auto companies did over the summer. GDP is volatile and I expect it will pick back up in the next few quarters, although, as I said in our December quarterly letter, I expect the economy will slow in the coming year to near 3%. Stock prices are a function of the dance between earnings/dividends and interest rates. I have been saying for a while that a "don't fight the Fed" mentality was probably the main reason that stocks were flat in 2005 in the face of great fundamentals. For this reason, a weakening economy may well be good for stocks, even if earnings and dividends grow at a slower rate. Slower economic growth would allow the Fed to go to the sidelines sooner, allowing stocks to be valued more on their fundamentals alone and less on how high or far the Fed will push rates. I still think stocks in general are between 10% and 15% undervalued. Remarkably, some solid blue-chip growth companies, as I have detailed in recent blogs, are 20% to 25% undervalued. Hang in there, if you take a long-term investment strategy and combine it with high quality companies with long histories of dividend increases, it is hard to lose. As I told a client today, I don't know when the 10%-15% valuation gap will be closed, but I don't think it is wise to bet against it. Moreover, stocks spend very little time at "fair value." When the gap closes, I would not be surprised to see an overvaluation gap occur. But, then let's fret over that later? Blessings,