Economic and Social Outlook (Archive)
ECONOMIC AND SOCIAL OUTLOOK: October 2001
Stock Market Overview
During the first week of market trading after the terrorist attacks, we sent you by fax, post or email a piece summarizing the results of an analysis done by Ned Davis Research and published in the September 15 issue of Barron’s. Davis’ analysis reviewed political shocks to the market dating back to 1940 (Pearl Harbor, JFK assassination, Cuban Missile Crisis, etc.) to see if there was a pattern to the market’s behavior. He found that a) the market consistently overreacted to the downside and b) the average time it took the market to recover from the decline was one month. As we write these comments on October 11 at 10:35 AM the S&P 500 is trading at 1092.13. It closed on Sept. 10 at 1092.54, so the pattern has held once again.
In our September 18 missive we noted that such a pattern would be consistent with our understanding of market psychology and its tendency to overreact in times of great uncertainty. Based on this understanding and our assessment of the valuations present in the market, we have been net stock buyers in the weeks following the attacks. While we have sold or trimmed a very few positions that were vulnerable to current events, we have done more buying and across a broader range of names. We’ve bought shares we believe to be very attractively priced and which give us expanded ownership of some of the best-run, most vibrant companies in the world.
That the market has recovered from its sharp decline after the horrific events of September 11 should not be taken to mean that we’re out of the woods. Great uncertainty remains and continued volatility should be expected. But given that the post-attack slump began after the stock markets had been declining for almost 18 months, it’s hard to see the post-attack sell-off as the beginning of a new sustained decline. More likely the attacks triggered the sort of panicked “selling climax” that characterizes the final phase of a market decline.
As we have said before, extremes of sentiment are contrary indicators of market direction. We follow various indicators of investor sentiment and they are almost unanimous in their extreme pessimism. Perhaps the most notable sentiment indicator is the current level of money market holdings. Weighing in at $2.14 trillion, money market holdings (cash) as of September 11 represented 21% of the total market value of common stocks traded in the US. That is much higher than in the ’98 Asian Contagion panic and higher even than during the recession of 1982. That cash hoard represents a huge reserve of buying power, which following the Fed’s interest-rate cuts is now earning a paltry 2.3%. As recent market action indicates, it doesn’t take much to get some of that cash put to work in stocks.
2001 Major Market Performance3nd Qtr. % chg.
1st 9 months % chg.
Value Line (price change only)
Russell 2000 (small capitalization)
S&P Mid-cap stocks
Lehman State Gen l Obligation (G.O.) Municipal Bonds
Lehman Gov t/Corp. Intermediate-term Bonds
Though the full extent of the terrorist attacks’ impact on our economy isn’t clear, we do believe that its net effect will be to change the shape, if you will, of the current economic slowdown and recovery. Before the attacks we anticipated a slowdown in the economy but not a recession, followed by a possibly tepid recovery. The attacks will almost surely push the US economy into a recession, defined as two consecutive quarters of declining GDP. That said, the powerful stimulus being applied through Federal fiscal (govt. spending) and monetary (rate cuts) policy suggests a much stronger recovery than otherwise would have occurred. So where we previously expected a shallow decline and fairly gradual recovery (think a very short, wide “U” shape) we now expect a “V”-shaped recession and recovery.
Specifically, we believe the attacks have “set the clock back” by about six months in the economy. Where we expected a recovery in the fourth quarter of 2001, we now look for recovery during the second quarter of 2002. As noted above, we expect it to be far more robust than previously anticipated.
As the stock market looks ahead roughly six months in pricing shares, a recession in quarters three and four of 2001 is not particularly relevant to the stock market going forward. That was already baked into the pie. The market now is looking to the second quarter of 2002, which is why it has lifted significantly off the lows reached on September 21. The market expects better times ahead.
The key risk to these expectations is geopolitical in nature. Further terrorist attempts are all but certain. The possibility of a widening military engagement in the Middle East is another wild card. But the emotional impact of any such future events, their effect on what Keynes called the “animal spirits” of consumers and businesses will almost necessarily be less than that of the September 11 attacks. It is very unlikely that we will be shocked again as deeply as we were that day.
What We’re Doing
As noted above, we’re buyers at current levels in the market. While we are not raising our target levels for equity exposure, the decline in stock prices requires us to do significant buying to get back up to those targets. That’s what we’re doing. We like a lot of names in technology, financial services, consumer cyclicals and several of the “growthier” healthcare names. And we’ve pared back exposure in a few names that are indirectly vulnerable to a slowdown in travel spending, which we expect to recover but slowly. Happily, we’ve had no direct exposure to the airline, travel and lodging businesses that have been hit so hard.
We are maintaining our fully invested position with bonds and stocks representing 95% of total portfolio value. We are keeping our equity-exposure targets for the Aggressive Balanced and All-Equity accounts tilted positively towards stocks and the targets for our Balanced and Conservative Balanced accounts in a neutral posture vis-à-vis the stock market. In most cases, getting portfolios back up to these targets requires buying stocks.
Trillium Asset Management continues through dialogue to press The Gap and Enron to endorse the CERES Principles. CERES stands for the Coalition on Environmentally Responsible Economies, an organization co-founded by our President and CEO Joan Bavaria in 1989. Joining CERES means endorsing the ten CERES Principles, one of which includes the publication of an annual standardized corporate environmental report.
CERES recently released the Green Hotel Best Practice Survey, a conference planning tool that businesses use to communicate their environmental preferences to the hotel industry. Companies that have committed to using the Best Practice Survey for business travel and hotel services include General Motors Corporation, Aveda Corporation, American Airlines, Bethlehem Steel and others. CERES’ godchild, the Global Reporting Initiative, recently received a $950,000 grant to fund research and development of a standardized approach for companies to share information on HIV/AIDS policies, practices, and programs. The extractive and itinerant-worker industries of mining, forestry, agriculture and ground transportation will be the initial focus for the project.
Trillium Asset Management has continued to lead dialogues with Citigroup and Morgan Stanley. We are working with both banks to help ensure that they incorporate environmental and human rights criteria when they lend money or underwrite a company’s stock or bonds. Citigroup has made progress in publishing an expanded environmental and social report this year as well as giving Trillium Asset Management and our dialogue partners access to top management of the bank. Morgan Stanley has pledged to unveil several new initiatives in November.
On the issue of AIDS epidemic in southern Africa and other developing countries, Trillium Asset Management has written to several of the major drug companies. We are joining the efforts of other concerned shareholders in lobbying the pharmaceutical companies to ensure that their life-saving drugs for AIDS and AIDS-opportunistic infections are accessible and affordable to all those who require them.
Trillium Asset Management clients have co-filed a proposal at Whole Foods Market that asks the company to indicate on its private label products whether the food contains genetically engineered ingredients.