January's Sputtering Offers Uncertainty

Physician's Money Digest, February28 2003, Volume 10, Issue 4

What is there to say aboutthe month of January?The new year roaredonto Wall Street as the Dow explodedon the upside during the firstweek of trading. Having closed 2002around 8341, the Dow was all theway up to 8896 by the 13th of themonth. As quickly as it rose 500points, it lost the gain and more, hittinga low of around 7800 by January31. Street talk turned to a revisit ofthe October lows when the Dow hitaround 7500. Talk about a rollercoaster, there's no need to take thekids to Great Adventure (PKS) for aride when you can lose your stomachjust watching CNBC-TV.

The markets began moving higheras talk about a rebounding economycoupled with positives on PresidentBush's tax plan and the cessation ofdouble taxation on corporate dividends.Currently, earnings are taxedfirst by the IRS, and the remainingearnings after tax are paid to investorsand taxed again on the individuallevel. The thinking behind the eliminationof double taxation may be thatit will change the way corporationsraise funds to expand their business.

Some economists believe that thisadjustment may effectively changethe system in the manner in whichcompanies manipulate their earningsto show higher stock prices. You reallycan't blame corporate executivesfor wanting higher stock prices.

EARNINGS VS GROWTH

We live in a world where consumersand investors alike wantresults now. The tax system duringthe 1980s favored the use of debt.Corporations would raise fundsthrough debt offerings, use thosefunds to expand their business, andthen pay high yields to institutionsand large investors for the capital.The interest on the debt paid toinvestors is tax-deductible by thecorporation. But dividends paid onstocks are not tax-deductible.

Now, growing earnings throughdebt issues may be fine in an economicworld where companies areearning high double-digit returns,and the spread between earnings anddebt issues is comfortable, but notnow. The game has changed. In thepast, companies focused on growingtheir revenues quickly and pushingtheir stocks up through mergers andInternet-related activities.

STABILITY IN STORE?

But when growth slowed, thecompanies had to continue payingthose high debts. Thus, the majorityof the overleveraged companies gotinto trouble. Their stock prices fell,and in some respects, that failurebecame a self-fulfilling prophecy.Debt holders used covenants to protecttheir interests, thus pushing companiesinto bankruptcy quickly andwiping out the existing shareholders.Once the public shareholders werewiped out, the debt holders (in mostcases, small groups of large investors)converted their debt into equity andthen controlled the company. Mostof the larger bankrupt companies ofthe past few years had good businesses,but too much debt.

If using dividends to raise capitalchanges the system, some economistsbelieve this would create amore stable environment. Companiescould base their dividends ontheir free-cash flow, earnings, andincreased growth. If business slowed,the dividends would be reduced oreliminated as needed. The IRS wouldtreat the payment of dividends morefavorably. So a stable stock price anddividend would be rewarded. Makessense to me, but are logic and economicsense really used in creatingtax law on Capitol Hill?

POLITICAL MARKET FACTORS

Meanwhile, talk shifted from dividendsto geopolitical events. Thedrums of war continued to beat louder,stock prices fell, and oil and goldrose. Foreign investors sold dollarsand dollar-based assets. Gold futurestopped $365 and are rapidly approaching1996 highs when theybriefly touched $383.20, according toHaver Analytics.

Freemarket Gold and Money

Report

Gold has been rising. Severalmarket players expect it to reachover $400 and beyond. James Turk,editor of , predicted that gold wouldreach over $430 by the end ofFebruary 2003. The gold stockssuch as ASA Ltd (ASA) approacheda new high, near $42. NewmontMining (NEM) rose above $11.

THE WEIGHT WE CALL OIL

The threat of war on 2 fronts, Iraqand North Korea, also continues todominate trading desks as marketsswooned on every piece of news, trivialor not. Oil prices jumped on problemsin Venezuela and war jitters. Butas the price of oil has gone up andyou and I pay more at the gas pumps,oil stocks haven't seen similar rises. Infact, some oil stocks are bumpingnear bottoms. Exxon-Mobil (XOM)slid down about 30% from its earlierhighs near $50. Conoco-Philips(COP) took a significant dive from itsearlier $64 yields. Marathon (MRO)also took a slip from its earlier high of$30. However, these companies allexperienced increases in yields. Try tofigure that one out.

SOME GLOOMY SENTIMENTS

Despite the yields on stocks growingas stock prices decline, and favorablenews on dividends, apathy continuedto be the preferred philosophy.January ended on a sour note withthe Dow closing down to 8053.81, off287.82 points or roughly 3.5%.Major blue chips followed the Dow asnames like IBM, Verizon (VZ),McDonald's (MCD), General Electric(GE), Wal-Mart (WMT), Sears(S), and Microsoft (MSFT) all fell.Smaller stocks didn't fare well as theNasdaq fell more than the Dow.

Short interest continued to growas bears continued to believe that themarkets and the economy would continueto decline. In this present environment,investors are frightened,fear has taken hold, and the sun willnever shine. To top this all, a nationaldisaster has occurred. The ColumbiaSpace Shuttle has been lost, breakingup during reentry. This disaster maybe yet another factor leading to bearishfeelings in the markets.

Despite the negativity, investorsmay be wise to look back at history.Fortunes have been made in theface of fear. Investors should keeptheir powder dry and use a dollar-cost-average approach as the marketsget a sense of direction fromthe potential war in Iraq.

Ernest Caponegrois a New

Jersey-based registered representative

affiliated with First

Montauk Securities, member

NASD/SIPC. He welcomes

questions or comments at

888-786-9507. Any opinions expressed are

the author's and do not necessarily reflect

the opinions of First Montauk Securities or

those of its officers, directors, or affiliated

registered representatives.