Half-Time Report

With the stock market recently reaching new highs (THOR clients were at new highs back in May of 2003!), we thought it would be a good time to take a step back and review what THOR’s expectations were for 2007 and where we are today. In our newsletter dated December 21, 2006, we thought that the stock market would perform well in 2007 for several reasons.

• The stock market is not expensive with the market selling at about 17x earnings. The stock market (as measured by the S&P 500) is still selling at reasonable levels – 18x past year earnings, 16x forward year earnings. However, there are pockets that are overvalued – emerging markets, REITs and small company value stocks – which we significantly underweighted in client portfolios.
• The supply of stock continues to drop. Just last week Home Depot announced a $22.5 billion stock buyback. This represents more than 25% of the company’s outstanding shares! There has been over $1.1 trillion of merger and acquisition (i.e., Caremark, Florida Rock, Oakley, etc.) activity this year, $315 billion in private equity deals and over $110 billion of company share repurchases. Excess regulation has also contributed to the reduction in the supply of stock. In 2006, Wall Street only had 7.2% of all initial public offerings world-wide. This is down from 50% in 1999. Due to the recent profitability of private equity firms, Congress has suggested taxing them at a higher rate. We will watch this closely over the next few weeks to see if anything passes that could slow the rate of privatization or company buybacks.
• The Federal Reserve will not be raising interest rates anytime soon and may in fact reduce them in 2007. At least we were half right on this point. Bernanke is a much different FED chairman than Greenspan. Bernanke tells you what he is actually doing instead of Alan’s “Greenspan speak” where he would have two countervailing points in one sentence. We believe Bernanke when he says he is holding interest rates at the current level. With many commodity (oil, natural gas, gold, etc.) prices at the same level or lower than a year ago, we believe the risk of rising rates by the Federal Reserve to be very low. On the other hand, we now believe that there will NOT be a rate reduction this year. We believe this is now built into the market with the rise of long-term rates over the past few weeks.
• Company earnings are very good. Company earnings are still robust. However, we do expect a slowdown from the previous two years. We expect earnings growth to be in the high single digits (8%-9%) instead of double digits. The economy is strong and multinational companies are better able to compete internationally with the dollar’s fall in value over the past few years. This will keep earnings strong over the remaining part of 2007.
• Inflation is moderating with expectations dropping considerably due to lower energy prices and weaker final demand. Inflation has been moderating over the past 6 months. Crude oil is at the same price level it was at the beginning of the year, while other commodities, such as gold and natural gas, are actually lower than where they were on January 1, 2007. The only commodity going up measurably in value has been corn, which is up 10% since the beginning of the year (but down from being up 20%just a few weeks ago!). We expect this moderation of prices to continue throughout the rest of the year.
• During the third year of the presidency, the market tends to do very well (1995, 1999, 2003, and 2007?). As Congress and the President bicker and remain at a stalemate, no major legislation should go through that will hurt the economy. We think this trend will continue and the market will do well throughout the remainder of 2007.

After the recent run up in the market, we will not be surprised to see a little bit more volatility over the next several months. It is normal and healthy for the market to have some down days. However, you need to look through the daily noise to see the real reasons for the market moving higher. We think that the overriding reason for the market’s rise in 2007 is the drop in supply of stock available to the public. We need to remember a basic economics principle – if supply drops and demand remains the same, prices go up. If demand rises too, prices rise even greater.

For a football analogy (we apologize to those few clients that aren’t football fans), you have to play both sides of the ball, offense and defense. We believe that over the next several months, it is time to play offense. Next year, given the presidential election, it may be time to play defense and protect some of the gains we have made over the past four years. Stay tuned.

THOR’s New Home

Thanks to the tireless efforts of Jenna and P.J., we moved into our new building on June 1st. If you are in the neighborhood, please stop by for a tour. 7346 Beechmont Ave.

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The purpose of the newsletter is to help educate and inform our clients on matters we think are important to them. However, we might be overlooking some topics that may be important to you. If there is a topic that you would like us to cover, please e-mail Jim at jgore@thorinvestment.com.