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Now that war has become an unfortunate reality, we expect the focus of attention of the financial markets will turn to a reappraisal of the economic outlook. To be sure, economic data has not been uniformly positive, and the contour of our economy is changing. Nevertheless, we believe the economy has passed the stress test brought about by geopolitical issues, and has remained on a positive growth track. Absent additional shocks or a prolonged war, economic fundamentals hint at an acceleration of growth over the remainder of the year. Despite rampant pessimism, the U.S. economy entered 2003 on firm ground. Data for both consumer and business spending in the fourth quarter was revised upward, leading to a major revision of 2002 Gross Domestic Product to a 2.8% advance. Reports on durable goods, industrial production, manufacturing, housing and mortgage refinancing, all indicate that our economy sustained its momentum in the first month of the quarter. February not only brought a sharp increase in the rhetoric about Iraq, but natural and human disasters as well. Bitter cold weather in many parts of the country crimped housing activity severely, and the space shuttle Columbia catastrophe added to the sadness. None of the negative pronouncements of February and early March will cause a reversal in the fundamental direction of our economy, in our opinion. Real incomes continue to grow at a healthy pace and consumer spending remains resilient, although not up to the high levels of a year ago. There are indications of cautious behavior by consumers. Credit card debt has plunged in recent months, and the savings rate has increased. As a result, some softness is apparent in retail sales. The higher savings rate also means that debt service burdens of consumers have started to recede from record high levels. If this trend persists, it will also ease worries about mortgage delinquencies, and quiet the unease about the consumer's financial posture. While not high in historical context, unemployment remains the major economic worry in this time of overall prosperity. Unemployment rose in February to 5.8% and the number of people out of work for extended periods continued to grow. Job creation is being restrained by the cautious business outlook and by productivity enhancements. Dramatic changes in some formerly expanding industries, such as airlines, telecommunications, and technology, have resulted in cutbacks and an extra degree of tightness by all businesses. One of the lasting affects of the major advances in productivity in recent years is excess manufacturing capacity and an ability to produce more with less. These pressures will remain, but not intensify. We believe that the large scale cutbacks and restructurings have run their course. Employment over the balance of the year will likely show modest improvement coincident with the rise in business spending overall. Business spending generally is making clear progress in early 2003, after a disappointing setback in the final months of 2002. Business technology spending has actually been quite strong, although pricing is weak. In January capital goods spending jumped 5.4%, a very strong advance. Since then spending has tailed off as business leaders remain reluctant to act on pent up demand. Inventories remain low, however, and the rebound in industrial activity generally is encouraging. We believe business spending is in the early stages of a recovery that will prove to be sharp and sustained upon clarification of the war. It is our view that the United States economic fundamentals are poised for a strong rebound once confidence recovers. Fears of the consequences of war have been the major impediment to a more salutary stock market environment. The road back from the 2002 recession remains slow but steady. Corporate balance sheets have been improved by record low interest rates, rising earnings, and drastic reductions in spending. Households balance sheets have been improving also. Consumer demand is holding up better than many anticipated, a testament more to the natural resilience and optimism of the American consumer than to economists. Business spending is beginning to stir. The rise in the price of oil has not resulted in serious damage to the economic recovery, and inflation generally remains muted. The stock market has yet to respond to the improving economic prospects. We believe that it will. We believe strongly that the potential for high quality stocks far outweighs bonds in this environment. Investment Policy Committee Alfred A. Lagan, CFA, Chairman March 26, 2003 The opinions expressed herein are those of Congress Asset Management and are subject to change without notice. 2 Seaport Lane Boston, MA 02210 www.congressasset.com
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