January 20, 2004The markets remained in rally mode during the 4th quarter of 2003 as genuine confirmation of the economic recovery gave investors the confidence to bid stock prices higher. The strong economic data included a 3rd quarter GDP gain of 8.2%, (fueled by robust consumer spending as well as an up tick in business spending), improved manufacturing data, including the highest reading for the ISM index in almost 20 years, and a decline in the unemployment rate to 5.9%. During the quarter, the S&P 500 advanced 12%, the NASDAQ Composite rose 13%, and the Russell 2000 gained 16%.
Although small cap, aggressive stocks remained strong during the first two months of the quarter, a major shift in market leadership occurred in December. A significant decline in liquidity, coupled with the realization that valuations had become stretched in certain sectors, led investors to rotate out of the high beta stocks which had performed so well all year and into stable growth, reasonably-valued segments of the market. As a result, the best performing sectors during December included Energy, Materials, and Health Care. Conversely, the Technology sector was a laggard during the last month of the year. Most importantly, the Westwood Large Cap composite outperformed the Russell 1000 Value Index in the month of December.
We believe the trend that began in December is likely to continue into 2004 and we are seeing what could be an ideal combination of factors for the Westwood portfolio strategy. Below are these key factors:
The investor preference for high yield/high quality was demonstrated in December as dividend paying stocks in the Russell 1000 Value Index returned 4.8% versus a return of only 4.4% for non-dividend paying stocks - a complete reversal of the pattern seen during much of the prior 11 months. The preference for quality was embodied in a rotation out of low quality, overvalued aggressive stocks and into the stable growers with reasonable valuations mentioned above.
The accelerating growth in the manufacturing sector has been verified by the ISM manufacturing index, which has increased for 6 consecutive months and is now at its highest level in 20 years. Conversely, growth in the ISM non-manufacturing, i.e. services, index began to decline in December. Manufacturing companies were the hardest hit during the recession and therefore had to reduce costs aggressively, as opposed to the service sector that actually expanded during the recession. Now manufacturing companies have a significant amount of operating leverage that translates to good potential for upside earnings surprises.
The dollar's weakness helps the Westwood portfolios in two ways - 1) many of the names we own have significant foreign operations and will see higher dollar revenues from overseas sales, and 2) dollar weakness along with continued strong GDP growth will eventually lead to inflation, and even sooner, will lead to the expectation of higher inflation. This is positive for our portfolios because it leads to higher potential interest rates and slower real GDP growth. Both factors should drive investors into the high quality stocks we own (e.g. energy, health care, consumer staples, materials, REITs).
As a result, we believe our portfolios are well positioned to benefit from a search for high quality and give our clients ample opportunity for investment success. We thank you for your continued support and look forward to discussing our thoughts with you.
The Westwood TeamThis information is provided for clients and prospective clients of Westwood Management and Westwood Trust, hereinafter "Westwood" and their employees. It is not an offer or solicitation to sell securities. The information provided here is copyrighted by Westwood and may not be used without its permission.
