The Second Quarter of 2004 proved to be rather directionless for equity prices. The S&P 500 began the quarter at 1126.21 and ended slightly higher at 1140.84. But underneath the rather tepid market movements of the quarter a few significant trends became clearer namely, rising interest rates and energy prices. More on those two items later.

As I sit to write this letter what best reflects the markets recent lack of conviction has to do with the fact that Wall Street has “great expectations” for corporate earnings this quarter and most investors, institutional as well as individuals, are in a wait-and-see mode as evidenced by the significantly light trading volume. By the 2nd week in August most companies will have reported their quarterly earnings and we shall see if the great expectations are met. My expectations are that the quarterly numbers will be strong but more importantly I will be watching the tone of the guidance remarks from corporations for the 2nd half. Specifically, are they downplaying expectations, or are they holding firm or are they more optimistic based on positive economic trends. If the expectations need to be lowered the markets will be a bit weak in the short term. If they are right on the market will be flat and finally if they are more optimistic the market should rally.

Getting back to the rising interest rates and energy prices… It is beginning to become apparent that the rising energy prices are starting to take their toll on the family pocketbooks as well as beginning to potentially slow GDP growth. The energy markets are volatile and I think it is too early to say that higher energy prices are or will significantly slow growth, but I do think it is fair to raise the suggestion that rising and prolonged high energy prices could affect the “great expectations” for the 2nd half earnings expectations. On the interest rate front, my view is that the market has priced in expectations of gradually rising interest rates. If reality brings rapid increases in rates this too would not bode well for current expectations. As I spoke of in my last letter the phenomenon of the improving economy vs. the unknown also contributed to a rather flat quarter.

What should you expect in the coming quarter (July - September)? More of the same. I expect the markets to continue to be flat to slightly down in the early part of the quarter as seasonally it is a time when many traders and investors are vacationing. In addition the political season is just reaching prime time with the conventions this summer and I expect most investors anticipate a horse race and will not likely be making significant bets early. I continue to feel that the US equity markets are fairly valued and that if current economic trends continue we should have equity prices rising by year end. My rationale for this view reflects the fact that corporate profits are strong, balance sheets are improving, employment and income gains are increasing and valuations have been moderating as stock prices have been flat this year. That being said we will be watching the interest rate and energy price trends carefully for any signs that they are beginning to have a negative impact on GDP growth, corporate profits, or earnings expectations.

Let me conclude by saying that as we discuss trends and market conditions from quarter to quarter here in this newsletter remember that short term trends or snapshots don’t necessarily reflect an accurate “big picture”. The “big picture” remains favorable for equities in my view. My goal each quarter is to give you a “snapshot” of what is happening in the markets and why and to convey some of the issues that we are weighing carefully in our effort to navigate the markets on your behalf.