Flat First Half Offers Few 2004 Clues

We have concluded the first half of 2004 atalmost the same point at which webegan in January. The Dow was down0.2%. The Nasdaq, S&P 500, and NewYork Stock Exchange were up just over 2%. TheSemiconductor Index, down 4.5%, was one of the lessattractive performers, reflecting the continuing malaisein the technology arena. As of the beginning of August,stocks have hardly shifted from these positions.

A few things have changed. Recently, the UnitedStates turned over Saddam Hussein to the new authoritiesof Iraq. The Federal Reserve has finally begun itsmarch to higher interest rates. However, national pollsindicate that the result of the November elections is stillvery much in doubt—a doubt that leaves the economypoised in uncertainty.

Business News Upswing

Netresult:

For certain, the economic news is better than it was6 months ago. Even though the unemployment rate hasn'tbudged much, more workers have found jobs.Business leaders indicate that they intend to slowly addpermanent employees to their work force. As the sharplyreduced cost structures established to weather the recessiontake full effect, many companies are reporting vastlyimproved earnings compared with a year ago. Fewer employees are producing more work. Theeconomists' jargon for that effect is "a dramatic increasein productivity." When emerging from a downturn,companies usually ask workers to work overtime beforethey add new workers—better to have an alreadycovered employee work more.

Federal tax incentives included rapidwriteoffs for the cost of new equipmentpurchased this year. They wereexpected to increase capital spendingfor technology equipment such ascomputers. However, so far, theyhave not spurred as many new purchasesas anticipated.

Consumer optimism is improving.The more secure people feel about their economicfuture, the more likely they are tospend money. New home and new car saleshave remained robust throughout the firsthalf. However, fear that rising interest rateswill cause purchases of these two big-ticket items todecline has kept a lid on stocks in these two sectors.Many housing stocks have recently fallen in value.

Questionable Factors

Why is the stock market lethargic in the face of bettereconomic news? Last year, the argument against investingin stocks over bonds was that corporate earnings didn'tlook very favorable. The stock market went up despite allthe pessimism. Positive corporate earnings reports anticipatedfor this year sent stocks up in 2003, and plenty ofmoney on the sidelines flowed back into equities.

This year, the market is trying to gauge what willhappen next year. Thus far, it has concluded that theoutlook after the election is not clear. Interestrate increases, inflation, the nationaldeficit's surge, the effect of more expensiveoil, and the constant threat of terrorismall contribute to a general airof uncertainty. Who wins the WhiteHouse and what tax policies he pursuesare also looming questions.

In an attempt to decipher what toexpect from the stock market thisyear, I undertook a review quarter byquarter of all election periods since 1950. Ilooked at what happened when the party incontrol changed or when it was reelectedand what the effects of third-party candidateswere. I tried to discern if there wasa quarterly pattern that could be identified.

I couldn't find any patterns in any of the data.However, happily, in 10 of the 13 election years, the marketrose. Also, of the 3 prior down election years, theworst was a decline of only 9%. Armed with a bettereconomy, improving consumer psychology, and a modestgain in the first half, I vote for an up year this year.

Joan E. Lappin is the chairman and chief investmentofficer of Gramercy Capital ManagementCorp, a NYC-based registered investment advisor.Gramercy develops personally managedportfolios tailored to your investment goals.Ms. Lappin appeared in the year-end issue ofBusinessWeek on "How to Invest in 2004." Shewelcomes questions or comments at 212-935-6909.