Rational Investing: Ignore media negativity; take common sense instead

Clark Davis is a 34-year investment veteran and CEO of St. Louis Investment Advisors, a specialized money-management company.

Skip the next four paragraphs if you truly believe network financial reporting and/or political party spin.

It hasn't been that many years ago that economists established, and the general public accepted their guideline, that 6 percent unemployment was considered full employment.

What's changed? Best guess would be the old culprits, the media, at work, still preferring to put a negative spin on the economy. And using the media, like professional musicians play their instruments, are the politicians especially those not in office, but wanting to be.

In an earlier column we addressed the fact that unemployment figures are lagging indicators, a point known by even the greenest economist, and one that should be known by any media professional, but especially those covering the economy and markets. Funny, clients and readers know that, why not the media mavens? Or do they know that and show a bias in their reporting? Nah, they aren't biased they have told us so themselves.

So, let's use a dose of common sense in talking about unemployment and why it is a lagging economic indicator. American productivity has steadily improved over the past decade, meaning more products and services are being provided by fewer workers. That has been a trend necessitated by competition from nondomestic producers and deflationary pressures in which companies have had little pricing flexibility. Underlying all this has been the cutback in capital spending in the period of the recession, a situation that occurs in every economic cycle, although liberals would have us believe that it is a problem caused by conservatives' policies. (That's as far as we'll go into that discussion this time around.)

When will employment pick up? Not until corporate sales and profits expand on a consistent basis. Such expansion is already here, although a couple of quarters are not enough to establish a well-defined trend. However, both statistical and anecdotal evidence strongly suggest that third-and fourth-quarter Gross Domestic Product the value of all goods and services is accelerating. The naysayers are shaking their heads and doubting the sustainability of the growth of the economy. That has always been the attitude among many in the early stages of a recovery.

Here's how we believe improved employment will come about: First, inventories have to be rebuilt, as companies depleted them during the uncertain time resulting from the convergence of the terrorist attacks and the then nascent economic slowdown. Increased productivity will allow companies to accomplish the early stages of that rebuilding.

Beyond that point, with corporate capital spending increasing and consumers continuing to spend (thanks in part to having more cash as a result of the tax cuts), sales will increase. Then profits will improve, providing the impetus, financial capability and need to increase employment.

The result in 2004 is likely to be unemployment below the 6 percent once deemed full employment. Our estimate is that it will fall below the 5.9 percent bandied about by the more nervous economists.

What does that mean for investors? Bear in mind that that is a macro view or, as Wall Street refers to it, a "top down" analysis. While we don't ignore it, recognizing that it can have a psychological impact on many market participants that are sometimes irrational, we prefer the "bottom-up" method of selecting investments. That calls for looking at individual companies that meet our screens for both fundamental and technical attractiveness, which we have written about often.

We prefer that method of investment selection for two reasons. One, it recognizes that, even in bear markets, there are opportunities for investors in properly selected equities or bonds. Two, it works for us and our clients and has for over 34 years.

Here are a couple of examples: In the recession that many read as an all-encompassing bear market, both long-term government bonds (the highest quality investment) and housing stocks provided investors outstanding returns. So, while those who either lost money in the tech bubble or were scared off by the media recession drumbeat failed to participate, those two investment areas paid off handsomely.

It took some common sense to analyze interest rate trends, housing starts and home builders' profitability, but it didn't take a lot. Nor did it take genius to recognize value in dividend-paying stocks, but for years they were dismissed by many as stodgy investments.

Look for 2004 to be an I-told-you-so year, when portfolios consisting of stocks of fundamentally solid companies outperform the broad equity market averages and the bond market total returns.

We have been through the worst; look for a better overall investing environment, but don't let the media prattle sway you. And don't let them lead you into fighting the last war investing in what was hot. It's better to use 10 minutes of common sense than to listen to a hundred hours of network negativity and hype.