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Edgewood Management Company

VIEW FROM EDGEWOOD



ECONOMENTS

Edgewood Management Company
January 7, 2004

The stock market closed its first positive year of the twenty-first century with a flourish. December was strong across many areas, with classic early stage growth sectors such as technology and media acting well. For the first time in the memory of many investors steel and coal stocks performed strongly at the same time. The financial markets began 2003 with very subdued expectations and fear of the unknown as the war in Iraq erupted, and ended with widespread optimism among investors. By October it was evident that the massive fiscal and monetary stimulus was finally accelerating the economy with an 8.2% GDP growth rate reported for the third quarter. While this was unsustainably strong, all indications are that fourth quarter growth could come in around 4%.

Capital spending as evidenced in the demand for technology is showing strength, although much of this demand in 2003 was for consumer products: DVD and MP3 players, digital cameras, home networking and digital televisions. Spending should stay strong in 2004, but marginal growth will come from corporate network upgrades, the long awaited PC replacement cycle, demand for telecommunications gear for VOIP services and wireless infrastructure upgrades and expansion.

Media stocks are anticipating several positive forces in 2004. The elections, where every cycle sees more money spent on advertising, as well as the Olympics, are biennial recurring factors. Cable television system operators should start reaping the benefits of their system upgrades as digital cable gets rolled out and cable modem access reaches critical mass. Newspaper publishers should start seeing growth in help wanted advertising, an important part of their advertising revenue.

The strength in steel and coal stocks reflects the anticipation of continued demand from China. The Chinese are rapidly developing their infrastructure. While they are the second largest steel producer, they import so much steel they are actually decreasing worldwide supplies. President Bush lifted steel tariffs in November; their impact had lessened considerably as steel prices have climbed around the world. Most of China’s power is generated by coal burning power plants, and they are importing increasing amounts of U.S. coal. While this is not good news for the long-term health of the environment, it has strengthened another struggling U.S. basic industry. While Edgewood does not invest in these heavily cyclical companies, we certainly do take note of what industries are doing well as the economy moves through the business cycle.

Talk of deflation has stopped and speculation now centers on when the Federal Reserve will raise rates. We think they will delay any action as long as possible this year, instead preferring to see the economy become much firmer and to avoid getting tangled in election year politics if at all possible. The long end of the bond market will remain volatile as the economy strengthens, yet the yield on the ten year Treasury note has declined from its late summer high even as the economic news has gotten better.

This is a Presidential election year, and while political news will be prominent in the second half of the year it should have a minimal impact on the financial markets. Short-term economic policy will not change regardless of the election outcome, and any impact from major changes in fiscal policy or monetary policy after the election will not be fully felt until 2006. We think this should be a good year for the markets and the U.S. economy. We hope it is a happy and prosperous year for you and yours.


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