Second
Quarter Update and Launch of Arnold Capital Management
As of April 1st, Sullivan Wood Capital Managementofficially launches as a registered investment advisor based
in Washington DC. This change offers clients the opportunity
to base their investment strategies and portfolios on a fee
basis, removing the inherent conflict of interest with a commissioned
structure. This change also offers a lower cost structure,
increased investment opportunities and the ability to create
more powerful and ultimately rewarding portfolios. However,
this new structure does not change the current difficult investment
climate as geopolitical concerns and the economic environment
continue to challenge the best of investors. After coming
off the largest stock market bubble ever, we are continuing
to work off the excesses of this mania and are beginning to
build a base in the equities market. Warren Buffet said it
best in his most recent letter to investors, "The hangover
should be in proportion to the binge." As we work off
the mother of all hangovers we need to position ourselves
for the next true growth opportunity, which may take a few
more quarters to work through but we are beginning to see
positive signs of a recovery.
The quarter ending March 31, 2003, ended
in similar fashion to this same quarter last year. The SWCM
composite index was up 1.5% while the S&P was down 3.8%
and the NASDAQ Comp. was up .01%. I am proud to say, that
the SWCM composite index continues to outperform the market
as a whole. As I have continued to preach, I believe we still
have 3-6 more quarters of increased volatility and uncertainty
that will lead, in some cases, to trading gains as we build
a solid base from which the next bull market will be born.
A balanced portfolio, with an emphasis on taking trading gains
in the equities market, will continue to be a profitable strategy.
Equity market and SWCM Composite Portfolio
Equity market valuations continue to remain
generally high based on slower top line sales growth and high
multiples on weak growth. Economic conditions remain flat
and seem to be treading water and now geopolitical conditions
are dominating the world headlines. With that said, we believe
there are signs of a corporate rebound in some, not all, sectors.
This has led us to begin to reduce our holdings in fixed income,
an instead selectively purchase the higher quality strong
cash flow names in selected industries. We have recently added
Teva Pharmaceuticals (TEVA) and Fox network (FOX) to the SWCM
Composite index. Both companies are leaders in their respective
fields and are generating cash flow and ROE in the 20% or
greater level. We continue to look for more investments similar
to these. During this quarter one of SWCM's largest holdings,
Friedman, Billings Asset Management, a mortgage REIT (FB),
will merge with its brother company, Friedman, Billings, Ramsey,
Inc., to become a billion dollar MREIT while incorporating
an investment banking business within that structure. These
two companies have always worked side by side; this new structure
will allow them to operate in a tax friendly and more synergistic
environment while continuing to provide a healthy 16% dividend
to investors. In addition, the combined companies complement
themselves well during cyclical cycles within each company's
respective sector. Currently the investment banking environment
is struggling while the Mortgage REIT continues to be profitable.
The companies combined assets, cash position and ROE are greatly
enhanced and provide investors a great opportunity for growth
with significant dividend income. We will continue to add
to this position as the situation develops.
Fixed Income
We continue to hold a significant position
in fixed income, in both short and long term maturities. However,
we have begun to move from the Treasury Indexed Protected
Securities into a longer duration corporate bond exposure.
As mentioned in the equity and overall market outlook, we
see signs that corporate expense reductions are beginning
to pay dividends while increasing bottom line results, though
top line growth is still anemic. With greater cash flow growth
at the corporate level we see a greater ability for corporations
to fulfill their debt obligations. With this thesis we see
opportunity in corporate and longer duration bonds. We continue
to believe that interest rates will remain low throughout
the year as the U.S. economy and world events sort themselves
out, adding more fuel to our fixed income and interest rate
sensitive holdings.
Our outlook for the quarter
The quarter is practically impossible to
predict. However, one thing remains a recurring theme: volatility.
On a day to day basis, the markets are reacting to war headlines
and economic numbers. Both have been moving the equity and
fixed income markets wildly, allowing investors to make gains
by taking profits in large movements in stock prices. We will
continue to follow this strategy and take gains when some
of our holdings become highly valued or are overbought.
Our outlook for the rest of the year:
As we said, we are optimistic about the
future. Yet over the short term, we find ourselves in a period
of above average risk. The U.S. economy is still struggling
to gain momentum, while war and terrorism loom. Our vision
of the financial future becomes clearer as we look further
out in time. Current stock market valuations are generally
overvalued. And we know that, over time, stock prices grow
in line with corporate earnings which, in turn, grow with
GDP. We are confident that the majority of value-oriented
investors will earn favorable returns over the next three
to four years. As the time horizon shortens, however, there
is more uncertainty. However, with this uncertainty comes
great opportunity which we believe will provide us with many
great opportunities to invest. Still, we are expecting positive
stock market returns during the coming year. The probabilities
favor a continuing trend of economic improvement. And with
very large cash reserves on the sidelines earning meager returns,
there is enormous potential buying power for stocks should
investors begin to regain confidence.
Closing Statement:
We continue to remain quite optimistic regarding
the long term opportunities in the equity market, however
we tread cautiously. Our strategy of making opportunistic
purchases on prolonged market sell offs, by taking trading
gains when overbought conditions exist, and by owning high
dividend paying equities continues to outperform. With this
approach we are adding to our core equity holdings when the
opportunity presents itself. In conclusion, the strategy that
has worked well last year continues to work well this year.
However, during the next 2-3 quarters we may begin to add
more core names as we position the portfolio for better economic
conditions, as geopolitical concerns abate and as opportunities
present themselves.
As always, we value each client and continue
to focus on your investment objectives. If you have any question
or concerns please do not hesitate to call.
Jim Sullivan
President
