NEW YORK---/Wi-Fi Technology News/---May 30, 2003--Fred Alger Management, Inc. today released its monthly Market Review.
Frankly, it's getting a bit difficult to find new angles on the economy and the markets these days. It's not that there's any lack of information. Each day, we are greeted by a deluge of statistics - on inflation, housing starts, retail sales, unemployment claims, and manufacturing activity. Add that to the testimony of Alan Greenspan, the prognostications of economists in print and on television, and to consumer sentiment surveys, and there is more than enough raw data to sift through, analyze, and digest.

But for many months, the story of the economy has lacked drama. Drama means change, for better or for worse, and there has been little of either in the economy. The world, of course, has been tumultuous, with the build-up to the war in Iraq to the fighting of the war and now its aftermath, but the economy, well, it's been chugging along with all the excitement of a turtle running a 100-yard dash.

Since March 10, the markets, at least, have rallied. As we suggested in our March review, once it became clear that the United States would act militarily to remove Saddam Hussein, the markets began looking to the future, and when earnings for the first quarter of 2003 were reported in April, it also became clear that the corporate profit picture was better than many had expected. The Nasdaq has seen particularly robust gains, reflecting the improved fundamentals of many leading tech companies. The Dow, after a nice bounce, has continued to trade in the mid-8000 range. Overall, we believe that the markets are at last reflecting improved corporate profits and prospects, and that this will continue, barring a major resurgence of al-Qaeda or some other sudden shock.

While the economy has lacked oomph, exciting things are happening just below the radar screen. The German philosopher Georg Friedrich Hegel once described the evolution of history as a process of thesis (a new, dominant idea), followed by an antithesis (the debunking of the idea), which then gives way to a synthesis. If the period of the late 1990s was dominated by the New Economy (the thesis), the past three years have been defined by the debunking of the New Economy and its market excesses. That phase is now coming to a close, and many are taking a second look at everything from e-business to the productivity gains of the past years and realizing that while the New Economy wasn't all that it was cracked up to be, it wasn't complete bunk either.

What has been emerging is a picture of numerous companies refining their use of technology to carve out new sources of revenue. Some of these are established companies like Wal-Mart and Procter & Gamble, both of which have made innovative use of radio frequency integrated device (RFID) tags. RFID chips are embedded on a product package, such as a box of Pampers, and the tag emits a radio-signal, which carries information about where it is in the supply-chain. This allows inventory to be tracked and accounted for with less reliance on physical inspection or sampling. RFID software and hardware combined are inexpensive relative to the cost-savings, and the system gives companies the ability to track inventory in real-time to a degree only dreamt of a few years ago. The cost-savings and efficiencies augment the bottom-line.

Other companies are introducing technology as an add-on to their business. Starbucks has always been able to find new ways to keep customers coming back, and many of those ways have little to do with coffee. Comfortable seating and enjoyable atmosphere have helped, but now the company is rolling out wireless Internet access (Wi-Fi) at their stores. Just as customers now sit and read papers or use their lap-tops, they may find that being able to access their e-mail and the Internet is one more reason to stay for that extra cup of coffee or sandwich.

And then there are new companies that are developing business models that would have been impossible even a few years ago. Take Netflix. The company rents video DVDs by mail for a monthly fee. In order to ensure that it has enough movies in stock, the company had to develop a sophisticated inventory control software system, and it's no coincidence that Netflix was created by a software engineer. Given that one of its most significant fixed costs is its DVD movie library, it has to buy just enough copies but no more to service its over 1 million customers nationwide (and on a 1-day delivery schedule!). The way to do that is to create tracking programs that analyze and predict patterns of DVD rentals. The other major cost, postage, is also less than it would have been a few years ago when the VHS tape was the dominant "technology." It cost much more to send bulky VHS cassettes than it does to send DVDs through the mail, and here too, technological innovations have made it possible for entirely new businesses to develop. Finally, Netflix customers rent DVDs through its website. This vital on-line component means that Netflix's customer service and marketing can reach customers' nationwide without any physical retail stores, an advantage that the Internet offers to all.

These are only a few examples of what is going on across the country and throughout the world. It doesn't require undue optimism to recognize that companies like these are thriving. A look at their earnings demonstrates that. And even in a period of slow economic growth and low inflation, many companies are creating next generation business models that will lead the next wave of growth and innovation. With bonds trading at 45-year lows and yields on the 10-year note below 3.5%, the stocks of those companies look very, very attractive.

The Economy

1) Jobs or no-jobs? The debate over the state of the economy hinges on jobs. Those who think the economy is sour say that the flat employment picture is on the brink of trending down. We disagree. Initial unemployment claims have stayed well above 400K since February, and the unemployment rate recently hit 6.0%. However, jobs are almost always a lagging indicator of economic recovery. For instance, the jobless rate peaked more than a year after the 1991 recession ended. Today, most analysts do not expect meaningful job creation to occur until the middle of 2004, even though the pace of economic growth should accelerate between now and then. More importantly, the pace of new layoffs has slowed, and a substantial percentage of recent layoffs have come from state and local government rather than the private sector. On the whole, the employment picture remains consistent with an economy that is continuing its shift away from manufacturing and is seeing growth from productivity gains.

2) GDP, manufacturing, and services: GDP for the first quarter of 2003 grew at a rate of 1.6%. This was lower than had been forecast at the beginning of the year, primarily because of bad weather in February (which depressed retail sales) and the surge in oil prices that preceded the beginning of the Iraq war. In general, Iraq uncertainty in January and February led to low business inventories and cautious spending by both consumers and corporations. That slow-down was reflected in manufacturing numbers. The Manufacturer's Alliance/MAPI survey for first-quarter activity showed that only 50% of all industries had new orders or production levels above a year ago. But the survey also found that a majority of businesses intend to increase activity in the second half of the year, either to restock low inventories or to satisfy new demand. The ISM index fell to 45.4 in data released in early May, which indicates contraction in manufacturing. However, this was offset by the New York Fed's Empire State manufacturing survey, which surged into positive territory at 10.6 in May up from -20.2 in April; by the Philadelphia Fed survey, which showed marked improvement; and by new factory orders, which were up 2.2% and showed particular strength in durable goods. The Non-Manufacturing ISM survey was more positive, registering 50.7, and showing an increase in both orders and hiring in the service sector, which accounts for a majority of jobs and business activity in the United States.

3) Homes and mortgages Housing continues to boom. The NAHB Housing Market Index was at 56 after a 52 reading in April; any number over 50 shows expansion, at least from the vantage point of the homebuilders who comprise the survey. New residential construction (i.e. housing starts) was at 1.63 million in April, down from 1.748 million in March but still quite high by historic standards. Most of the decline was in multi-family units, while single-family units showed almost no decrease from the high levels of the past year and a half. In addition, the drop in interest rates to 45-year lows has triggered more mortgage refinancing activity. According to the Mortgage Bankers Association, the refi-index is up 65% in May from April, and the rate for a 30-year fixed mortgage hit a new low of 5.17%. If interest rates stay below 3.5%, that should trigger a new wave of refinancing could add half a percent to overall economic growth this year.

4) Sales: Retail sales were flat to down, off 0.1% in April, though still up 4.1% year-over-year. Excluding auto sales, it is a 2.8% gain year-over-year. Most of the decline was the result of lower gasoline prices. Meanwhile, after the speedy conclusion of the war, consumer confidence rebounded to its highest level (93.2) since May of 2002 according to the University of Michigan survey. Though consumer confidence numbers fluctuate much more dramatically than spending, this is yet another positive indicator. Weekly stores sales from early May were decent, and chain stores sales are strong on a year-over-year comparison.

5) Taxes and the dollar: The news in late May was dominated by concern over the weakness of the dollar internationally and by the culmination of months of stalemate over the size of the tax cut. The dollar has depreciated almost 20% against the Euro in the past year, and that has led, we believe, to considerable popular confusion about the relative strength of the US economy. There seems to be a false perception that a weak dollar equals a weak economy. In truth, the dollar has appreciated substantially since the mid-1990s, and the recent pull-back is restoring some needed balance. The weaker dollar should help stem the growth of the trade-deficit and aid US exports. On the tax front, Congress agreed to a $350 billion tax cut just before the Memorial Day weekend. While the president did not get the full dividend cut, the bill does lower the capital gains rate to 15% from 20% and lowers the tax on dividends to 15% from its previous high of 38.6%. The top marginal tax rate will also go down, from 38.6% to 35%. Overall, for all the hoopla surrounding this plan, we do not think it will have a substantial effect on the economy in the short term. The decrease in dividend taxes should, however, encourage companies to increase their dividend payouts to shareholders, and that will likely boost the equity markets by making stocks more attractive to investors.

The Market

1) Since the date of our last market review, the markets continued to rise, though the rally that began in March did begin to slow. From the open on April 24 through the close on May 27, the Dow gained 3.12%; the S&P 500 rose 3.53%; and the Nasdaq gained 6.17%.

2) Investors have begun to take a new look at equities, at least judging from the continued inflows in equity mutual funds. Inflows increased for the tenth straight week in data released on Friday May 23, which means that new money going into funds exceeded redemptions. As the yield on fixed income continues to decline, investors are re-evaluating their portfolios. Stocks on forward earnings look ever more attractive relative to the yield on bonds. In addition, the flatter yield curve means that the cost of capital for corporations is decreasing, and companies have been taking on new debt as a result. That is usually a sign that capital spending is about to increase, which will mean a more robust economy in the second half of 2003.

Our view of the economy has not changed from what we've been saying for many months - slow, steady growth. What has changed is market sentiment. In March, we predicted that the war would serve as a positive catalyst from fear to hope, and we believe that is happening. The market's recent rally doesn't mean we are returning to irrational exuberance, and near term, we think the market may take a breather and consolidate recent gains.

But overall the shift in sentiment supports higher levels for the market. Investors appear to be rediscovering that well-managed businesses continue to innovate and create, and that the economy may be half-full, rather than half-empty, following two years of recession, fear of terrorism, weak corporate capital spending, and consumer demand that has been steady but not accelerating. This more positive sense of the future, for the potential for growth, and the recognition that the dreary weather of Memorial Day notwithstanding, the winter of our discontent has ended, leads us to think that a summer of possibilities beckons.

Fred Alger, President
Dan Chung, Chief Investment Officer
Zachary Karabell, Senior Economic Analyst and Futurist
Founded in 1964, Fred Alger Management, Inc. is a leading asset management firm employing a bottom up approach in its attempt to identify the fastest growing companies in their respective sectors. Over four decades, Alger has continued its tradition of pure growth investing, independent research and style purity. Fred Alger Management, Inc. offers investment advisory services to separately managed, sub-advised and wrap accounts. Fred Alger & Company, Incorporated offers mutual funds as well as institutional funds for defined benefit and defined contribution plans.

To read Alger's Market Review in its entirety, please visit http://www.alger.com.

The view and opinions expressed herein are not meant to provide investment advice and there is not guarantee that they will come to pass.
Web site: http://www.alger.com