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We are pleased to report that your account enjoyed solid performance during the first quarter, meeting or exceeding the performance of many major indices. The following discussion will outline our views of the prospective market environment and the implications for your portfolio.
Since the middle of 2004, equities have faced a headwind from steadily rising short-term interest rates. Having forestalled the previous specter of deflation through aggressive easing of monetary policy, the Federal Reserve found itself facing an inflation threat in the form of rapidly rising energy and commodity costs and escalating real estate prices. Fifteen consecutive rate increases later, there finally appears to be growing consensus within the Federal Reserve that interest rates have reached appropriate levels. Recent stock market strength therefore reflects anticipation that the majority of the tightening cycle is now behind us.
Evidence suggests that the Federal Reserve has thus far succeeded in cooling the real estate market without material adverse consequence to the overall economy. Looking ahead, however, we believe that the American consumer no longer can look to residential housing appreciation as a substitute for savings or as a piggybank to fund consumption. The upward repricing of variable rate debt and higher energy prices also will compete for discretionary dollars. Collectively these negative factors are likely to restrain growth in consumer spending.
In light of our concern for the consumer economy, some may question our gaming sector investments due to the perceived discretionary nature of such entertainment activities. However, our long history with these companies has taught us that the business is largely immune to economic cycles. We believe the industry will remain in secular growth mode as state governments, viewing gaming as a relatively painless means to enhance tax revenue or facilitate economic development, continue to authorize increased capacity and new jurisdictions.
We also expect our healthcare-related investments to be largely unaffected by any potential slowdown in consumer spending. On the positive side, growing concern about the affordability and accessibility of healthcare is beginning to translate into political action. In this vein, several states are currently promulgating legislation that would require all employers to offer some form of healthcare insurance coverage. This development has the potential to substantially enhance the financial performance of our hospital operators, which to this point have had to absorb the cost of uncompensated care.
We have articulated in prior communications our rationale for investing in the newspaper industry, as well as our appreciation of the near term challenges it faces. It is important to reiterate our belief that Wall Street has overstated the industry’s fundamental weakness in general, and the Internet threat in particular. The negative hype also fails to consider the value and durability of the local market content and advertiser relationships controlled by the newspaper companies. As the newspaper industry continues to demonstrate rapid growth in web-based advertising revenue, we expect valuations and stock performance to markedly improve.
While much attention is focused on the outlook for consumer spending, it is apparent that the industrial side of the U.S. economy is growing robustly. Based upon our ongoing dialogue with corporate managements, we believe that business-related capital spending is likely to accelerate meaningfully this year. Our technology sector investments should benefit substantially from this trend.
Finally, we are encouraged by the financial health exhibited by much of corporate America. Excluding some unfortunate but high-profile sectors such as the auto industry, U.S. corporations are broadly generating record profitability, substantial free cash flow and enjoying the greatest balance sheet strength in memory. Corporate financial strength is further evidenced by substantial and significant stock repurchase activity, something we have long viewed as an important indicator of equity undervaluation.
As you know, Private Capital Management always has been committed to bottom-up, company-specific stock selection. Nevertheless, we remain cognizant of exogenous macroeconomic factors. As such, your portfolio has been constructed to broadly capitalize on the economic climate we foresee. Accordingly, we are optimistic about the outlook for your portfolio.
We appreciate your continued support.
Private Capital Management
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Bruce S. Sherman
Chief Executive Officer |
Gregg J. Powers
President |
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