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April 1, 2004

Omega Watches for Trouble

By Kathryn M. Welling

Lee: Well, 24 of our top 25 portfolio positions we owned last year. The one that has dropped out, Edison International, EIX, we've written in-the-money calls against - it's as good as gone come next month. And we've added Altria (MO). Beyond that, considering that the stocks we owned last year were up 60 percent on average by definition, they've got to be a lot less attractive here. All things being equal, we made a lot of money, and we're not coming up with a lot of new things that are cheap.

That's what I meant about sounding cautious -

Lee: Until recently, the market did have the benefit of a perfect storm in reverse. The lowest interest rates in 45 years - and in my humble opinion, if rates go lower from here, it's going to be negative, not positive. It would be indicative of the economy not staying strong in the second half, losing its forward momentum. We also had low inflation - though we now probably passed the low point. If you look at copper, look at gold, look at oil prices, look at natural gas prices, but the bottom line is that the price is the price. And a whole array of commodities prices, from steel to copper to gold to natural gas to oil, are all up quite dramatically.

But if inflation stays moderate or declines from here, it would not be bullish, it would be bearish - again, indicative of an absence of economic growth in the second half of the year, and a negative for corporate profits.

The falling dollar has been a plus. I recognize the dollar has rallied here in the last few weeks. But if we break to new lows here in the dollar - which is not necessarily our forecast - but if that were to happen, it would be negative. The Democrats have their candidate and now they're going to unify and go after the enemy, which is Mr. Bush. I suspect the market will start to view the election as more of a toss-up than a runaway victory for Bush - and that's going to start to affect market psychology.

Lastly, there's virtually nobody out there any more who is not expecting economic growth. So Steve and I see one place for investors to be surprised - which is if corporate profits substantially exceeded expectations. My own view, though, is that given competition over the Internet, given China, given the costs that companies are living with now, I would not expect profits to substantially exceed expectations. Steve, how are they running currently?

Steve: Profits were up about 26 percent in the fourth quarter, which will be the peak year-over-year gain. They'll be up 18 percent to 20 percent in the first quarter and then recede on a year-over-year basis from there.

Lee: Doesn't the stock market generally peak along with the peak rate of change in corporate profits?

Steve: Usually coincidentally. It's been an unusual cycle, but it's typically coincident with or just after a peak in year-over-year profits.