domestic investment outlook & strategy · 2017. 2. 15. · domestic investment outlook &...

Domestic Investment Outlook & StrategyOctober 8, 1999

Contact:Peter L. Mitchelson, CFA – PresidentDavid A. Brown, CFA, CPA – Vice PresidentSit Investment Associates, Inc.90 South Seventh Street4600 Norwest CenterMinneapolis, MN 55402(612) 332-3223

Current Month Highlights

PageConclusions: Equity market shows resilience 1Current conditions: We expect economic volatility ahead 2Monetary policy and fixed income strategy: Federal Reserve 6

reinstates tightening biasFiscal policy: Arguing over the surpluses continues 8Equity investment strategy: United States technology 9

spurs profitability

Exhibits Warranting Special Attention

ExhibitPortfolio wealth is enabling consumer spending to- E

remain strongPreliminary economic forecast for the F

year 2000Tech stocks have dramatically outperformed the rest M

of the stock marketDeclining capital goods prices have led to a massive T

substitution of capital for labor in the 1990sNew capacity has permitted a surge in profit margins U

Sit Investment Associates, Inc.

■ Sit Investment Associates, Inc. ■

Investment Outlook & Strategy

October 8, 1999

EXECUTIVE SUMMARY

We have completed our preliminary estimates for the economy in the year 2000 and conclude that growthmay be slightly lower and inflation slightly higher than in 1999. Over the near term, economic growth ratescould be more volatile due to the likely snapback in third quarter GDP compared to the second quarter’sanemic +1.6 percent growth rate, possible inventory accumulation associated with the Y2K event, andgovernment revisions to the national income accounts. We are forecasting relatively stable interest ratesand if the Federal Reserve tightens again this year, it will be at the November 16th meeting. Federal budgetsurpluses are increasing rapidly and we are watching carefully whether Congress will be tempted toaccelerate spending in an already-extended economy. Corporate profit estimates are rising rapidly,improving valuation parameters. The improvement in profits has been driven by massive investments incapital that have benefited many technology companies. Sit Investment Associates’ portfolios remainoverweighted in this dynamic sector of the economy.


Investment Outlook & Strategy

October 8, 1999

CONCLUSIONS:Our review of recent economic and financial market conditionsproduces the following conclusions:

1. U.S. common stocks declined modestly in September for thethird month in a row on concerns that the economy’s strengthcould lead to further Federal Reserve tightening. From theirsummer peaks to late-September lows, both the Dow JonesIndustrial Average and S&P 500 Index declined approximately–10 percent, a meaningful correction. Technology and selectedeconomy-sensitive stocks (oil) have done well, but broaderstock market benchmarks achieved low single-digit returnsthrough the first nine months and fixed income securities havelogged slightly negative returns.

2. Final figures for 2Q99 real GDP were released and showedminor revisions and an annualized growth rate of only +1.6percent, which was impacted by slowing consumerexpenditures and a sharp contraction in inventories. Webelieve the third quarter will show much stronger growth in thearea of +4.5 percent, led by stronger consumer spending andinventory additions. On October 28th the government releasesmajor revisions to the national income accounts that willgenerally boost growth, in some cases substantially. The nextfew quarters could also be impacted by externalities, namely,the Y2K event. The Consumer Price Index has been creepingup slowly, but the “core” rate remains favorable. We believe

economic growth will be slightly lower and inflation slightlyhigher in the year 2000.

3. The Federal Reserve did not increase interest rates on October5th, but moved to a tightening bias in view of its concerns overtight labor markets. If the Fed tightens again in 1999, it islikely to be at the November 16th meeting. We believe interestrates will move in a fairly narrow range over the next severalmonths and are maintaining taxable bond portfolio durationsclose to related benchmarks.

4. The federal budget surplus for the year ended September 30th

exceeded $110 billion, but Congress could not complete ontime the 13 appropriations bills and passed a 3-week extensionbill. Given the emerging surpluses, we are concerned that analready extended economy may be overburdened withprograms similar to the 1960s Great Society package.

5. Despite modest overall stock market progress over the past sixmonths, selected segments, particularly technology, have donewell. Corporate profit estimates have risen significantly,impacting valuation parameters favorably. The source of theprofit improvement can be traced to a decade-long substitutionof capital for labor that has driven demand for technologyproducts in spectacular fashion. Sit Investment Associates’portfolios remain heavily exposed to this sector, whichcontinues to benefit performance both relatively andabsolutely.

Sit Investment Associates, Inc. October 8, 1999Investment Outlook and Strategy Page 2

CURRENT CONDITIONS: we expecteconomic volatility aheadDuring September, U.S. common stocks declined modestly forthe third month in a row. The economy’s continuing strength,tight labor markets, and a weakening dollar exchange rate fueledfears that the Federal Reserve might move interest rates upanother notch before year end to retrace entirely last year’s threedownward moves. From their summer peaks to late-Septemberlows, the DJIA retreated –9.8 percent and the S&P 500 –10.6percent, both qualifying as “meaningful” corrections. Apartfrom the technology area and selected economy-sensitive groups(particularly oil), a large number of stocks have shown verymodest returns, resulting in broad market measures achievinglow-single-digit returns on a 9-month basis. Major bond marketbenchmarks have logged small negative total returns year-to-datein the face of U.S. Treasury interest rates that have risen morethan 100 basis points (see Exhibit A).

Total Returns to 9/30/991 Mo. 3 Mos. 9 Mos. 12 Mos.

Large Cap S&P 500 Index -2.7% -6.2% 5.4% 27.8% Dow Jones Ind’l Avg. -4.4 -5.4 13.9 33.9 Russell 1000 Index -2.8 -6.6 4.2 27.0

Small/Medium Cap NASDAQ OTC Comp.* 0.3 2.2 25.2 62.1 S&P MidCap Index -3.1 -8.4 -2.1 25.5 Russell 2000 Index 0.0 -6.3 2.4 19.1

Fixed Income Lehman Aggregate Index 1.2 0.7 -0.7 -0.4 Lehman Muni Bond Index 0.0 -0.4 -1.3 -0.7

*Price Change Only

The narrowness of the stock market’s progress this year is seenin Exhibit B containing changes in group leadership for the 17industry sectors of the S&P 500 Index. On a year-to-date basis,eight out of 17 sectors have outperformed the total index butthree of the groups have risen more than +25 percent while sevengroups, accounting for over 40 percent of the total weight, haveactually experienced negative returns.

In the case of the S&P 400 Midcap Index, the results have beeneven more extreme: only five of 17 groups outperformed theIndex’s –2.1 percent 9-month return, 12 of 17 sectors postednegative returns (the worst, Health Services, was down –48.2percent), and the best sector, Electronic Technology, was up+44.1 percent (see Exhibit C). In every major equity index thatwe monitor, the Electronic Technology sector ranked no worsethan third out of 17 sectors during the first 9 months.Fortunately, Sit Investment Associates’ portfolios were wellrepresented in this dynamic area of the economy, which was amajor reason for superior performance this year.

Small cap stocks performed slightly better than large caps inSeptember, but far more noticeable was the superiority of“growth” over “value,” which occurred throughout thecapitalization spectrum and over all timeframes this year.Following the strong outperformance of value stocks in late-March and April, growth stocks have steadily reassertedthemselves over the past several months as inflation fears failedto materialize and stocks in many cyclical areas did not achievethe near-term positive earnings leverage that some were hopingfor. On both a 9-month and 12-month basis, the positive spreadof growth stock returns over value stocks is very pronounced, asshown in the following table:


Large and Small StockTotal Returns to 9/30/99

1 Month 3 Mos. 9 Mos. 12 Mos.Large Cap Russell 1000 Growth Index -2.1% -3.7% 6.4% 34.9% Russell 1000 Value Index -3.5 -9.8 1.8 18.7

Medium Cap Russell Midcap Growth -0.9 -5.0 8.5 37.2 Russell Midcap Value -5.1 -10.6 -3.7 9.3

Small Cap Russell 2000 Growth Index 1.9 -4.9 7.3 32.6 Russell 2000 Value Index -2.0 -7.8 -3.0 5.8The United States’ year-to-date performance ranking among 33global bourses did not change materially in September despitethe modest market correction. In fact, the U.S. ranking measuredin dollar terms improved by one position to 17th (see Exhibit D).An enormous performance spread between the best (SouthKorea, +51 percent) and worst (Belgium, -19 percent) countriespersists, with the broader Asia Pacific region being the strongestperforming area in 1999.

Turning to the domestic economy, we have examined in our twoprevious monthly outlook papers the slowdown in second quarter1999 real Gross Domestic Product compared to the first quarter,which occurred as a result of moderating consumer expendituresand cutbacks in inventories. The final figures for 2Q99 showedlittle change as real GDP came in at +1.6 percent (compared tothe previous +1.8 percent forecast), real final sales at +3.1percent (versus +3.0 percent) and the GDP Deflator at +1.3percent (versus +1.5 percent). Net exports were another majordrag on the economy as imports continued to surge +10.6 percenton a year-over-year basis (perhaps in anticipation of offshoreY2K-related production snags), while exports grew only +3.7

percent. However, net exports were actually much less negativein the second quarter than in the first, as seen below:

DOLLARS (Bil) of Real GDP Change4Q98 1Q99 2Q99Final Final Final

Personal Con. Expenditures $64.2 $85.9 $62.9Nonresid. Fixed Invs. 33.2 20.3 26.3Residential Invs. 7.6 11.8 5.9Inventory Change -11.5 -5.5 -31.3Net Exports 9.0 -53.6 -34.4Government 10.7 13.6 -6.4Residual -2.0 9.4 8.0Total $111.2 $81.9 $31.0

% Change in Real 6.0% 4.3% 1.6% GDP (ann.)

% Change in Real 6.6% 4.6% 3.1% Final Sales (ann.)

% Change in GDP 0.8% 1.6% 1.3% Deflator (ann.)

We believe that the third quarter is likely to show much strongerreal GDP growth than the second quarter, for a variety ofreasons. First, consumer spending moved ahead strongly inAugust at the GDP level following a relatively modest gain inJuly. By far the strongest increase in August expenditures was inautos, which is a direct reflection of continuing high consumerconfidence. Individuals’ faith in the future is reflected in theirwillingness to include in their spending plans wealth created bycommon stock appreciation (see Exhibit E) and to borrow for the


future. August consumer credit advanced at a +10.5 percent rate,the fastest this year and September retail sales jumped +5.5percent. We believe real Personal Consumption Expenditures(PCE) grew at a +4.7 percent annualized rate in the third quarter,and since PCEs account for two-thirds of total GDP, they willprovide a strong base for the rebound in overall economicactivity we expect. Updated consumer income and spendingtrends are shown below:

Consumer Income and SpendingYear-Over-Year Percent Change

Nominal RealDisposable

Personal Personal Consumption ConsumptionIncome Income Expenditures Expenditures

1998 March 4.9% 3.8% 5.2% 4.5%June 5.0 3.8 6.4 5.5Sept. 4.9 3.9 5.9 5.2Dec. 5.0 4.3 6.3 5.5

1999 Jan. 5.0 4.6 6.3 5.2Feb. 4.9 4.5 6.6 5.5March 4.8 4.5 6.9 5.7April 5.0 4.7 7.1 5.4May 4.9 4.6 6.5 5.2June 5.4 5.2 6.2 4.9July 5.2 4.8 6.5 5.2August 5.3 5.2 7.0 5.5

Second, we believe it is highly unlikely that inventories willcontract in the manner they did in the second quarter. In fact, webelieve this sector, which is volatile, could be the largest singleswing factor in the third quarter GDP report. Inventory buildingin anticipation of possible Y2K disruptions seems a reasonableassumption. Third, the government sector experienced negativegrowth in the second quarter, an outcome that appearsincreasingly suspect in an era of $100 billion-plus governmentsurpluses. It, too, could be a positive swing factor in the third

quarter. As a side note, the government will be presentinganother comprehensive revision of the National Income andProduct Accounts on October 28th. The last such revision wasreleased in January 1996. A major definitional change will be torecognize business and government expenditures for software asfixed investment. One estimate is that this change would haveincreased 1996 GDP by as much as +1.5 percent! This positivedefinitional change could offset the short-term negativeinfluences of Hurricane Floyd, details of which are beginning tobe recognized in the more than 50,000 person reduction inpayroll growth in September.

Despite our estimate of a strong recovery in 3Q99 real GDP, thenext few quarters could experience more than usual volatility dueto inventory activity related to possible Y2K problems, thegovernment’s statistical revisions, and a possible spendingslowdown related to the consumer balance sheet that has becomemore tightly linked to the stock market. Our preliminarythoughts on the shape of the economy in 2000 are contained inExhibit F, which includes a moderate slowing in first quarter2000 due to Y2K dislocations. The result of the quarterlyannualized real GDP figures in Exhibit F is positive real GDPgrowth of +3.9 percent in 1999 (virtually the same as in the priortwo years), and +3.6 percent growth in 2000, still very robust inhistorical terms.

The implication of a fourth successive year of greater than +3.5percent annual GDP growth together with tight domestic labormarkets, rising commodity prices, and improving globaleconomies, is gradually higher prices at the consumer level, inour opinion. Various studies have calculated the cumulativeimpact of a permanent $10 per barrel oil price increase on theConsumer Price Index in the order of one full percentage pointover three years. While it is by no means certain that the price of


oil will remain at today’s level, it has already lingered at thislevel longer than previously anticipated.

Not only oil has been rising, however, and the LeutholdCommodity Diffusion Index is now registering 61 percent, closeto the 70 percent “warning” level (see Exhibit G). The Index’supward slope is reminiscent of the spikes that occurred in 1983and 1986-87, which appeared to correlate quite well with theupward cyclical movements in the CPI in those two periods (seeExhibit H). The August Consumer Price Index report wasviewed as benign in the sense that the “core” rate, excluding foodand energy, was up a modest +0.1 percent on a monthly basis.While the year-over-year increase in the “core” rate deceleratedto +1.9 percent, the total CPI rose +2.3 percent, a definiteupward movement from the +1.5 percent rate of September1998. We believe the CPI will continue to trend modestly higherin the quarters ahead and average +2.5 percent in 2000, up from+2.1 percent this year.

U.S. CPI TRENDS - % CHANGE

Year- 6 Months 3 MonthsPeriod Over-Year Annualized Annualized

December 1997 1.7 1.2 0.2March 1998 1.4 1.2 2.2June 1998 1.7 2.1 2.0September 1998 1.5 1.7 1.5December 1998 1.6 1.1 0.7March 1999 1.7 1.7 2.7April 1999 2.3 2.7 4.6May 1999 2.1 2.7 4.1June 1999 2.0 2.8 2.9July 1999 2.1 2.9 1.2August 1999 2.3 3.2 2.2The price of gold burst into the news late last month, propelledupward by reports on September 26th that the European CentralBank and 14 individual nations, over the next five years, would

not part with any more of their gold holdings beyondpreviously scheduled sales. From a low of $254 an ounce onAugust 25th, the price soared to over $330 in early October,raising questions regarding its role as a possible inflationindicator. Most academic studies discount the role of gold asan inflation gauge due to its small relative size in the overalleconomy and its lack of correlation with reported inflation inrecent years. According to the Federal Reserve Bank of KansasCity, the percentage of inflation explained by the price of goldfell from 43 percent over the entire period 1973-94 to twopercent over the period 1983-94. Because of its minoreconomic significance, we do not rely on gold as a primaryindicator of future inflation, and much of its recent rise can beattributed to short covering by traders. Taken in the context ofother commodities that are also experiencing rising prices,however, gold appears to be simply a coincident indicator,reacting to unanticipated limitations on supply.

The U.S. dollar exchange rate continued to weaken modestly inSeptember against the “major currencies” series compiled bythe Federal Reserve (see Exhibit I). It is important to keepthese figures in perspective, however, as much of the mediaattention has been focused on the yen/dollar relationship, onlyone currency in the basket that accounts for just over 25 percentof the trade weight in the index. For background, the majorcurrencies index includes 16 countries and 7 currencies and thecurrencies are traded in “deep and liquid financial markets andfor which short- and long-term interest rates are readilyavailable.” Canada, in fact, has the highest weight in the indexat just over 30 percent and the euro area is next largest at 28.7percent. From 12/31/98 to 9/30/99, the U.S. dollar weakened–4.4 percent and –5.5 percent, respectively, against theCanadian dollar and the yen, but actually strengthened +11.0percent against the euro, +1.0 percent against the pound and


+9.4 percent against the Swiss franc. Interestingly, the U.S.dollar was virtually unchanged against the major currenciesindex using the December 1998 and September 1999 end pointnumbers. Notwithstanding media hype, we do not believe theterms of trade for the United States have been significantlyaltered this year due to currency fluctuations.

In conclusion, the stellar performance of the U.S. economycontinues, but with emerging inflationary strains. Due topossible external shocks (Y2K) and statistical recalibrations,quarter-to-quarter GDP growth rates could gyrate in above-average fashion over the near term, but overall growth shouldremain strong in 2000 as well. It is the potential fear ofinflationary pressures resulting from strong growth thatprompted the Federal Reserve to reinstitute a bias towardtightening on October 5th, which is the subject of the nextsection.

MONETARY POLICY AND FIXED INCOMESTRATEGY: fed reinstates tighteningbiasIn last month’s Investment Outlook and Strategy paper, weexpressed the view that the Fed could well raise interest ratesby another 25 basis points at either the October 5th orNovember 16th FOMC meetings, which would be the third stepin a series of moves offsetting entirely the 75 basis pointreduction in rates implemented in the second half of 1998 inresponse to international financial turmoil. In the periodfollowing the August 24th FOMC meeting, various economicdata releases were scrutinized with care to divine the possibleshifting sentiments of the Fed governors. The favorable “core”CPI report, for example, was greeted with joy whereas thesoaring NAPM Prices Paid figure provided cause for concern.In the days leading up to the October 5th meeting, consensus

thinking coalesced around the view that the Fed would make nochange in interest rates or in its previously dictated“symmetric” operating directive. As evidence of thereasonably strong consensus on the last-noted issue, 24 of 37economists surveyed by Bloomberg News expected no changein the directive.

The actual result of the October 5th meeting was no change ininterest rates, but the Fed moved to a “directive that was biasedtoward a possible firming of policy going forward.” Theprimary rationale for resuming a tightening bias was tight labormarket conditions, as indicated in the Fed’s supportingstatement:

“The growth of demand has continued to outpace thatof supply, as evidenced by a decreasing pool ofavailable workers willing to take jobs. In thesecircumstances, the Federal Open Market Committeewill need to be especially alert in the months ahead tothe potential for costs to increase significantly inexcess of productivity in a manner that couldcontribute to inflation pressures and undermine theimpressive performance of the economy.”

In spite of this more hawkish tone, the Fed again played aneffective balancing act by adding that “committee membersemphasized that such a directive did not signify a commitmentto near-term action.” The definition of “near-term” remains anopen question, but it appears likely that if the Fed is to moverates again in 1999 it will probably be on November 16th sincethe December 21st FOMC meeting is very close to the Y2Kevent. As always, the Fed will continue to monitor ongoingindicators and retain the flexibility to react as it believesappropriate. Sit Investment Associates interest rateexpectations include relative stability over the next twelve


months across the U.S. Treasury yield curve, as reflected inExhibit J, with long-term Treasury yields moving around a 6.00percent to 6.25 percent central tendency range.

While fixed income yield levels have risen significantly thisyear, taxable bond yields moved slightly lower in the month ofSeptember as investors became more confident that inflationand economic growth were not high enough to cause the Fed toraise short-term rates a third time. While U.S. Treasury yieldsfell slightly, all other sector yields fell further as yield spreadsnarrowed. Stabilizing to declining prepayments, coupled withrelatively stable Treasury yields, provided the mortgage sectorwith the basis for a strong month. The mortgage market alsobenefited from a declining supply of new mortgages as higherinterest rates dampened loan volume. Lower loan volume, inturn, leaves banks with available funds to invest, frequently inthe mortgage market. The combined higher demand, lowersupply, and reduced prepayment volatility caused the mortgagesector to outperform by a wide margin. In fact, if the +1.6percent monthly return for mortgages could be repeated for 12consecutive months, its annual return would reach +21 percent!

While narrowing yield spreads in the corporate and asset-backed sectors helped them to outperform Treasuries, theirreturns were significantly below that of mortgages. Thenarrowing of yield spreads in the corporate and asset-backedsectors reflects a slowing of the record pace of debt issuance.September marked the end of five months of widening yieldspreads. We believe that investor anticipation of the illiquidityexpected at year-end caused yield spreads to widenprematurely. In fact, we suspect that many investors have nowpositioned themselves to be able to purchase securities atattractive levels at year-end and are hoping for a majornarrowing of yield spreads to occur early next year (i.e., a

repeat of 4Q98-1Q99). As a result, we believe that SitInvestment Associates’ taxable total return bond portfolioshave reaped the majority of the benefits that could be obtainedfrom the sector shift implemented in the second quarter.

The sector shift involved reducing weightings in corporates,asset-backeds and CMOs and increasing the weighting in U.S.Treasuries. We have now begun to reverse the sector shift byselectively purchasing corporates and asset-backeds in order to“beat the rush” of investors with pent-up demand. Whilehigher quality securities should do well, we still believe therewill be opportunities to purchase higher yielding, lower-ratedsecurities at year end and are positioning portfoliosaccordingly. Lastly, portfolio durations are near those of theirbenchmarks as we expect interest rates to be relatively stable.

In contrast to taxable bond yields, municipal yields continuedto increase during September. The yield on the Bond Buyer40-Bond Index increased 11 basis points during the month to5.89 percent on September 30th, its highest level since March1997. Year to date, the Bond Buyer Index has increased by 73basis points, most of which has occurred over the past fourmonths, and have almost caught up to the increase in longTreasury yields since the beginning of the year. Municipalbonds remain cheaply valued, particularly on an after-tax basiswhen compared to Treasury securities. The relative yield ratioof long municipals to long Treasury bonds increased from 95.2percent to 97.2 percent during the month, but remains belowthe 101.3 percent relative valuation at the beginning of theyear. Municipal bond prices continue to be negativelyimpacted by a number of factors, including net mutual fundredemptions (as investors have been able to find attractiveyields in individual bonds), competition from the large volumeof corporate issuance (which has caused yields to rise further),


and lack of demand from property/casualty companies.Although corporate bonds have performed better in recentweeks, municipals continue to be weak.

Total Returns Through 9/30/991 3 9 12

Mo. Mos. Mos. Mos.Lehman Index Aggregate 1.2% 0.7% -0.7% -0.4% Government 0.8 0.7 -1.6 -1.7 Corporate 1.1 0.3 -2.0 -1.4 Asset-Backed 1.0 1.1 1.5 2.0 Mortgage Pass-Through 1.6 0.9 1.5 2.3 5-Yr. Treasury 0.9 0.8 -1.4 -1.9Municipal 0.0 -0.4 -1.3 -0.7 5-Yr. Municipal 0.4 0.9 0.7 1.6 Revenue 0.1 -0.6 -1.2 -0.7 Electric 0.0 -0.7 -1.4 -0.8 Hospital 0.2 -1.1 -2.8 -2.2 Housing 0.2 0.0 0.4 0.9 IDR/PCR 0.1 -0.5 -0.6 0.1 Transportation -0.1 -0.6 -1.3 -0.8 Education 0.0 -0.6 -1.4 -0.9 Water/Sewer -0.1 -0.8 -1.6 -1.1 Resource Recovery 0.2 -0.3 0.5 1.3

Municipal bond indices underperformed taxable bond indicesagain in September and during the third quarter. Municipalreturns in the third quarter, however, were less negative thanthose posted for the month of June. Shorter duration sectorshave continued to perform best in this environment of risinginterest rates. The housing sector has continued to outperformdue to its stable price characteristics while the health caresector continues to be weak as credit concerns persist. Wecontinue to focus on opportunities to shorten duration andincrease coupon income in municipal portfolios. Currently, wefind municipals in the 8 to 15 year maturity range to offer themost attractive risk/reward opportunities.

FISCAL POLICY: arguing over thesurpluses continuesPresident Clinton proudly announced on September 27th anupward revision in the forecasted federal budget surplus for thefiscal year ended September 30, 1999 to a figure of $115billion, which was more than 15 percent higher than theadministration’s previous estimate. Based on the fact that therolling 12-month surplus through August was $104 billion, astrong final month is implied (see Exhibit K), continuing theyear-to-date trends of receipt growth of +5.5 percent and outlayadvances of just over +3 percent. Final figures for fiscal year1999 will be released on October 22nd and some believe there isa one-third chance that the government may actually show asmall non-Social Security surplus. In July, the CongressionalBudget Office predicted a $4 billion deficit in the non-SocialSecurity portion of the budget, thus a small surplus is not out ofthe question.

Despite the emergence of sizeable surpluses in the past twoyears, however, Congress still labors under the burden of notbeing able to manage its affairs under the rules it establishedfor itself. As was expected, Congress failed to complete the 13appropriations bills on time, and opted for a three-week stop-gap bill to keep federal agencies open and enable the task to becompleted. In fiscal year 2000, the federal government isexpected to post a surplus exceeding $160 billion (an increaseof 39 percent!), yet all but $14 billion of that is the result of theSocial Security surplus, which the politicians don’t want totouch. The net result is that the “caps” on spending imposed in1997 are limiting program initiatives, thereby leading to featsof “creative accounting.” To make desired funds available, onemember even proposed adding a 13th month to the year to dipinto the surplus expected in FY2001. As we write this review,


the Republican party was proposing to cut 2.7 percent from thespending bills of every government agency, in a bid to “sharethe pain.” If one shields active military and veterans fromthese cuts, other domestic programs would have to be reducedby 6 percent, a highly unlikely outcome. What is painfullyclear is that the spending “caps” are going to be exceeded, notby a lot, but it will set the stage for even larger violations goingforward.

From a longer-term perspective many fiscal issues remainunresolved. President Clinton, as expected, vetoed the $792billion Republican 10-year tax cut plan, but left the door opento seek long-term solutions to the issues of taxation, domesticspending, Medicare and Social Security. The result is thatthese major issues will be left to the elections next year and ourinterpretation is that additional spending will be at the root ofthe debate. Governor George W. Bush’s recent speechesclaiming Republicans are trying to “balance the budget on thebacks of the poor” and that the G.O.P. had “put too muchemphasis on economic wealth and too little on socialproblems” is an attempt to co-opt Democratic positions, butthey also imply spending initiatives. Former Senator BillBradley’s proposed $65 billion-a-year plan to make health careavailable to virtually all uninsured Americans and a $26 billion10-year program to help parents juggle jobs and families carrylarge price tags, but at least his health care plan does not carrythe massive bureaucratic baggage that President Clinton’s 1994proposals did. Our overriding concern is that an alreadystretched economy will be overburdened with programsanalogous to the 1960s “guns and butter” Great Societypackage that ultimately led to rising inflation. We note,parenthetically, that in mid September Congress sent to theWhite House a Treasury bill that includes doubling the pay of

the next president and provides lawmakers with a $4600 cost-of-living increase at the end of the year.

EQUITY INVESTMENT STRATEGY: unitedstates technology spurs profitabilityIn the early paragraphs of this review, we noted how severalbroader stock market benchmarks had experienced quitemodest (or even slightly negative) 9-month returns, but thatmany technology sectors had done well. The prime example ofthe positive impact that large technology stocks have had is theNASDAQ OTC Composite’s +25.2 percent year-to-date return(versus +5.4 percent for the S&P 500), more than half of whichwas attributable to the ten largest companies in the index. Nineof these companies are technology leaders (Microsoft, Intel,Cisco, etc.) and the tenth, Amgen, may be considered a healthtechnology company (see Exhibit L). Technology stocks havealso favorably impacted the S&P 500 and Russell 2000 Indiceson a third-quarter and year-to-date basis, although not to thesame extent as the NASDAQ Composite (see Exhibit M).

The relatively modest performance of the broad market iscaptured in the decelerating 6-month price momentum chartsfor large, mid and small cap stocks (Exhibit N), decliningmarket breadth statistics (declining issues exceeding advancingissues), and “technical” charts showing the market’s range-bound trading pattern since the end of the first quarter (seeExhibit O). The stock market’s primary “worries” have been agenerally high level of current valuation, signs of inflationarystress points in some areas (mainly commodities), risinginterest rates, and uncertainty over the Federal Reserve’s courseof action. While all of these factors may serve to limit thestock market’s near-term progress, a critical offsetting elementis that corporate profits have been exhibiting very strongtrends, which has already resulted in a gradual diminution of


the trailing price earnings ratio of the S&P 500 Index fromnearly 35x to 30x earnings (see Exhibit P). Reported S&P 500profits advanced over +26 percent year-over-year in the secondquarter (due to much lower-than-expected writeoffs) andoperating profits advanced +14 percent. Third quarteroperating profits should accelerate to over +20 percent, led bythe turnaround in energy and financial company earnings inaddition to the technology sectors (see Exhibit Q). Theimproving profit picture can be seen in the sharp accelerationof earnings estimates on the Institutional Brokers EstimateSystem (IBES), where S&P 500 forecasts have been raised bymore than $1.00 per share in each of the past two months. Thishas resulted in an increase in the earnings yield for stocks thathas been more than competitive with the increase in interestrates over this period, and the stock/bond yield spread, a keymeasure of the interaction of the stock and bond markets, hasbecome more favorable for stocks (see Exhibit R). As profitscontinue to advance, the next base for further stock marketprogress is being built, and for the vast majority of stocks (i.e.,the bottom 480 stocks in the S&P 500) valuation levels arealready not excessive (see Exhibit S).

The source for the surprising strength in corporate profits canbe traced to technology investments in several ways. One is thetrend of relative prices of labor and capital goods. LehmanBrothers has recently measured this relationship in the 1990sand found that the relative price of capital goods compared tolabor has fallen by -34 percent, which has led to a surge incapital investment and a massive substitution of capital forlabor (see Exhibit T). As a result, the economy hasexperienced the best capacity creating cycle since the 1960s,which has led to a resurgence in profit margins (see Exhibit U).Other evidence of the long-term impact of capital investment isthe sharp upward trend of research and development spending

over the past twenty years. Expressed as a percentage ofrevenues, R&D spending increased from 1-3/4 percent ofrevenues of non-financial corporations to over 3 percent,representing a massive absolute dollar change. Tabulations ofpatents issued corroborate the surge in research and a recentstudy by the Federal Reserve Bank of Philadelphia suggeststhat if price-earnings ratios are adjusted for R&D and otherintangibles, the stock market is not so highly valued (seeExhibit V).

We see the manifestation of a strategy of investing above-average amounts in technology-related companies is sustainedhigh earnings growth rates across all of Sit InvestmentAssociates’ domestic equity portfolio strategies. An updatedtabulation of the 5-year projected earnings growth rates for thethree major strategies is presented below and Exhibit Wcontains detailed financial characteristics, including valuations,for each of them:

5-Year Projected E.P.S.Growth Rates

Dates ofProjection

LargeCap

Medium Cap

Small Cap

S&P 500

Dec 1996 +19.3% +24.5% +30.1% +12.2%Dec 1997 +19.3 +24.7 +26.3 +9.0Dec 1998 +20.4 +25.7 +31.2 +8.0Sept. 1999 +21.7 +29.7 +35.5 +10.0Modest cash reserve levels continue to be maintained in equityportfolios. We are cognizant that uncertainties surrounding Y2Kissues, Federal Reserve actions, and company-specific eventsmay create interesting opportunities in the period ahead and weremain alert at all times for opportunities to upgrade holdings tomaximize potential.

This analysis contains collective options of our analysts and portfolio managers, and is providedfor informational purposes only. While the information is deemed accurate at the time of writing,such information is subject to change at any time without notice.

Exhibit A


Securities Markets

E Q U I T I E S 09/30/99 08/31/99 06/30/99 12/31/98 12/31/97 OneMonth

ThreeMonths

NineMonths

21Months

Dow Jones Industrials 10336.95 10829.28 10970.80 9181.43 7908.25 -4.5% -5.8% +12.6% +30.7%S&P 500 1282.71 1320.41 1372.71 1229.23 970.43 -2.9 -6.6 +4.4 +32.2NASDAQ OTC Composite 2746.16 2739.35 2686.12 2192.69 1570.35 +0.2 +2.2 +25.2 +74.9

F I X E D I N C O M E

U.S. TREASURY

1-Year Bill 5.15 5.24 5.18 4.48 5.48 -9 b.p. -3 b.p. +67 b.p. -33 b.p.2-Year Notes 5.59 5.68 5.53 4.54 5.66 -9 +6 +105 -75-Year Notes 5.77 5.87 5.66 4.55 5.71 -10 +11 +122 +610-Year Notes 5.89 5.98 5.80 4.66 5.74 -9 +9 +123 +1530-Year Bonds 6.06 6.07 5.98 5.12 5.92 -1 +8 +94 +14

AA INDUSTRIAL

Intermediate Maturity 6.89 7.08 6.75 5.41 6.29 -19 +14 +148 +60Long Maturity 7.21 7.32 7.08 6.07 6.62 -11 +13 +114 +59

MORTGAGES

Current Coupon GNMA (7.00%) 7.37 7.74 7.30 6.35 6.71 -37 +7 +102 +66

MUNICIPALS

Bond Buyer 40-Bond Index 5.89 5.78 5.55 5.16 5.26 +11 +34 +73 +63S H O R T T E R M

Fed Funds 5.30 5.31 4.95 4.45 5.45 -1 +35 +85 -15Discount Rate 4.75 4.75 4.50 4.50 5.00 -- +25 +25 -25Prime Rate 8.25 8.25 7.75 7.75 8.50 -- +50 +50 -2513-week Treas. Bills-Disc. 4.71 4.84 4.67 4.44 5.20 -13 +4 +27 -49

E-09/99pp-107.doc

Exhibit B


Changes in Group Leadership

S&P 500

S&P 500 Year 1997 Year 1998 9 Months 1999 September 1999ECONOMIC SECTOR Weighting Return Rank Return Rank Return Rank Return RankNON-ENERGY MINERALS 0.9 -16.5 17 -6.9 16 27.2* 3 1.8* 5PRODUCER MANUFACTURING 7.3 36.6* 5 19.7 8 19.2* 4 1.9* 4ELECTRONIC TECHNOLOGY 18.1 21.0 14 65.8* 2 32.0* 1 -2.2* 8CONSUMER DURABLES 1.8 22.8 12 28.3 6 -7.3 13 -7.2 13ENERGY MINERALS 5.7 22.0 13 6.7 12 15.8* 5 -3.4 9PROCESS INDUSTRIES 2.8 16.3 15 -4.5 15 3.6 9 -4.9 10HEALTH TECHNOLOGY 9.8 48.0* 2 49.2* 4 -9.4 14 -7.3 14CONSUMER NON-DURABLES 7.3 30.3 9 11.4 11 -17.1 16 -10.5 16INDUSTRIAL SERVICES 0.9 31.8 8 -28.2 17 6.3* 7 -8.7 15COMMERCIAL SERVICES 0.7 27.1 11 14.3 9 5.4* 8 2.4* 2TECHNOLOGY SERVICES 7.6 36.1* 6 74.0* 1 29.0* 2 3.4* 1HEALTH SERVICES 0.8 2.0 16 -1.5 13 -30.7 17 -16.7 17CONSUMER SERVICES 4.6 42.0* 4 27.5 7 8.7* 6 2.0* 3RETAIL TRADE 6.2 46.0* 3 63.3* 3 -1.9 11 1.2* 7TRANSPORTATION 0.8 28.6 10 -2.1 14 -11.3 15 -5.0 11UTILITIES 10.6 35.3* 7 40.2* 5 2.9 10 1.6* 6FINANCE 13.9 48.8* 1 11.7 10 -4.5 12 -5.2 12

UNIVERSE(S&P 500) 100.0 33.2 28.7 5.3 -2.8

Groups Outperforming (cap weighted) 7/17 5/17 8/17 8/17 to Total Groups

S&P/BARRA GROWTH 36.4 42.3 7.3 -1.7 S&P/BARRA VALUE 30.0 14.8 3.3 -3.9

* Group OutperformedSource: Wilshire Associates, Inc.

Exhibit C


Changes in Group Leadership - S&P 400 Midcap Index

1999 Market Leadership has Focused on Electronic Technology

S&PMIDCAP Year 1997 Year 1998 9 Months 1999 September 1999

ECONOMIC SECTOR Weighting Return Rank Return Rank Return Rank Return RankNON-ENERGY MINERALS 1.7 29.1 9 16.3 7 -11.1 12 -2.8* 9PRODUCER MANUFACTURING 5.7 18.9 11 -4.9 14 -8.5 11 -7.2 14ELECTRONIC TECHNOLOGY 14.6 17.0 13 29.7* 4 44.1* 1 -2.4* 8CONSUMER DURABLES 3.6 20.1 10 18.6 5 -8.5 10 -4.7 11ENERGY MINERALS 1.9 11.2 16 -38.9 17 13.0* 3 -1.0* 5PROCESS INDUSTRIES 4.8 14.9 14 -19.7 15 -6.0 8 -1.0* 6HEALTH TECHNOLOGY 8.2 14.8 15 44.9* 2 3.7* 5 -6.0 13CONSUMER NON-DURABLES 4.5 40.6* 5 0.9 11 -14.6 14 -0.6* 4INDUSTRIAL SERVICES 3.0 43.9* 3 -34.3 16 29.0* 2 -8.0 15COMMERCIAL SERVICES 4.4 29.5 8 -0.1 12 -19.2 16 -3.9 10TECHNOLOGY SERVICES 8.2 37.6* 6 155.4* 1 -7.8 9 3.3* 2HEALTH SERVICES 2.2 5.4 17 12.6 9 -48.2 17 -21.4 17CONSUMER SERVICES 6.8 18.6 12 7.8 10 -4.8 7 1.1* 3RETAIL TRADE 4.5 44.3* 2 39.9* 3 5.4* 4 5.7* 1TRANSPORTATION 1.4 43.0* 4 -1.5 13 -11.9 13 -11.0 16UTILITIES 11.3 29.8 7 17.5 6 -4.2 6 -1.4* 7FINANCE 12.9 72.1* 1 13.4 8 -16.0 15 -5.0 12

UNIVERSE(S&P MIDCAP) 100.0 32.5 18.8 -2.0 -3.1

Groups Outperforming (cap weighted) 6/17 4/17 5/17 9/17 to Total Groups

* Group OutperformedSource: Wilshire Associates, Inc.

Exhibit D■ Sit Investment Associates, Inc. ■

U.S. Ranked 17th Out of 33 World Equity Markets Through September 1999, Up One From the Previous Month

PERFORMANCE IN U.S. DOLLARS

DJ Global, Change fromIndexes, US$ 12/31/98 Country

Country on 9/30/99 points percent RankAustralia 153.70 12.68 8.99% 15Austria 96.36 -8.96 -8.51% 27Belgium 234.37 -55.04 -19.02% 33Brazil 225.52 -13.07 -5.48% 25Canada 167.58 21.34 14.59% 14Chile 154.57 23.63 18.05% 13Denmark 181.26 -8.87 -4.67% 24Finland 830.70 226.18 37.41% 5France 240.10 19.09 8.64% 16Germany 236.59 -11.42 -4.60% 23Greece 419.12 137.12 48.62% 2Hong Kong 258.18 54.12 26.52% 8Indonesia 51.00 10.55 26.08% 9Ireland 299.57 -36.07 -10.75% 28Italy 207.31 -27.11 -11.56% 30Japan 106.22 32.02 43.15% 3Mexico 122.63 33.61 37.76% 4Netherlands 323.41 -22.62 -6.54% 26New Zealand 126.48 -2.92 -2.26% 21Norw ay 144.40 28.28 24.35% 11Philippines 121.49 -5.80 -4.56% 22Portugal 241.74 -56.15 -18.85% 32Singapore 139.93 30.52 27.90% 7South Africa 92.28 21.58 30.52% 6South Korea 92.60 31.37 51.23% 1Spain 240.98 -29.65 -10.96% 29Sw eden 310.64 57.18 22.56% 12Sw itzerland 346.85 -49.08 -12.40% 31Taiw an 154.35 31.06 25.19% 10Thailand 39.79 0.03 0.08% 19United Kingdom 201.74 3.17 1.60% 18United States 1207.35 38.01 3.25% 17Venezuela 39.84 -0.09 -0.23% 20

COMPOSITE INDICES

Latin America 146.45 18.12 14.12%Europe/Africa(ex S.Africa) 241.02 -3.37 -1.38%Asia/Pacif ic 110.75 29.72 36.68%World (ex U.S.) 162.45 15.43 10.50%

Source: Dow Jones Company, October 1, 1999

Exhibit F


Economic Assumptions

1997 1998 1999 2000E1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3QE 4QE 1Q 2Q 3Q 4Q

QUARTERLY DATA (% CHANGE)

Real GDP (New) 4.2 4.0 4.2 3.0 5.5 1.8 3.7 6.0 4.3 1.6 4.5 4.0 3.0 4.0 3.5 3.5(Qtr. to Qtr. Ann.)

S&P 500 Reported Profits 16.9 3.1 0.8 -9.3 -1.7 -5.5 -8.9 -4.3 6.5 26.7 20.9 30.3 23.2 3.5 8.6 0.8 (Year-over-Year)Consumer Price Index 2.9 2.3 2.2 1.9 1.5 1.6 1.5 1.5 1.7 2.1 2.2 2.5 2.6 2.3 2.5 2.7

(Year-over-Year)

LEVELS (QUARTERLY AVERAGE)

Unemployment Rate 5.3 4.9 4.9 4.7 4.7 4.4 4.6 4.4 4.3 4.3 4.3 4.2 4.4 4.2 4.2 4.2Prime Rate 8.3 8.5 8.5 8.5 8.5 8.5 8.5 7.9 7.8 7.8 8.1 8.4 8.5 8.5 8.5 8.513-week Treasury Bills-Disc. 5.1 5.1 5.0 5.1 5.1 5.0 4.8 4.3 4.4 4.5 4.7 4.9 5.0 5.0 5.0 5.010-year Treasury Bonds-Yield 6.6 6.7 6.2 5.9 5.6 5.6 5.2 4.7 5.0 5.5 5.9 6.0 6.0 5.8 5.8 5.9

E-10/99

pp-100.y2000doc

Exhibit H� Sit Investment Associates, Inc. ��

Broad-Based Inflation Measures Have Been Rising Recently

`

Source: ISI Group & Department of Labor, September 10 & 15, 1999E-9/99

Consumer Price InflationYear-over-year change in prices paid by consumers

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

'60 '61 '62 '63 '64 '65 '66 '67 '68 '69 '70 '71 '72 '73 '74 '75 '76 '77 '78 '79 '80 '81 '82 '83 '84 '85 '86 '87 '88 '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99

All Items

Core Rate

All: +2.3%

Core: +1.9%

Producer Price InflationYear-over-year change in prices paid forfinished goods by manufacturers

-4

-2

0

2

4

6

8

10

12

14

16

18

20

'60 '61 '62 '63 '64 '65 '66 '67 '68 '69 '70 '71 '72 '73 '74 '75 '76 '77 '78 '79 '80 '81 '82 '83 '84 '85 '86 '87 '88 '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '99

All Items

Core Rate

Core: +1.3%

All: +2.3%

Exhibit I


Dollar Exchange Rate Trends Versus Major Currencies

1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9

ExchangeRate

Year-Over-Year% Change

6-MonthRate of ChangeAnnualized

ExchangeRate



ExchangeRate



ExchangeRate



January 84.32 -0.8% 13.9% 88.03 4.4% 6.3% 96.37 9.5% 11.0% 92.37 -4.2% -14.0%February 84.59 0.6 7.8 90.71 7.2 13.9 95.39 5.2 4.6 93.76 -1.7 -14.3March 84.51 4.3 3.9 91.43 8.2 13.9 95.83 4.8 6.2 95.69 -0.1 -2.7April 85.01 8.6 7.0 92.58 8.9 15.7 96.41 4.1 8.8 95.76 -0.7 4.9May 85.44 8.5 7.2 90.88 6.4 13.7 96.88 6.6 8.2 95.79 -1.1 3.3June 85.70 8.9 6.0 90.38 5.5 8.9 98.68 9.2 7.2 96.56 -2.1 6.8July 85.36 8.3 2.5 91.34 7.0 7.5 99.31 8.7 6.1 96.78 -2.5 9.5August 84.82 4.2 0.5 93.26 10.0 5.6 100.96 8.3 11.7 94.74 -6.2 2.1September 85.48 3.1 2.3 92.93 8.7 3.3 96.99 4.4 2.4 93.24 -3.9 -5.1October 85.83 4.5 1.9 92.34 7.6 -0.5 93.46 1.2 -6.1November 85.05 3.1 -0.9 93.07 9.4 4.8 94.23 1.2 -5.5December 86.55 4.0 2.0 95.26 10.1 10.8 93.40 -2.0 -10.7

Average 85.22 91.85 96.49 94.97

Note: THE EXCHANGE RATE ABOVE IS AN INDEX OF THE TRADE-WEIGHTED AVERAGE EXCHANGE VALUE OF THE U.S. DOLLAR AGAINST CURRENCIES OF THE G-10 COUNTRIESAND OF THE OTHER COUNTRIES OF THE EURO AREA AND THE AUSTRALIAN DOLLAR.

Source: Federal Reserve Bulletin

E-09/99

pp-105.doc

Exhibit J


Expected Range Of Future Fixed Income Returns

From September 30, 1999

T I M E H O R I Z O N

6 Months 1 Year 3 Yrs (Ann. Return)

Risk Level/ Representative Issue Interest RateForecast

Terminal Yield TotalReturn

TerminalYield

TotalReturn

TerminalYield

TotalReturn

LOW RISK

2 yr. Constant Mat. Tsy. Pessimistic 6.25% 1.6% 6.00% 4.9% 5.50% 5.7%Present YTM 5.59% Most Likely 5.75 2.5 5.50 5.8 4.75 6.1

Optimistic 5.00 3.9 4.50 7.7 4.00 6.6

MEDIUM RISK

10 yr. Constant Mat. Tsy. Pessimistic 6.50 -1.5 6.50 1.5 6.00 5.7Present YTM 5.89% Most Likely 6.00 2.1 5.75 7.0 5.25 7.4

Optimistic 5.25 7.9 4.75 15.0 4.25 9.8

HIGH RISK

30 yr. Constant Mat. Tsy. Pessimistic 6.75 -5.8 6.75 -2.7 6.25 5.4Present YTM 6.06% Most Likely 6.25 0.5 6.00 7.0 5.50 8.5

Optimistic 5.50 11.2 5.00 22.5 4.50 13.2

Exhibit K


1999 Federal Deficit Trends Compared To 1998

RECEIPTS OUTLAYS SURPLUS/DEFICIT

FY98 FY99 Diff FY98 FY99 Diff FY98 FY99 Diff

OCTOBER $114.9 $120.0 $5.1 $150.9 $152.4 $1.5 $(36.0) $(32.4) $3.5 NOVEMBER 103.5 114.0 10.5 120.8 130.9 10.1 (17.3) (16.9) 0.4

DECEMBER 168.0 178.6 10.6 154.4 183.8 29.4 13.6 (5.2) (18.8)

JANUARY 162.6 171.7 9.1 137.2 101.2 (36.0) 25.4 70.5 45.1FEBRUARY 98.0 99.4 1.5 139.7 141.8 2.1 (41.7) (42.3) (0.6)MARCH 117.9 130.3 12.4 131.7 152.7 21.0 (13.8) (22.4) (8.6)

APRIL 261.0 266.1 5.1 136.4 152.7 16.3 124.6 113.5 (11.1)MAY 95.3 98.6 3.3 134.1 122.6 (11.5) (38.8) (24.0) 14.8JUNE 187.9 199.5 11.6 136.8 145.9 9.2 51.1 53.6 2.5

JULY 119.7 121.9 2.2 143.8 147.1 3.3 (24.1) (25.2) (1.1)AUGUST 111.7 126.3 14.6 122.9 128.8 5.9 (11.2) (2.5) 8.7SEPTEMBER 181.0 143.6 37.4

FY TO DATE(11 MONTHS) $1540.5 $1626.5 $86.0 $1508.7 $1559.9 $51.2 $31.8 $66.6 $34.8

Source: Treasury Bulletin and ISI Group, Inc.

E-09/99

pp-102.doc

Exhibit L�� Sit Investment Associates, Inc. ��

Year-to- Date 1999 Nasdaq Performance Primarily DrivenBy The Top Ten Issues (through 9/30/99)

YTDMARKET CLOSING 1999 PERCENTAGE

PERCENT VALUE PRICE TOTAL POINTSYMBOL ISSUE OF INDEX ($ MIL.) 8/31/99 RETURN CONTRIB.

MSFT MICROSOFT CORP 14.0 $465,627.5 $90.563 30.6 4.11INTC INTEL CORP 7.5 248,336.9 74.313 25.4 1.93CSCO CISCO SYSTEMS INC 6.8 226,085.6 68.563 47.7 2.69WCOM MCI WORLDCOM INC 4.1 135,741.4 71.875 0.2 0.01DELL DELL COMPUTER CORP 3.2 106,701.8 41.813 14.3 0.51SUNW SUN MICROSYSTEMS INC 2.2 72,591.4 93.000 117.2 1.49ORCL ORACLE CORP 2.0 65,087.0 45.500 58.3 0.93YHOO YAHOO INC 1.4 46,489.6 179.500 51.5 0.47AMGN AMGEN INC 1.3 41,561.4 81.500 55.9 0.57QCOM QUALCOMM INC 0.9 30,373.1 189.188 630.3 0.88

AVERAGE 143,859.6 103.1

TOTAL 43.4 13.61

NASDAQ COMPOSITE % RETURN 25.2

Source: Nasdaq Stock Market, Inc., and FactSet Data Systems Inc., 9/30/99

Exhibit M■ Sit Investment Associates, Inc. ■

Tech Stocks Have Dramatically Outperformed the Rest of the Market

S&P 500 Index

Russell 2000 Index

Note: Tech stocks consists of the sectors electronic technology, technology services and Internet services.

YTD(12/98 to 9/99)

30.40%

-1.23%

5.37%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

Tech Stocks Non Tech Stocks Index Return

3Q99(6/99 to 9/99)

3.24%

-9.10%-6.24%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%


YTD(12/98 to 9/99)

31.59%

-4.00%

2.37%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%


3Q99(6/99 to 9/99)

1.34%

-8.25%-6.32%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%


Source: Wilshire Associates, Inc.

Exhibit N■ Sit Investment Associates, Inc. ■

Large, Medium and Small Cap Stock 6-Month Price Momentum

E-10/99g :\research\charts \6moprmo

S&P Midcap 6-Month Price Momentum

-25.0

-15.0

-5.0

5.0

15.0

25.0

35.0

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

%Change

July: 8.2 August: 10.3 Sept.: 4.0S&P 500 6-Month Price Momentum

-25

-15

-5

5

15

25

35

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

%Change

July: 3.8 August: 6.6 Sept.: -0.3

Russell 2000 6-Month Price Momentum

-35

-20

-5

10

25

40

55

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

%Change

July: 4.1 August: 9.1 Sept.: 7.5

Exhibit P

� Sit Investment Associates, Inc. �

Stock/ Bond Yield Spread

S&P 500 Earnings Yield Minus Long-Term Bond Yield

-6.00

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

'62 '63 '64 '65 '66 '67 '68 '69 '70 '71 '72 '73 '74 '75 '76 '77 '78 '79 '80 '81 '82 '83 '84 '85 '86 '87 '88 '89 '90 '91 '92 '93 '94 '95 '96 '97 '98 '990.0x

5.0x

10.0x

15.0x

20.0x

25.0x

30.0x

35.0x

40.0x

*E/P ratio on trailing 4-quarter earnings for the S&P 500 minus yield on weighted combination of 20 and 30 year U.S.Treasury Bonds

P/E RATIO FOR THE S&P 500

STOCK/BOND YIELD SPREAD

Source: Department of Commerce, Compustat, and Sit Investment Associates, Inc., September 30, 1999

Exhibit R

� Sit Investment Associates, Inc. �

Stock/Bond Yield Spread

THE S&P 500 YIELD TO MATURITY STOCK/BOND SPREAD

EST’DEPS (A)

CLOSINGPRICE

E/PYIELD

LONG-TERM

TREASURIESONE-YEARTREASURY

LONG-TERM

TREASURIESONE-YEARTREASURY

1992 December (Act.) $19.09 $435.71 4.4% 7.4% 3.6% -3.0% 0.8%1993 December (Act.) 21.89 466.45 4.7 6.4 3.6 -1.7 1.11994 December (Act.) 30.61 459.27 6.7 7.9 7.2 -1.2 -0.51995 December (Act.) 33.96 615.93 5.5 5.9 5.1 -0.4 0.41996 December (Act.) 38.73 740.74 5.2 6.6 5.5 -1.4 -0.31997 December (Act.) 39.72 970.43 4.1 5.9 5.5 -1.8 -1.41998 December (Act.) 37.71 1229.23 3.1 5.1 4.5 -2.0 -1.4

1999 EPS 1999 January 43.29 1279.64 3.4 5.1 4.5 -1.7 -1.1

February 42.64 1238.33 3.4 5.6 4.9 -2.2 -1.5March 42.66 1286.37 3.3 5.6 4.7 -2.3 -1.4April 42.87 1335.18 3.2 5.7 4.7 -2.5 -1.5May 42.76 1301.84 3.3 5.8 4.9 -2.5 -1.6June 42.96 1372.71 3.1 6.0 5.2 -2.9 -2.1July 43.00 1328.72 3.2 6.1 5.1 -2.9 -1.9August 44.24 1320.41 3.4 6.1 5.2 -2.7 -1.8September 45.46 1282.71 3.5 6.1 5.2 -2.6 -1.7

2000 EPS 1999 January 43.18 1279.64 3.4 5.1 4.5 -1.7 -1.1

February 43.50 1238.33 3.5 5.6 4.9 -2.1 -1.4March 44.60 1286.37 3.5 5.6 4.7 -2.1 -1.2April 45.58 1335.18 3.4 5.7 4.7 -2.3 -1.3May 45.69 1301.84 3.5 5.8 4.9 -2.3 -1.4June 46.02 1372.71 3.4 6.0 5.2 -2.6 -1.8July 46.08 1328.72 3.5 6.1 5.1 -2.6 -1.6August 47.62 1320.41 3.6 6.1 5.2 -2.5 -1.6September 49.43 1282.71 3.9 6.1 5.2 -2.2 -1.3

(A) EARNINGS ARE REPORTED E.P.S. (AFTER WRITE-OFFS).

Source: Institutional Brokers Estimate System (ibes) and sit investment associates

Exhibit S�� Sit Investment Associates, Inc. ��

1999 S&P 500 Performance Primarily DrivenBy The largest 20 Stocks * (thru 9/30/99)

F1999 F19999/30/99 MKT P/E P/E YTD

PERCENT CAP @ @ 99 % EPS % TOTALSYMBOL ISSUE OF INDEX ($MIL) 12/98 09/99 GROWTH RETURNMSFT MICROSOFT CORP 4.4 462,655 58.8x 67.1x 51.5 30.6 GE GENERAL ELECTRIC CO 3.6 384,037 32.0x 36.8x 15.0 17.3 INTC INTEL CORP 2.4 250,426 27.4x 32.3x 30.0 25.5 CSCO CISCO SYSTEMS INC 2.2 227,116 63.5x 92.3x 27.2 47.7 WMT WAL-MART STORES 2.0 214,929 37.3x 38.6x 24.8 17.2 IBM INTL BUSINESS MACHINES CORP 2.0 213,020 24.5x 30.9x 19.1 31.6 LU LUCENT TECHNOLOGIES INC 1.8 191,882 52.5x 53.8x 40.1 18.1 XON EXXON CORP 1.7 181,173 26.2x 31.3x -8.2 5.6 MRK MERCK & CO 1.5 159,789 30.0x 26.5x 14.0 -11.0 C CITIGROUP INC 1.4 146,068 14.3x 15.9x 55.8 34.0 PFE PFIZER INC 1.4 144,584 50.3x 43.8x 22.3 -13.4 BMY BRISTOL MYERS SQUIBB 1.3 139,646 32.9x 32.9x 14.5 2.2 T AT&T CORP 1.3 133,420 18.5x 20.0x -5.2 -12.6 WCOM MCI WORLDCOM INC 1.3 132,054 36.3x 36.6x #N/A 0.2 AIG AMERICAN INTERNATIONAL GROUP 1.3 131,596 24.3x 27.1x 14.3 12.6 RD ROYAL DUTCH PET -NY REG 1.2 127,318 26.6x 29.3x 33.5 26.2 JNJ JOHNSON & JOHNSON 1.2 126,378 28.3x 30.6x 12.4 10.5 PG PROCTER & GAMBLE CO 1.2 122,884 32.2x 33.2x 10.5 3.6 KO COCA-COLA CO 1.2 121,145 44.8x 37.2x -7.3 -27.3 AOL AMERICA ONLINE INC 1.1 119,534 275.2x #N/A #N/A 34.2

TOP 20 TOTAL WEIGHT 35.4TOP 20 EQUAL-WEIGHTED AVERAGE 46.8x 37.7x 20.2 12.7 TOP 20 MEDIAN 32.1x 32.9x 17.0 14.9

NEXT 480 TOTAL WEIGHT 64.6NEXT 480 EQUAL-WEIGHTED AVERAGE 22.7x 24.9x 11.1 5.9 NEXT 480 MEDIAN 18.0x 18.4x 12.5 -3.4

TOTAL INDEX WEIGHT 100.0TOTAL INDEX EQUAL-WEIGHTED AVERAGE 23.7x 25.4x 11.4 6.1 TOTAL INDEX MEDIAN 18.5x 18.9x 12.7 -2.8

Source: First Call, FactSet Data Systems Inc., and Sit Investment Associates, Inc. 09/30/99

Exhibit W


Equity CharacteristicsSeptember 30, 1999

Large Cap Mid Cap Small CapGrowth (33) Growth (6) Growth (103) S&P 500(1) S&P 500(2)

Earnings Outlook - Strong Growth

1999 Projected Gain +24.7% +29.6% +40.6% +19.3% +10.3%2000 Projected Gain +22.9% +31.3% +33.0% +8.9% +8.0%

5-Year Projected Growth +21.7% +29.7% +35.5% +10.0% +9.0%

Dividend Yield

Equities Only +0.5% +0.2% +0.2% 1.3% 1.3%

Total Fund +0.8% +0.2% +0.3% 1.3% 1.3%

Implied Return

5-Year Growth & Yield -Equity Only +22.2% +29.9% +35.7% +11.3% +10.3%(Assumes no Change in P/E Ratio)

Average Price/Earnings Ratio

1999 Calendar P/E 39.1x 42.2x 42.6x 28.5x 25.7x2000 Calendar P/E 31.9x 33.3x 38.9x 26.2x 23.8x

Beta Level - Risk/Reward Ratio (3)

Equity Only 1.12 1.20 1.21 1.00 1.00

Weighted Average Market Capitalization ($ Billion) $114.395 $7.262 $2.484 $106.715 $106.715

(1) Based on S&P 500 reported earnings(2) Based on S&P 500 earnings prior to write-offs(3) Beta is based on Vestek's fundamental risk model, not the conventional historical beta.

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