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If tech and telecom stocks were removed from the S&P's 500, the past few years would have looked like a steady bull market - it would have actually gained 5.9% last year, instead of the 9.1% decline with them in the index. "If you take tech and telecom out of the market, you're still left with 75% of the market capitalization of U.S. stocks - and those stocks never came close to a bear market and are now on the verge of an all-time high," says Jim Bianco, who wrote the study. The S&P 500, with tech and telecom stocks taken out, is just 4% off its record high set in June 1999, much like the Dow, which is about 5% from its record. So far in 2001, nontech issues in the S&P 500 have added 1%, compared with a loss of 8% for tech stocks. Overall, 287 stocks are up in the S&P 500 while 213 are down, with 60% of nontech companies gaining ground, despite the loss of 3.2% for the overall S&P 500.
Even worse, the withdrawals will increase their incomes so much that a larger percentage of their Social Security benefits will be taxed by the federal government. (Richer households do not have that problem because their Social Security benefits are already taxed at the upper limit.) According to the study, which is expected to be published next month, a married couple earning $50,000 combined at age 25 will indeed do well in a 401(k) if it returns a steady 4% a year. Their lifetime taxes will go down; the money they have available to spend will go up. But if the return increases to 6%, their taxes increase 1.1% and their available money falls by 0.39%. With an 8% return, taxes rise 6.38% and available money falls 1.73%. And that leads to the question: Why get into an investment at all if you have to hope it does not do too well? (The authors also discovered that IRA's generally do not share the same problems as 401(k)'s, but they will if Congress increases the IRA investment maximum to $5,000, a move it is considering.)
Real estate remains real estate, subject to economic fluctuations just like other industries. If stores shut down in shopping centers because of declining consumer demand, rents will decline. If businesses occupying office buildings shut down, offices may sit empty. REITs differ from other dividend-paying stocks in one critical way. With ordinary dividend-paying companies, the government effectively taxes profits twice, once when earned by the company and again when distributed to the shareholder. Under federal law, REITs do not have to pay taxes on their profits -- as long as they pass 90% of their proceeds to shareholders, who do pay taxes. There are roughly 200 publicly traded REITs. A small percentage are "mortgage" REITs - which invest in debt. Most are equity REITs, owning property. They are valued differently than conventional stocks, by "funds from operations" (FFO) per share as well as by earnings per share. Investing professionals offer three basic guidelines for evaluating REITs: Look for a management with at least five years of experience before the company went public; look for a substantial management ownership interest (10 to 15 percent) in the REIT; watch out for excessive debt, especially short-term, variable-rate debt; and carefully examine the assets of a REIT. "You should really be looking to the REIT for a history of paying out dividends and those dividends increasing each year," added Edmund Cronin, chairman of Washington Real Estate Investment Trust. "Going beyond that, you have to ask what is your risk tolerance. Some REITs are involved in development, which is riskier than companies that buy existing properties. The Achilles' heels of REITs are too much debt and overdevelopment." Ken Statz, managing director of Security Capital Research and Management, said REIT shoppers' greatest mistake is succumbing to the lure of exorbitant dividend yields. "When you go over a 10% yield, that's a sign of distress," not health, said Statz. "It means that the only way they can keep people buying stock is by offering a very high yield, and that the yield will probably be cut rather than increase. If the average yield is 7% and you see a 10, the market is saying it's not sure about a company." Related: More REIT Guidelines, LA Times 5-29 Apartment and industrial REITs are relatively strong bets in a slowing economy, said analyst Ross Smotrich of Bear, Stearns, because both tend to weather economic slowdowns better than offices or some other property classes. Apartment and industrial REITs usually own properties over a broad geographic area, offering protection against a sharp downturn in any one local market, Smotrich said. Apartments also do well in a slowdown because home buying slackens and people stay in apartments longer, Smotrich said, while industrial properties benefit from some of the choices that corporate managers make in a slowdown. "Industrial space is more likely to be mission-critical for a lot of companies," Smotrich said. "A company with expensive office space as well as inexpensive warehouse space is more likely to vacate the office space and keep the warehouse space because it needs it for its inventory." Related: REIT Forecasts, NY Times 5-27 "We're running our business today on the basis that the economy may be a whole lot less robust," said Bill Rouse, the chairman of Liberty Property Trust. In the near term, the market will be under pressure not only from newly created space, but an additional 10% increase in space vacated by foundering companies and a slide in demand of between 10-15%. "That said, I don't think a catastrophe is around the corner," he said. "It's not hard to imagine REIT's increasing earnings 7-8%." Experts said REIT's will probably be able to keep their growth rates moving even if the economy slows because office and industrial leases typically extend five to eight years, making them less susceptible to tenants' weaknesses. After jumping 10.1% in 1997 from an advance of 5.4% in 1996, rental prices have risen more than 9% every year since, said Jim Costello, a senior economist at Torto Wheaton Research. Yet, even if rent growth is flat in 2001, renewals are likely to be at significantly higher levels than leases signed in 1996. A larger concern may be the declining demand for space. Mr. Costello said that the first quarter of 2001 showed negative absorption in the office sector, meaning that more new unoccupied space was left vacant than rented. "It's not just the vacancy level that helps set the rents, it's the number of people coming to the door," Mr. Costello said. "With the number of people coming to the door declining, REIT's can't set their rents so high." Yet even the hovering concern of a modest rise in inflation may turn out to be a positive for REIT's, said David Shulman, a REIT analyst for Lehman Brothers. Rents in the long run are determined by the costs of building. "If reproduction costs rise in response to inflation, so too will rents," he said. "If supply is tight then real rents will rise. With supply and demand in rough balance, REIT's should be able to reasonably push through an inflationary period." So far this year, REIT's have withstood broader economic woes. In Q1-01, REIT's posted growth in funds from operations of 7.7%, compared with the average 10.6% earnings decline posted by the S&P 500. However, REIT's are still trading at a discount of roughly 10% to their net asset value. The 111 component Amex Morgan Stanley REIT index is at a record high and up 20% since last May. Expected revenue growth for the sector is 7% in 2001 and 8% in 2002. Analysts and money managers view REIT's as a major diversification tool. This week a study by Ibbotson Associates showed REIT performance had only a 0.25 correlation with the S&P 500 in 2000, down from 0.65 in the 1980's and 0.45 in the 1990's. Related: Falling Demand, WSJ 5-29 Office and industrial space is emptying at a faster pace than at any time in the recent past, a sign the economic slowdown is hitting commercial real estate harder than expected, according to a new study by LA real-estate services firm Torto Wheaton Research. The amount of occupied office space in the first quarter dropped by 17 million square feet across 72 U.S. markets tracked by the firm. This was the first time the overall "net absorption rate" has fallen since Torto began its quarterly study in 1987, and in part reflects the 20 million square feet of sublease office space that tenants poured into the market. On the industrial and warehouse side, the amount of occupied space dropped by 14.4 million square feet. The last time the industrial net absorption rate decreased was Q1-91. In Q1-01, average office-vacancy rates increased to 9.5% from 8.3%, the biggest percentage-point jump in the survey's history. For industrial properties, vacancy rates climbed to 7.2% from 6.6%. Related: Mortgage REIT's, WSJ 5-30 Driven by the Fed's cutting of interest rates, mortgage real-estate investment trusts have become the hottest thing in REIT-land. Lower short-term interest rates make borrowing less costly. As a result, mortgage REITs have seen a rise in their earnings and dividend payments to shareholders. Mortgage REITs have returned 45% to investors year-to-date. Small in number and size - there are 22 mortgage REITs compared with 157 equity REITs, and the group's stock-market capitalization is $2.4 billion compared with $136.24 billion for equity REITs - few analysts cover them. Mortgage REITs' dependence on the economy, particularly on the Fed, makes their success quite fragile. The industry suffered in 1998, the result of a big refinancing boom and a climate that made it more challenging for mortgage companies to obtain capital. Subsequently, a number of companies sought bankruptcy-law protection. Making matters worse, the Fed began raising interest rates in 1999 to cool the economy and keep inflation in check.
Now they're dropping like flies. The first to go was the 20-year Treasury bond. The last bunch of these was auctioned in January 1986. Then came the demise of the three-year note. Last auctioned in March 1998, this poor bird is already extinct. And now, as of February, the Treasury has announced that the one-year T-bill is history. The last one-year bills were issued on Feb. 27. So, come Feb. 28 next year, the existing crowd will be gone. This is only symptomatic of what investors are facing; less and less income from fewer sources. Only 2,421 of the 7,201 stocks pay actual dividends. The others, a 2-to-1 majority, apparently expect their shareholders to live on capital gains. As recently as 1991, stocks were yielding an average 3.24%, and the 10-year constant maturity Treasury was yielding 7.86%. Mixed 50/50, the two provided a portfolio yield of 5.55%. So $18,018 of investment would produce $1,000 of annual income. Today, the dividend yield on stocks has fallen to 1.23% and the 10-year constant maturity Treasury is at 5.28%. The same 50/50 portfolio now produces a yield of 3.26%. So you need $30,675 to produce $1,000 of annual income. Worse, you now need $1,294 of income to enjoy the purchasing power that $1,000 had in 1991. As a result, you now need $39,693 of investment to duplicate the purchasing power you could produce with less than half as much money in 1991.
With stocks rallying and bonds responding negatively to hints of higher inflation, one can't help but wonder if we're not back in an era where modest inflation and stocks are fellow travelers. What's changed? The Fed's goal of zero inflation has been replaced by growth at any cost. Steve Wieting, an economist at Salomon Smith Barney, disagrees with the idea that rising inflation and an indifferent Fed is a good combination for stocks. `Rising inflation has predicted a bad macro-economic performance and weaker profit margins, independent of the policy response,' Wieting says. `It leads to bad pricing decisions: input costs often rise faster than prices.' Of course, stocks outperform bonds in such an environment. But `inflation isn't good for any asset class,' he says. Tom McManus, chief equity strategist at Bank of America Securities, thinks inflation, or `the ability of companies to pass through rising costs,' isn't good for stocks in the current environment. `Inflation is only good for stocks if they are cheap relative to the underlying asset value, which they're not right now,' McManus says. `Pricing power is great because it helps drive earnings - until investors realize that the higher discount rate is applied to (stock) prices.' For the moment, the bond market has found religion. The yield on the 10-year note has risen 65 basis points in the last two months, even as the federal funds rate has fallen by 100 basis points. Stocks, led by consumer cyclicals, are celebrating in expectation of an economic rebound. The Fed's indifference to rising inflation is still a blessing, which, if McManus and Wieting are right, could quickly become a curse.
The aluminum industry, which produces nearly 40% of the nation's output in the states of Oregon, Washington and Montana, commands a huge amount of electricity, enough to power Seattle daily. Closing the smelters freed up a lot of power and significantly reduced Bonneville's reliance on the electricity spot market. But Bonneville now wants the 10 smelters in the region to stay closed for two years. For the aluminum companies, closing plants isn't such a bad thing, at least in the short term. Besides getting a big chunk of cash from Bonneville, the closures will cut nearly 5% of the world's aluminum smelting capacity. Industry experts expect prices to jump at least 11% by the end of the year as a result of supply-side bottlenecks. Outside the Pacific Northwest, existing smelters in the U.S. are pretty much operating at capacity. "The problems in the Pacific Northwest have kept aluminum prices relatively stable despite the current period of weak demand for aluminum. The icing on the cake will be when the U.S. economy starts to recover. You will see aluminum prices skyrocket" says Michael Gambardella, metals analyst for J.P. Morgan. For companies using aluminum as a raw material, rising prices may become another burden, just as labor and energy costs and dwindling revenue damp profits. But the biggest victims will be the rural towns in the Pacific Northwest whose economies have relied on aluminum employment. For now, Alcoa said it will not immediately lay off the 900 employees at the shuttered Ferndale plant, primarily because Bonneville agreed to reimburse Alcoa for employee wages and benefits. Still, the news of plant closings is sending shock waves through communities. Example: Goldendale, Wash., where aluminum manufactoring employs about 1,300 people, more than one-third of the immediate area's working population.
I understand the theory behind the market's recent rise. The theory is that the market anticipates everything. The market is all-knowing. The all-knowing market now knows there's going to be an economic turnaround even before it turns around. Of course, this is utter nonsense. We're not even sure we're in a recession. Yet we're confident that if we are, we'll come out of it in roughly six months to a year? But investors are particularly susceptible to this message. They want it all to make sense. On top of that, they've absorbed all this propaganda in recent years about the horrors of being out of the market for even a split second. I've seen studies on this. And I'm sure there must be somebody out there who can document that someone who was in cash for just 15 minutes at select moments over the past 92 years would have earned just $700 over that period on an initial investment of $1,000. The hang-in-there-at-all-costs investor, of course, who stuck with the market through thick and thin, would have $10,732,896.53, adjusted for inflation, taxes, transaction costs, and World Wars I and II. The big fear is that the mythical 15 minutes is now. Or maybe Monday.
Americans spent nearly $4.7 billion on the prescription allergy drugs Claritin, Allegra and Zyrtec last year. But many of those people may not even have allergies. The problem, say doctors, is that people who suffer from a chronic runny nose, congestion or sinus problems often think they have allergies when their symptoms are actually triggered by foods, medication, bacteria or some other reason. Rather than be tested, many patients simply get their doctor to prescribe one of the popular allergy drugs they've seen advertised on television. An Ohio State University study tested 246 North Carolina patients taking Claritin, Allegra or Zyrtec. The study, presented in March at the American College of Osteopathic Family Physicians, found that 65% of those taking the drugs didn't have allergies. All of the patients had been prescribed allergy drugs by a general practitioner rather than an allergist. Other Causes An estimated 35 million people suffer from chronic sinusitis, which occurs when a cold, polyps or some other problem obstructs the sinuses. Symptoms include congestion, dull pain around the eyes and cheeks, postnasal drip and other problems. Allergy is often the culprit, but about 40% of sufferers don't have allergies. About 17 million people suffer from chronic nonallergic rhinitis, which causes a runny nose, sneezing and sinus congestion. Sheldon Spector, a UCLA clinical professor of medicine, says he recently treated a 24-year-old man who thought allergies caused his drippy nose. The problem was gustatory rhinitis, a nonallergic reaction to certain foods, and a nose spray was prescribed. Others suffer from chronic runny nose and congestion triggered by regular use of aspirin or anti-inflammatory drugs like ibuprofen. "It's not uncommon," says Dr. Spector. "It's just not recognized." Most allergy medications work by blocking the histamines that cause a runny nose and other symptoms. Some nonallergic patients feel better when they take allergy pills not because of the antihistamine but because they take a type that also has a decongestant. Far less expensive decongestants, however, are sold over the counter.
The Fed's rate cuts are being undermined because longer-term interest rates have shot sharply higher recently. The yield on the 10-year Treasury note jumped to 5.50% Tuesday, up from 4.76% just under two months ago. The average interest rate nationwide on a 30-year fixed-rate mortgage is now up to 7.02% from 6.83% in March. Refinancing of mortgages is one way that many consumers can get more money to spend. So if refinancing is cut off by higher rates, it could cut into consumer spending. These higher rates could also discourage corporations from selling bonds to raise money for critical capital investment. The slowdown in capital investment this year is one of the main reasons why the economy is stalling, and it is a major concern to Fed policy makers, who cited the slowdown as a primary reason for the last four rate cuts. What may be difficult for Fed policy makers to take is the fact that the surge in longer-term interest rates is, in part, a result of their aggressive cuts in short-term interest rates to help re-ignite economic growth. Analysts say that surge is a response to expectations that the economy will turn around in the second half of the year. And when it does, interest rates will move higher. So investors are just taking them there ahead of time. Concerns about inflation are also playing some role in the rise of longer-term interest rates, analysts said, as some investors fear that the aggressive Fed rate cuts will over-stimulate growth and lead to higher prices.
Now, the company is witnessing the dark side of that formula. In the past year, its development expenses doubled, as it invested the bounty from software sales in new applications. But sales have taken a nosedive, and the company reported a staggering $58 million loss for the first quarter of this year compared with a $1 million profit in the year-earlier period. (In one quarter, Yahoo! saw revenue fall 42% while expenses barely dropped. It swung to a $33 million operating loss in Q1 2001 from an $87 million operating profit in Q4 2000. In Cisco's quarter ending April 28, revenue fell 30% from the previous quarter, and operating profit before charges plunged 95%. This 'formula' even hits non-tech companies. Movie studios and pharmaceutical companies spend heavily on a new film or a drug. If it's a hit, the profit potential is immense, since it costs little to sell extra tickets or pills. A dud can leave the company awash in red ink. Another example: Profit at Charles Schwab tumbled 68% in Q1 from a year ago on a 30% fall in revenue. Smaller, upstart brokers like E*Trade and Ameritrade have been hit harder, in part because their smaller revenue bases are less able to absorb the high marketing and technology costs. Inktomi's reversal, seen at many other U.S. companies this year, may reflect more than just the bursting of a technology bubble. In today's economy, an increasing portion of a product's value is the intellectual property embedded in its design, its brand or its network of users. It takes enormous fixed costs in the form of research, technological equipment (a typical semiconductor plant costs $2 billion now, four times what it did in 1995) and marketing to develop such value. Moreover, intense competition and the rapid obsolescence of intellectual property mean that companies must make that heavy investment again each time the market demands new product - in effect, continually. The growing number and prominence of companies with this sort of cost structure (Microsoft, Intel, etc.) could be changing the nature of the business cycle, subjecting companies and industries to more dramatic reversals of fortune and leading to bigger swings in profits, stock prices, capital spending and hiring. This may not be enough to offset other factors making the business cycle less volatile, nor is it clear whether the phenomenon will persist beyond the current period. A year ago, profits were growing more than 20% a year, according to Thomson Financial/First Call. This quarter, they could fall almost as much. That reflects both the suddenness of the economy's slowing and the effect of New Economy businesses' cost structure. Related: Out of 'orders' - John Lonski, Moodys 5-7 New orders for high-technology equipment plummeted by 21.4% annualized from Q4 2000 to Q1 2001. High-tech orders have averaged a quarter-to-quarter annualized decline of 14.5% since the end of June 2000. Never before in recorded history have high-technology orders undergone as pronounced a slump over a 3 quarter span. As recently as the 9 months ended March 2000, high-tech orders averaged a quarter-to-quarter annualized surge of 29.4%, which was the categoryÌs most explosive showing since the 33.2% average quarter-to-quarter annualized growth rate of the 9 months ended March 1984. By no means has the contraction of factory orders been limited to high technology. The yearly change of manufacturing orders excluding high-tech has dropped from the +9.4% of Q2 2000 to the -3.8% of Q1 2001 - the deepest decline since the -3.9% of 1991's recession-plagued 1st quarter. Related: Ignored? - Ken Brown, WSJ 5-15 Battered technology companies are starting to be ignored. Wall Street firms quietly have dropped analyst coverage on dozens of now-small tech companies in recent months. In some cases, Wall Street firms have dropped companies that they took public, and, in nearly all cases, the analysts had been urging investors to buy the stocks all during their slides, only to drop coverage at the point when investors needed the most guidance. According to research by Marketperform.com (which tracks analysts' recommendations) individual analysts have dropped coverage 81 times so far this year, and, in many cases, companies have seen two or three analysts drop their research efforts. At the beginning of the year, there were 747 analysts covering technology companies, according to Zacks Investment Research, which tracks analyst estimates. As of last week, there were 690. Most of these beaten-up tech companies still have far more analysts than other companies their size, a sign that more coverage reductions are in store. Joel Tillinghast, manager of Fidelity Low-Priced Stock Fund, looked at a database of companies whose market capitalizations were $100 million to $1 billion, a typical definition of a small-company stock, and found that a quarter of the 2,400 companies had no analyst coverage, while the median stock had three analysts. Then he looked at stocks that had fallen 90% in the past year, mostly technology companies, and found they had a median of eight analysts.
Related: Speculation Part 2 - Barrons 5-7 Wall Street investors claim they don't expect the dramatic stock moves of yesteryear, when prices doubled or tripled in months or even weeks. But the options market is signaling otherwise. A look at the implied volatility in IBM reveals that last August option traders were pricing in 28% volatility in the underlying stock. Today, option traders project a 40% move in IBM's stock price over the next 12 months - even after the computer giant's recent run-up. Related: Spec Part 3 - John Dorfman, Bloomberg 5-23 Fifty-nine percent of companies with above-average profitability have risen 10% or more since the end of March. That compares with 75% of companies with no net profits in their latest fiscal year. About three-quarters of the stocks that sell for at least 30 times the past four quarters' earnings are up 10% or more in the past seven weeks. Forty-two percent of stocks that sell for more conservative multiples - 15 times earnings or less - are up the same amount. What does one make of these results? Here are a few theories. You pick your favorite and then I'll tell you mine. (a) The good performance by low-earnings companies and those with high price-earnings ratios is a logical reaction to the Federal Reserve's five interest rate cuts this year. (b) The technology and communications sectors, which led the stock market from 1996 through 1999, have resumed their dominance following an unpleasant but cleansing 12-month interruption. (c) The past seven weeks are a countertrend rally in a bear market, the result of stocks' being oversold. I disagree with the first two and endorse theory (c). It's tempting to believe that the stock market's behavior lately is a rational reaction to the Fed's actions. But if lower rates are the driving force here, then high-debt stocks should be doing great because their load is getting less burdensome. That hasn't happened, at least yet. In April and May, low-debt stocks have outperformed high-debt ones. If theory (b) were true, it would be unusual in stock-market history. Groups that are toppled after a long period of dominance usually stay down for considerably more than a year.
Retirees definitely want to own more than just the big blue-chip stocks that they tend to favor. For proof, look no further than recent returns. Over the 13 months through April 30, the best-performing stock-fund categories have included surprise winners such as real-estate funds, up 24.4%, and small-company value funds, which gained 18.7%, according to Morningstar. During the same stretch, the S&P 500 slumped 15.6%. I often advocate investing in total stock-market index funds. But retirees may fare better with a fistful of more-specialized index or actively managed funds that invest in, say, large-company growth, large-company value, small-company growth, small-company value, foreign stocks and real-estate investment trusts. Why? If the market decline drags on and you need cash, you can sell your most-buoyant stock funds, while leaving other funds to recover. By contrast, with a total-market index fund, you can't selectively sell winning market sectors.
"What is novel about our study is that it reveals, essentially for the first time, that [the same groups] of households whose portfolios surged in value decreased their saving rates sharply over this period," the economists, Dean M. Maki and Michael G. Palumbo, wrote in the study published last month. They were speaking of saving as the difference between disposable income and spending - not including capital gains from the rising value of stocks, real estate or other assets. Using Commerce figures on disposable personal income, Maki and Palumbo divided U.S. households into five income groups of equal size. Their analysis focused on the 20% of households with the highest income level because the vast bulk of stock ownership is by that group. The Fed's 1998 Survey of Consumer Finances found that the wealthiest 1% of households owned almost half of all common stock, the top 5% owned three-fourths of it, and the wealthiest 20% of American households owned 96% of common stock. The top 20% of households by 'disposable income' have about 44% of total income and about 63% of the wealth. By consuming out of both current income and wealth, the top group accounted for 46% of all U.S. consumption last year. Maki and Palumbo found that in 1992 the saving rate was 5.9%. The saving rate for the top income group was a high 8.5%. The rate for the second highest income group was 4.7%, for the middle group 2.7%, then 4.2% for the next-to-lowest and 3.8% for the bottom one-fifth. By last year, the overall saving rate had fallen to zero. Nevertheless, for the bottom two groups, the rate had nearly doubled, with both rising above 7%. The saving rate for the middle income group had risen slightly, to 2.9%. The rate for the next-to-highest income group had fallen to 2.6% from 4.7%. But the saving rate for the top income group had simply collapsed. From that 8.5% rate of 1992, it had plunged to a negative 2.1%. In other words, that group was spending 102.1% of its disposable income. The swing over the eight-year period was an incredible 10.6% points. And since total disposable income for the top group is far higher than that of the other groups, this decline swamped the increases in saving at the lower levels of the income scale. Related: Timing - David Wessel, WSJ 5-24 A squad of New York Federal Reserve Bank economists conclude that consumers respond quickly to the market. But Fed economists in Washington belive people hesitate to be sure a market move won't be quickly reversed; when it persists, they adjust spending. In short, consumers will be reacting to shrinking stock portfolios for another few quarters Mr. Greenspan sides with the Washington economists. And the difference between Mr. Greenspan's opinions and those of all other economists is that his matter. Related: Another Study - WSJ 5-10 A survey by the Employee Benefit Research Institute and others finds that fewer Americans are saving for retirement (71% this year, compared with 75% in 2000), fewer are confident that they will have sufficient funds to live comfortably in retirement (63% of those surveyed said they were "very" or "somewhat" confident, down from 72% a year ago), and fewer have tried to calculate how much money they need to save for later life (only 39% of those surveyed said they had taken a stab at the math, down from 51% last year).
In a separate report also released Wednesday, TIGTA said the IRS didn't properly review potentially inaccurate notices last year before they were sent to taxpayers. The service generated about 12.4 million notices to taxpayers from January through September 2000 to inform them of taxes, interest and penalties due, errors on their tax returns or an adjusted refund (Note: My family received 2 notices). Before they were sent, a computer program designed to identify potentially erroneous communications screened out 4.1 million. Although IRS operating guidelines call for review of all questionable communications before they are mailed, TIGTA said it discovered 539,852 letters "identified as having a high potential for error" that weren't checked before being mailed.
While 'past performance isn't a predictor of future performance', the Schwab Center for Investment Research discovered that funds with histories of tax efficiency predictably continue to minimize taxes. The reason: Portfolio managers rarely change their investment philosophies. So funds with good tax-efficiency records are the ones to look for. And which funds should you avoid? Those that have suffered heavy recent withdrawals. "Large negative cash flows were indicators of future taxable distributions," says Jim Peterson, an author of the study and a Schwab Center vice-president. To reach these conclusions, Peterson, a former University of Notre Dame finance professor, and his colleagues studied after-tax returns of domestic stock funds over the 1981-98 period. As they set out in their research, they hypothesized that several variables, including a fund's riskiness, its portfolio turnover, and its investment style, might bear on after-tax returns. They were surprised to find that portfolio turnover had no apparent influence on the after-tax return, despite a widely held belief that low-turnover portfolios are necessarily more tax-efficient. Peterson explains that turnover can be used to "harvest" capital losses, which can be used to offset gains. That way, an active portfolio manager can limit the fund's taxable distributions. The researchers also ruled out the possibility that funds enjoying large cash inflows would do better, just as funds with large cash outflows do poorly. The reverse case doesn't hold true, Peterson notes, because portfolio managers who are deluged with cash often have trouble finding enough good investment ideas to soak it all up. These funds may have lower tax bills, but heavy inflows dilute their ability to deliver high pre-tax returns. Practically speaking, how can you use this research? Peterson suggests that once you've picked a diversified group of low-cost funds, you should also check their tax efficiency over the past three or five years. Tax efficiency, simply put, is how much of your fund's return is left over after you pay taxes on its dividends and capital-gains distributions. For example, if a fund's pre-tax return was 10% but after taxes it was 8%, its tax-efficiency ratio would be 80%. What's a good tax-efficiency ratio? It depends on the type of fund, but here are a couple of touchstones. In a field of 2,537 domestic equity funds given five-year tax-efficiency scores by Morningstar, the median tax-efficiency ratio was 76.3%. So you would want to do better than that. Just 244 funds, or less than 10%, had scores over 90%. That tells you 90% might be a good target. Learning about a fund's cash flow is harder, Peterson acknowledges. But here's a proxy: Because investors in the main tend to cash out of funds that have suffered big investment losses, Peterson thinks that it makes sense for taxable investors to avoid heavy losers because they're more likely to be suffering cash withdrawals and generating tax liabilities for shareholders. It's easy to get lost in the weeds of funds and taxes. Don't just look at pre-tax returns. Don't just look at tax-efficiency. Don't just look at turnover, investment style, or expenses. Weigh them all, and strike a balance.
Just the Facts Vanishing trust A year ago, as the Nasdaq was collapsing, analysts across Wall Street rated just 206 stocks, or 0.8% of all rated issues, either Sell or Strong Sell, according to Thomson Financial/First Call. Nearly 74% of all ratings were either Strong Buy or Buy. Is it any wonder that investors have lost trust in Wall Street's advice? It's time to replace a dysfunctional system. One thing that will help - Reg FD, which removes the fear that an analyst will be cut off by a CEO for offering a negative view of a company's stock - a reason for the Street's bias against making downbeat recommendations. The best cure - alter analysts' compensation so they are not contingent on bringing in investment-banking business. (Michael Santoli, Barrons 5-28) Who needs protection now? The Private Securities Litigation Reform Act of 1995 was instituted to protect corporate America from class-action suits. The act provides protection from lawsuits for corporate managers who make public projections regarding the future of their businesses that are based only on beliefs and expectations. The result? A lot more talk of rosy tomorrows are appearing in company earnings reports today. But how reliable are the forecasts? These, after all, are the same executives who never saw the cliff approaching and watched, stupefied, as their businesses fell off it earlier this year. Why investors are willing to believe that these same people can see an improvement coming is a puzzle. (Gretchen Morgenson, NY Times 5-27) Small caps outperform Small stocks have outperformed blue chips by a widening margin over the past 12 months. And so far this year, the Russell 2000 index containing them has risen more than 5%, one of the very few important indexes in positive territory. Analysts at Merrill Lynch think that low valuation is a significant factor. Small-cap stocks are cheap. And the smallest of the small caps are very cheap. Last week, the firm noted that roughly 20% of the small-cap market and 35% of the microcap market sell for less than 10 times last year's earnings. The last time such a big proportion of the small caps sold at such a multiple was in 1991, when the economy was in a recession. (Kenneth Gilpin, NY Times 5-27) The layoff gap The effect of an involuntary job loss has changed little over the last 20 years, according to a recent study by Princeton economist Henry Farber. Whether the unemployment rate has been rising or falling, layoffs have forced workers to take pay cuts averaging 11%, relative to what they would have been earning if they had been able to keep their old jobs (and recieved expected pay increases). The gap between the two salaries does fluctuate with the economy. In the late 1990's, there was virtually no gap. In the early 1990's, people who lost their jobs took pay cuts of more than 10% in their new positions. (NY Times 5-27 ??) Benefit check An estimated five million older Americans who qualify for any number of perks - government health benefits, insurance counseling, tax breaks, transportation and more - aren't getting what they're entitled to, according to the National Council on the Aging. As a result, the council, a nonprofit research and education organization, will launch www.benefitscheckup.org on June 5 to help connect people over 55 years old with billions of dollars in untapped public assistance. The site, will include programs such as Supplemental Security Income, Medicaid, state drug benefits, Meals on Wheels, food stamps, health-insurance counseling, veterans' medical care and transportation; give information about the paperwork involved; and offer the addresses and phone numbers of local government offices. The site also screens hundreds of other goodies, such as talking-book programs, a $10 lifetime pass to national parks, property-tax exemptions, utility-bill relief, and home repair and renovation services. (WSJ 5-25) Virtual or vice? Digital technology may be used for the first time to place "virtual" products and other advertising images regularly in scenes of a syndicated television series. Viewers of reruns of the crime drama "Law and Order" on TNT cable could see sponsored imagery interpolated where it had not been before as a result of an agreement in principle to allow the insertion of computer-generated items like cans, bottles, signs and logos into scenes. (NY Times 5-23) The 'new zero' curse The Dow first reached the 100 level in January 1906. It traded above and below that level for more than 36 years; it wasn't until May 1942 that the market left 100 behind for the last time. The Dow first reached 1000 in February 1966. It traded above and below that level for the next 17 years, leaving that figure behind for the last time in February 1983. The Dow first reached the 10,000 level in March 1999. [WSJ 5-21: While some investors worry that we could be in for a replay of the 1970s, when stocks went nowhere for a decade, the economic situation looks different from the 1970s, when inflation and interest rates were soaring.] Considering the unprecedented gains of the past several years, would it be that unusual for this benchmark to take a decade or even two before leaving 10,000 in the dust for the last time? (Daniel Turov, Barrons 5-21) Popular excuses For many folks, their finances resemble their basement. There's just way too much stuff. Why? "We're weak planners, strong doers," suggests Hersh Shefrin, a finance professor at Santa Clara University. "People are always reacting to things that are happening, but they don't have a plan for putting it all together." We are, by all accounts, a little impulsive. A new credit card? We'll take it. A new mutual fund? We'll buy it. Washington's Investment Company Institute calculates that 10% of mutual-fund investors own 11 or more funds. What explains this financial proliferation? (1) Procastination - we'll clean up our mess tomorrow. (2) Novelty - a new investment offers fresh hope. (3) The endowment effect - "We bond with inanimate objects," Shefrin says, so that we tend to place a higher value on the item than others do. That makes it tough to sell at a price we consider fair. And (4) Our burgeoning collection of financial accounts and assets also reflects what is called "mental accounting." Instead of developing an overall financial plan, we match a financial account or asset to each of our investment goals. (Jonathan Clements, WSJ 5-20) P/E's vs Interest rates When last I checked my Bloomberg, the price-earnings ratio of the battered Nasdaq was still a lofty 80 to 1. The S&P 500 Index had a P-E multiple of 28. That's down from 36 two years ago - but still a long way above 19, where it stood four years back. As recently as the late 1980s, the S&P 500 seemed to have established a comfortable norm of about 15. At market bottoms in 1974 and 1982, according to Jurrien Timmer, an analyst at Fidelity Investments, the S&P 500's P-E stood at 7.2, or scarcely one-fourth its current level. So it's the easiest thing in the world to hesitate now before putting new money in a stock fund. Trouble is, this innocent-seeming impulse exposes you to a big risk. If you draw a hard-and-fast line at an S&P 500 P-E of 15 or less, you have put no new money into the market since 1991. Most other bear markets were caused by sharply higher interest rates. And all computer models of the stock market that aspire to any degree of sophistication take account of interest rates. `Most stock market valuation measures that adjust for the level of interest rates tend to classify the stock market as fairly valued or undervalued at current levels,' said Richard Hoey, chief economist at fund manager Dreyfus. (Chet Currier, Bloomberg 5-15) Stimulation Over the past decade, lower transaction costs and improved financial technology have narrowed the spreads between fed funds and other interest rates. Those other interest rates are the ones that govern decisions about spending and investment. The fact that the interest rates that really matter to consumers and businesses are now closer to the funds rate means - all else being equal - that financial conditions in general will be more stimulative for a given level of the funds rate today than they would have been in the past. (Lou Crandall, cheif economist at Wrightson Associates, Barrons 5-14) Therapy The Fed is like a behavioral therapist. It can't exactly speak to your fundamental problems, but it can motivate you to act by making you more comfortable with your environment. But it can't dictate to these companies and say have confidence in the next two or three years and make long-term investment decisions. That is their own choice. (Gene Epstein, Barrons 5-14) Markets and uncertainty Thanks to the Internet-searching capacities of google.com, I can report that at least 100 commentators from all over have gone on record lately with the observation that `the stock market hates uncertainty.' Isn't the future always absolutely uncertain? Any day the market is open, you never know when some nasty surprise might hit. That doesn't stop stock prices from rising about two-thirds of the time. If the market couldn't thrive amid uncertainty, it would have died a long time ago. (Chet Currier, Bloomberg 5-8) "Living-wage" Striking Harvard students claim 1,000 workers are paid less than the "living-wage" threshold of $10.25 per hour set by the city of Cambridge. About 35% of U.S. workers currently earn $10.00 per hour or less, about 25 earn $8.50 or less, and about 15%, $7.25 or less. If these 35% are somehow not earning a living wage, one wonders just how they manage to live. The answer, of course, is that many of them work two jobs, many are in two and three-earner families, many are teenagers who live with their parents -- and some may even be immigrants who actually think a lousy seven bucks an hour is great pay, compared with the alternative in their country of origin. (Gene Epstein, Barrons 5-7) "Street name" What does it mean if my broker is holding my stocks in "street name"? It simply means that the stock is registered as belonging to your broker, not you. This sounds shady, but it's not. By having shares registered under your broker's name, you can trade them immediately by phone or computer. If you register shares in your own name, you'll receive the actual certificates, will have to store them safely and will have to mail them in when you want to sell. Holding your stocks in "street name" doesn't mean you don't own them. It's merely an artificial classification designed to facilitate trading. (Motley Fool, AJC 5-6) Unemployment prediction James W. Paulsen, chief investment officer at Wells Capital Management, says that within three to four months, the nation's unemployment rate may be as high as 5.4%. "We're going into this slowdown with the highest fixed-cost structure ever at companies, because of the technology boom," he said. Those costs are the interest expenses and depreciation costs that followed corporations' big investments in technology. "If you can't cut your fixed-cost structure, you've got to cut your variable," he said. With such high fixed costs, corporations may continue to pare jobs even when the economy is growing slowly. "Because interest rates have been coming down, consumers have been able to pile on more debt," he said. "But if you start destroying jobs, we're going to find out there is a consumer debt problem. And that's one of the reasons we are going to have a hard time restarting the economy." (Gretchen Morgenson, NYT 5-6) Telecom reform? If it feels like you're spending more money than ever to use the phone and watch TV, you're right. Despite the Telecommunications Reform Act's promise to unleash price-slashing competition in phone and cable-tv service, most households today have no choice in local phone service, and their bills are higher. For example: (1) Basic cable rates on average have risen 33% since the act took effect in 1996 - almost three times the rate of inflation; (2) Local phone bills are ballooning due to numerous fees the Bells have slapped on or ratcheted up; (3) The universal-access fee [a government-ordered subsidy for providing phone service and computer connections to rural communities, schools and libraries] fee rose this year to about 9.9% of a long-distance bill - a year ago, the fee was a flat $1.38; and (4) There are more fee-based services - like called ID and voice mail - to tempt consumers. The result: Total spending on local, long distance, Internet access, wireless and cable TV per household last year rose more than 13% to $167.40 a month from $147.95 a month in 1996, according to surveys conducted by Yankee Group, a Boston telecommunications consulting firm. (WSJ 5-3) The 'sideline' strategy The temptation is to sit on the sidelines and wait to see how things play out. But that could be a big mistake. For proof, consider a study by Richard Bauer and Julie Dahlquist that appeared in the January/February 2001 Financial Analysts Journal. They found that, if you were deciding each month whether to hold Treasury bills or the S&P 500 stocks, you would have had to make the right call, on average, 66% of the time simply to match the S&P 500's results in any given year. "Our study says that jumping in and out is a pretty risky business," says Mr. Bauer, a finance professor at St. Mary's University in San Antonio. "You've got to be very accurate in the calls you're making to beat a buy-and-hold strategy." (Jonathan Clements, WSJ 5-1) Tick tock At midnight last night, while you were most likely sleeping, you did a dangerous thing. You got a day older - an act which in 21st Century life invites trouble in a thousand different forms. A deadline passes; a warranty runs out, or the battery in the smoke detector goes dead. Something in your cupboard went past its `best if used by' date. Unbeknownst to you, something bad might have happened involving your credit rating or blood pressure. Termites were active. New information may surface to prove you made a bad choice yesterday with your asset allocation, HMO or wireless calling plan. Could be an overnight rise in interest rates pushed your mortgage payment higher or triggered a lease escalator clause. The deductibility of your mortgage payments may have been compromised by a change in your status vis-a-vis the alternative minimum tax. Midnight brought you one day closer to an old age for which you're totally unprepared. If you were asleep at midnight, you failed to notice any of these things as they happened to you. Don't make the same mistake tonight. (Chet Currier, Bloomberg 4-25) Quick Stats Under the tax package approved by Congress, taxpayers will get as much as $300 if single, as much as $500 for a head of household and as much as $600 for a married couple filing a joint return. The new legislation makes 441 tax-law changes. For a 15-page summary of the new legislation on the Web, go to www.house.gov/jct/x-50-01.pdf or Congress's Joint Committee on Taxation (Congress's Joint Committee on Taxation). (WSJ 5-30) Eric Bjorgen, director of research at Leuthold Group, a research firm, said 15% of inflows into equity funds this year through May 23 have gone into stock funds that track broad market indexes such as the S&P 500. That's up from just 4% in the same period last year. In the late 1990s, a period when the S&P consistently beat actively managed funds, index funds received about 25% of inflows. (Bloomberg 5-29) Federal Reserve Board economists Bruce Fallick and Charles Fleischman say 2.7%, or four million members, of the work force switched employers in an average month in 1999. (WSJ 5-29) According to a report released last week by AARP, Social Security provided 90% or more of the total income for 27% of the population older than 65 in 1998, up from 23% in 1980. Social Security kept 40% of people older than 65 out of poverty and made up more than half of most Americans' retirement income, the report added. Social Security was the sole source of retirement income for 17% of those older than 65. (Reuters, 5-27) Back in the bear market of the 1970s, mutual funds suffered net redemptions in seven years of one eight-year stretch. The number of shareholder accounts shrank by more than one-third from 1971 to 1981. (Chet Currier, Bloomberg 5-25) Only five of the Fed's twelve district banks requested a reduction in the discount rate (on May 15th), the fewest number of banks to press for action this year. (Mathew Freedman, Dismal.com 5-25) Vanguard, making its debut into etfs, said it will launch exchange-traded shares Thursday for its Total Stock Market Index Fund (VTSAX), which seeks to mimic the return of the broad-based Wilshire 5000 Index. They will trade on the Amex under the name Vanguard Total Stock Market Vipers. (WSJ 5-25) About 47% of employers reporting a first-quarter mass layoff expect to recall workers. That is the lowest percentage for a first quarter since the measure began six years ago, says the Bureau of Labor Statistics. (WSJ 5-22) The key component of investing success that seldom gets mentioned is `amount contributed.' If you invest $20,000 a year for 10 years at a modest return of 6% a year, you'll have $263,615.90. If you invest half as much, $10,000 a year, at twice the return, 12% a year, you'll have $175,487.35. (Chet Currier, Bloomberg 5-21) Joseph Kalinowski, U.S. equity strategist at Thomson Financial, says the worst in negative corporate announcements have hit bottom. While total pre-announcements for Q2 continue to eclipse those of Q1 - 533 this quarter compared with 438 at this time last quarter - the positive announcements in Q2 of 109 are greater than this time last quarter of just 75. "We probably are in for more negative pre-announcement news, but tThe bad news is not coming from large-cap companies, which had a huge price impact and market impact. (WSJ 5-21) In 1997, Dept of Labor investigators found 70% of 288 nursing homes they looked at complied with overtime, minimum-wage and child-labor laws. Last year, investigators visited 136 facilities and found a 40% compliance rate. Most of last year's violations were overtime-related, though more than 100 minors were illegally employed at 20 homes. (WSJ 5-22) Bullish investment strategists forecast continued big stock gains. Abby Joseph Cohen of Goldman Sachs sees the S&P 500 soaring 24% by year's end, to 1550 from Friday's 1245.67 (although as recently as last month, she was forecasting 1650 by year-end.) Edward Kerschner of UBS Warburg forecasts a 47% gain to 1835 by the end of 2002.(WSJ 5-14) The US' much slower rate of jobs creation helps to explain consumer spending's deceleration. As corporate America fires more and more of its customers, consumer spending will suffer to the degree that borrowing costs do not decline and taxes are not cut. Quarter-to-quarter, the annualized growth of real consumer spending will probably drop from the first-quarter's 3.1% to 1.8% in the second. The fastest growing household outlays of 2001's first quarter were the yearly gains of 13.8% for energy products, of 13.0% for recreation, and of 10.7% for taxes. In Q1 2001, consumer spending on durable goods rose by only 1.4% yearly. (John Lonski, Moodys 5-7) April's loss of 223,000 jobs was the deepest decline by this measure of employment since February 1991's 259,000-worker trimming of payrolls. During the recession of July 1990 through March 1991, employment fell by 171,000 jobs per month, on average, or by 0.16% per month. April's nonfarm payrolls fell by 0.17% from March. (John Lonski, Moodys 5-7) It was reported that payroll employment fell by 223,000 in April, with the unemployment rate rising to 4.5%. But the BLS reported that before seasonal adjustment, nonfarm payroll employment increased by 672,000 positions in April. Only after seasonal adjustment did the agency record a decline of 223,000. In effect, this meant that it decided that payrolls would "break even" at 895,000, a haircut that seems a bit excessive, since last April it subtracted about 800,000 in order to arrive at the seasonally adjusted number. (Gene Epstein, Barrons 5-7) Economy.com pointed out that "while the Q1 GDP report seemed surprisingly strong, much of that strength was in January and there has been weakening in subsequent months." (Barrons 5-7) Arnold Kaufman, editor of Standard & Poor's Outlook, a weekly newsletter, says the S&P 500 companies last year paid out just 32% of their reported earnings as dividends, compared with an average 57% for the past 75 years. (Jonathan Clements, WSJ 5-1) Thanks to the market drubbing, recent stock returns have fallen to the point where they no longer appear gaudy compared with the 11%-a-year historical average. For instance, as of March 31, the Wilshire 5000 index of most regularly traded U.S. stocks had a trailing three-year average annual return of 1.7%, a five-year return of 12.4% and a 10-year return of 13.7%. Moreover, growth stocks have been hit so hard that their three, five and 10-year returns are now below those for value stocks. (Jonathan Clements, WSJ 5-1) Home Page Previous Factoid Top Sites |