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Re-Opened Funds a Bullish Sign Charles Jaffe, Boston Globe 8-14 One market sign that might make you feel bullish: Some big-name stock funds that stopped taking on new investors have re-opened their doors. Admittedly, some of the funds that are now accepting new cash may want the money to flow in expressly to help stem the tide of outflows. But even in that situation, a manager would be a complete idiot to re-open to new investors if he or she expects the bear market to last another two years. If the pace of re-openings continues to pick up, it could be that the big investors are starting to see prices as more reasonable and less inflated. That kind of optimism will be essential in any recovery. Two Bullish Indicators Josh Friedman, LA Times 8-18 Despite the stock market's downturn, corporate insiders are buying more shares in their companies and selling fewer, signaling they think stocks could be hitting bottom, analysts say. In addition, companies are stepping up announcements of stock buybacks. "We've seen a dramatic change in a short period," said David Coleman, editor of Vickers Weekly Insider, a newsletter published by New York-based Argus Research. "The insiders are extremely bullish. They feel their stock is undervalued, and their message is, 'Buy.' " In July, companies vowed to buy back $44 billion worth of stock, second only to September's record total of $53.6 billion, according to TrimTabs.com Investment Research.
I still expect the economy to grow at a reasonable clip in Q3 and beyond. But with the pace of growth having slowed substantially in Q2, only a fool would argue that there is no possibility of a decline in GDP. The drop in stocks has pulled powerfully on the reins, but must be seen in the context of the forces pulling in the other direction. First, as Federal Reserve officials never tire of saying, the current stance of monetary policy is very accommodative. The money supply is expanding very rapidly indeed, and it's hard to argue that near-8% year-over-year growth in M2 is anything but positive for growth. Bank lending remains very subdued, but that is normal at this stage in the cycle. A key reason for the softness in lending is that companies have unloaded huge piles of unwanted inventory. Inventory shedding turbocharges a downswing, ensuring that overall GDP falls faster than spending on consumption and investment -- final demand, in other words. If there is no excess inventory to shed, this cannot happen: Companies cannot get rid of what they don't have, and the extent of the downturn is limited by what happens to final demand. But capital spending has already been dramatically reduced and may have reached something like an irreducible minimum. Meanwhile, consumers are awash with cash, despite the very soft labor market. Wages are growing only modestly, but total real disposable personal income - the key measure of consumers' spending power - has risen a very substantial 5% over the past year. About half of this has come from tax cuts. Income growth at this pace is sufficient to support both a robust increase in spending and a rise in the saving rate, which has already hit its highest level in more than three years. Note, too, that the income numbers don't take account of the latest huge wave of mortgage refinancing, which is putting billions into consumers' pockets every week. Low mortgage rates are also sustaining the extraordinarily strong housing market. From the Fed's perspective, this all adds up to a long list of reasons to believe that a dip in economic activity needn't translate into a new recession. It follows that treating the dip with a dose of lower interest rates is pointless. Some recessions last much longer than others. But we can't think of any that have started against a backdrop of very loose monetary and fiscal policy, extraordinarily low inventories, hugely compressed capital spending and a slightly weaker dollar. While the next round might go to the double dippers, remember that a knockdown isn't necessarily a knockout. Oil & The US Economic Recovery WSJ 8-26 Oil prices hovering near $30 a barrel on fears of a U.S.-Iraq war are threatening to impede a U.S. economic recovery, even as Saudis and some other OPEC members said they would make up shortfalls if there's an attack. The high price of oil could squeeze both corporate profits and household incomes, and hurt the consumer spending that has been the economy's mainstay in the past year. It comes as growth forecasts already are being revised downward for the rest of the year. Because of its cuts in production, OPEC has spare capacity of about six million barrels a day that it could put into the market, most of it in Saudi Arabia. The economic consequences of keeping the spigot turned down could be serious. Economists note that the last four U.S. recessions have coincided with - or been preceded by - $30-a-barrel oil. A return trip over that $30 threshold now wouldn't necessarily mean a renewed recession because the economy is less reliant on oil than in the past. But, says Jan Hatzius, an economist with Goldman Sachs, "it ranks as a big risk." Rising oil prices also have the potential to hurt corporate profit margins - by increasing materials costs - at a time when companies are trying to recover from last year's historic profit collapse. Airlines are especially vulnerable, with jet-fuel costs up about 1% from a year ago, and up 4% from their December lows. Added together, this is likely to restrain an already limping economy. Macroeconomic Advisers, a St. Louis forecasting firm, revised its predictions for the second half of the year to 2.5% annual growth from 3.25%. But even the new forecast was built on the assumption that oil prices would average $26 to $27 a barrel. Higher-than-predicted oil prices darken the growth outlook even more. According to Joel Prakken, the firm's chairman, every $10 increase in the price of a barrel of oil shaves about 0.5% off growth.
The SEC Rules LA Times 8-28 Mutual fund companies will be required to certify their portfolios' financial results, just as corporate executives certify their companies' results, the Securities and Exchange Commission decided Tuesday. More on Mutuals Ian McDonald, WSJ 8-29 So far this year the Investment Company Institute (ICI), the fund industry's largest trade group, has asked corporate managers to: speed up their earnings reporting; be more open about corporate insider trading; and seek shareholder approval for stock option plans, among other corporate governance initiatives. In a puzzling twist, however, the ICI maintains its long-held stance that funds shouldn't have to disclose their full portfolio holdings more than twice each year. Among its arguments: few of the more than 93 million individual U.S. fund investors have asked for more frequent and robust disclosure of where their more than $5 trillion in assets are stashed. Critics believe fund companies are reluctant to be freer with portfolio data simply for fear of second-guessing and even possible litigation when a fund's moves go quite wrong. Lost in all this is the investors right to know what's happening with their cash.
Compare the 2.1% yield on the Dow with the 2.1% yield Friday on two-year U.S. Treasury notes and the 3.3% yield on federal securities that mature in five years. Using data from the Federal Reserve going back to 1976, I could not find a single year in which two-year T-notes were not yielding more (in most cases, substantially more) than the Dow. Currently, rates are within a tenth of a percentage point of each other. The next-best year was 1993, when T-notes yielded an average of 4.1% and the Dow yielded 3.1%.
At the time, the deficit was 2.9% of GDP, or the dollar value of the economy. But the $165 billion deficit projected for the 2002 fiscal year, which ends on Sept. 30, is just 1.6% of the economy. A $200 billion deficit in the next fiscal year would be just 1.8%, assuming modest economic growth. For bond investors, that means that a pickup in the economic growth rate, along with rising stock prices, will do much more to push interest rates higher than budget deficits of this size. For equity investors, the huge swing from surplus to deficit is a plus, because it turns what was a drag on growth into a boost. Because growth is good for earnings, that is good for stocks. Another measure of the lesser threat from federal budget deficits is the size of the marketable public debt sold by the Treasury and the overall fixed-income market. That debt, which has been sold to the public to cover past deficits, is now just 17% of the total value of the fixed-income market, according to Wrightson Associates. That is down from its recent high of 27% in 1996. A third factor minimizing the deficit effect is a decline in the amount of debt the government has to roll over in the next year. So there should not be any significant increase in the sale of Treasury securities in the near term. Such increases in issuance can put upward pressure on interest rates.
The question is how much of a good thing is enough? "The sweet spot is somewhere between four and 10," says Mr. Di Teresa at Morningstar, which has conducted research on what happens to the volatility of portfolios holding anywhere from one fund to 30. "Things begin to level off between four and 10 funds, and after 10 funds, there really was not much difference." Charles Schwab's Center for Investment Research came to similar conclusions when it examined how thousands of fund combinations departed from various benchmark indexes. Investors gain the most moving from one fund of a given type to three funds of that type. After that, adding more funds in the same category reduces risk only marginally. But there is more to the equation than risk. "How much time do you want to spend monitoring your portfolio?" says Bryan Olson, who runs the Schwab research center. "You can create a portfolio with a huge number of funds, it takes you forever to monitor them, you have a lot of redundancy, and it creates a paperwork nightmare." Owning a big collection of funds isn't much different from owning a broad-market index fund, except that an index fund can mimic the market's performance much more cheaply. Owning a plethora of funds also can actually increase an investor's risk if the portfolios aren't different enough.
I base this conclusion on historical research by Jeremy Siegel, a finance professor at the the Wharton School of the University of Pennsylvania. He has studied the long-term performance of the Nifty Fifty, a group of generally large-cap growth stocks that were Wall Street darlings of the late 1960's and early 70's, only to be battered in the bear market of 1973-74. His long-term research, however, shows that the Nifty Fifty did not need long to recover from their wounds, and that they would go on to become strong performers over the years. In that sense, they are a source of hope for investors in the more recent crop of fallen large-cap wonders. Professor Siegel provided me with the month-by-month performance of a Nifty Fifty list issued by Morgan Guaranty Trust in the early 1970's. It shows that a portfolio of these stocks bought near the market top would break even by July 1980, then keep climbing over the years. From December 1972 through November 2001, he found, the portfolio produced an annualized gain of 11.8%, including dividends. That is barely behind the 12.1% annualized total return of the S&P 500. The Nifty Fifty's long-term performance illustrates a pattern that a number of studies have recently found. Contrary to the once widely held conviction that the future growth of growth stocks is no different than the market's, many researchers now believe growth stocks do indeed grow faster. That means that the higher P/E ratios of growth stocks - even sky-high ones - may be justified after all. Of course, this sanguine assessment assumes you hold a stock many years. Bear in mind, too, that this analysis applies to a diversified portfolio of large-cap growth stocks. Buy and Hold Chet Currier, Bloomberg 8-13 You hear it noised about that the great bear market has discredited the idea of buy-and-hold investing. I beg to differ. While many a buy-and-hold investor is manifestly bruised and hurting, the principle is far from dead. istorical studies make plain, though, that the risk of loss in broad U.S. market indexes falls as the length of one's holding period increases. Besides, what's the alternative? Nothing except trying to time the markets, which requires that we correctly figure out over and over again when the right moments arise to get in and out. Fat chance. Go ahead, he challenged me, name a famous and successful market-timer who has stayed famous and successful for very long. What's more, trading in and out tends to run up commissions and other costs, not to mention taxes for those adept enough to turn a profit. That leaves buy-and-hold, with all its imperfections, as the choice by default.
Realizing a fistful of gains early in retirement makes particular sense if you expect to be in the 27% or higher tax bracket later on. For instance, you may get pushed into a higher tax bracket once you turn age 70.5 and start taking required minimum distributions from your individual retirement account. To avoid getting taxed at a higher rate later, you might begin taking money out of your IRA while you are in your 60s even though such withdrawals aren't legally required; that way, your total tax tab over many years could be lower. While you are rethinking your attitude toward taxes, you should also change the way you look at your portfolio. Think of Social Security retirement benefits, pension income and immediate annuities as similar to owning bonds. All three provide a predictable stream of income, just as bonds do. Got a pension that pays $10,000 a year? To generate that sort of income, you would need to invest $200,000 in bonds yielding 5%. Similarly, if you plan to work part time, you may want to count that in your portfolio calculations. You might need $100,000 in bonds to generate the $5,000 you earn from part-time work. You can even apply this sort of math to your debts. Every $5,000 of mortgage payments or credit-card payments or auto-loan payments that you eliminate is like having another $100,000.
Continued buying through the bear market certainly hasn't insulated our investor from losses. As of Aug. 9, this person had invested a total of $6,300 and held fund shares valued at $4,850, a 23% loss. Still, practicing dollar cost averaging has left this investor in far better shape than someone who bought at or near the market peak. Consider the case of a one-shot investor who had the awful timing to plunk the same $6,300 into Vanguard Total Stock Market on March 24, 2000. As of Aug. 9, that person would hold a smaller number of fund shares valued at $3,779, a 40% loss. A look back at the bruising bear market of 1973-1974, when the S&P 500 tumbled 43% even with dividends reinvested, proves the case. It wasn't until mid-1976 that the index rebounded to its December 1972 level. But a person who invested in the S&P 500 each month beginning in January 1973 would, by January 1976, have come out ahead of someone who steadily invested the same sums in Treasury bills, according to an analysis by researchers Ibbotson Associates. And that was in an era when Treasury bills paid 6% or 7% a year.
Tempted to give up on indexing? Vanguard's S&P 500 fund has beaten 50% of U.S. stock funds over the past five years, 64% over the past 10 years, 67% over 15 years and 81% over 20 years, according to calculations by Vanguard using Lipper data. Even in the short run, indexing doesn't look nearly so foolish if you make a cleaner comparison. Instead of comparing funds to the S&P 500, I asked Chicago fund researchers Morningstar Inc. to look at its nine style boxes. The nine boxes are based on the size of companies bought (small, medium or large) and on stock-picking style (growth, value or some blend of those two styles). For all nine style boxes, actively managed funds were compared to an appropriate S&P index. For instance, small-company growth funds were stacked up against the S&P SmallCap 600/Barra Growth Index, mid-cap blend funds were compared to the S&P MidCap 400 Index, and so on. Result? In seven of the nine style boxes, the majority of actively managed funds have lagged behind their index since the March 2000 market peak. More from Jack Bogle Jack Bogle, Charles Jaffe, Boston Globe 8-18 The reason to stick with index funds and to keep money in the market is because no one knows what is going to happen. ... I am pretty confident that American business will make more money in 2005 than it did in 2001, and I am very confident it will make a lot more money in 2010. Index funds will give you those returns when they happen.
Now, consider another shock: Wall Street's summer free fall. This time, consumers are showing signs of strain. So what gives? How were consumers able to largely shrug off the specter of more terrorism but not the readjustment of what many believe is still an overvalued stock market? "Sept. 11 had a traditional shock effect: We got punched in the face, you reel backward and come forward again," said Dr. Ray Perryman, president of the Perryman Group. In that sense, Sept. 11 was more abstract. Sagging equities, though, hit millions of households right in their pocketbooks - to the tune of more than $7 trillion. It has weakened their employers and threatened their retirements. In the background are some relatively positive signs, economists say. If hiring is still weak, at least the layoff wave seems to have eased. Low interest rates have kept real estate healthy. Many economists keep the faith. "American consumers like to consume, and they're very good at it," said Gregory Miller, chief economist at SunTrust Bank. "And when consumers perceive a bargain, it's tough to hold them down."
Over time, the price changes created by buying and selling behavior create patterns on the charts. Each pattern is usually followed by a certain high-probability response in the market. This is not to say that charts can predict the future. Rather, they lay the foundation for the bottom-line decision to buy, sell or hold, which is really all that counts. For Enron, the charts showed a large topping pattern in place months before the stock slid into oblivion. The pattern WorldCom formed was one that usually has a bearish response. In this case, rallies ended at lower prices while selloffs maintained their low levels. In other words, sellers got more aggressive earlier during swings higher, while buyers did not step up until prices fell all the way back to earlier lows. Michael Kahn writes the Getting Technical column for Barron's Online. His free newsletter, Quick Takes, is available at http://michaelkahn.tripod.com
Here's the first important adjustment: Instead of using the S&P Composite Price Index, we should use the Total Return Index. Since most individual investors have their money in mutual funds that reinvest their dividends, using a price index to determine the movement of markets does not reflect the results that investors receive. Dividend yields are currently at historically low levels, so using a total return analysis increases the overall return to investors in the past more than in the present. The 1920s bull market topped out on Sept. 7, 1929. If some late-arriving bull had invested money in the stock market on that day, how long would he have had to wait to get his money back? Using the price index, the answer would be September 1954, but on a total-return basis, this unluckiest of investors would have broken even in April 1945 -- nine years earlier. Similarly, the S&P Price Index in April 1942 was still below its level in June 1901, but on a total-return basis someone who had invested in the market in June 1901 would have gotten a seven-fold return between 1901 and 1942 because of the role of reinvested dividends. Investors also have to consider inflation. Between 1966 and 1982, when the Dow Jones Industrial Average struggled to move above 1000, consumer prices tripled. Adjusted for inflation, the DJIA declined by two thirds. We can adjust for inflation by dividing the index values by the Consumer Price Index. On a price basis, the 1973-1974 decline (-48%) was worse than the bear market of 2000-2002 (-47.8%), using July 23, 2002, as the current bottom, but not as bad as the 1937-38 bear (-54.5%). If you include dividends and calculate total returns, the 2000-2002 bear market (-46.6%) already is worse than the 1973-1974 bear (-45.1%), but not as bad as the 1937-38 bear (-51.2%). But if you adjust for inflation, the 1973-1974 bear market (-54.2%) not only becomes worse than the 2000-2002 bear (-48.1%), but worse than the 1937-38 bear (-51.2%), as well. Depending upon your definition, you can choose any one of the three as the worst bear market.
This doesn't mean fund managers had to sell stock to meet the redemptions. That's because stock mutual funds held an average of 4.6% of their assets in cash at the end of June, according to Lipper. For example, in June 2002, which was another period of extreme market volatility, investors withdrew $18 billion from their stock funds. But portfolio managers used cash to meet those redemptions, and additionally they purchased $9 billion in stock. That's because the mutual fund industry is much bigger now than it was five years ago, and "Cash flows play a much more influential role on stock prices than in the past" says Eric Bjorgen, research analyst at Leuthold. When measured this way, the July outflows represent 0.64% of the total stock market. (He uses the Wilshire 5,000 index as a proxy for the stock market.) This is the highest percentage ever, more than double the 0.28% outflow in September 2001 and the 0.27% of October 1987.
This kind of talk isn't unusual when markets are in disarray. But as the near collapse of giant hedge fund Long Term Capital Management in September 1998 demonstrated, it often isn't just talk: Extraordinary losses in markets naturally increase the risk of extraordinary failures. Citigroup and J.P. Morgan Chase were in a freefall July 22 and 23. Morgan's shares dropped 23% in those two days, bringing their total decline from June 28 to 40% - wiping out $27.5 billion in market value. James Bianco, head of market research firm Bianco Research in Chicago, believes that one message in the bank stocks' plunge, and in the dive in stocks in general last month, was that the risk of financial accidents was mounting. In the parlance of the money management business, the issue was one of "correlation" -the degree to which markets move in the same direction. Big investors create diversified portfolios specifically to avoid the potential for gross correlation. They want some investments to be zigging when others are zagging. But from mid-May to late July, markets worldwide were moving in stunning correlation with the U.S. blue-chip Standard & Poor's 500 index, Bianco and other analysts say. The last time correlations were improbably high among financial instruments was in August and September 1998, when the Russian debt crisis triggered sell-offs in markets worldwide. Did the global financial system dodge a bullet, or was there no material threat of a crisis this time? Some Wall Street pros argue that big banks and investment banks learned important lessons about risk from the Long Term Capital Management affair. Those lessons may have lowered the threat to the system this time around, even as market correlations became intense, some say. "Professional investors learned to keep within more reasonable risk limits," said Ethan Harris, co-chief economist at Lehman Bros. In particular, use of leverage may be more restrained. Others say the pain of market losses this time has been spread more broadly among investors, diffusing the risks rather than concentrating them. Another argument is that the oft-maligned "derivatives" market - over-the-counter financial contracts that big investors use to hedge risks with one another - is working the way it should to protect portfolios from volatility. But if the stock market's turnaround has lessened the chances of a financial crisis developing, the question then becomes: What if markets begin to unravel again? What troubles some experts is that bear markets of the current one's severity have always had a nasty habit of taking down one or more big players. "I've never seen one of these periods without a financial accident--and I mean never," said Stephen Roach, economist at Morgan Stanley in New York. "Just because it hasn't happened doesn't mean it won't."
One common theme in both periods was new technology. In the 19th century that meant railroads and the industrial revolution. In 1864 a dozen handmade glasses cost $3.50. By 1888 those same glasses, made by machine, cost 40 cents a dozen. In the 1920s the spread of electricity and the rise of the automobile had an equally powerful effect. Both those boom periods also gave rise to excesses. In today's world, deflation doesn't have to be homegrown. It can be imported from places like China. The Wall Street Journal recently reported that the makers of golf clubs are moving their factories from Mexico to China. The reason? The average Mexican worker earns $288 a month compared to $75 for his Chinese counterpart. If the Chinese can make cheap golf clubs, why not cars and semiconductors?
Last week, Alice Schroeder, a property-casualty insurance analyst at Morgan Stanley, issued a report on insurer Chubb Corp., with an estimate for the company's full-year earnings that was well below Chubb's own forecast. Ms. Schroeder's $2.60-a-share forecast was a full $2 below the company's estimate of $4.60 because, she reasoned in her report, Chubb appeared likely to take charges later this year to boost asbestos-claims reserves and potentially uncollectible reinsurance. But when Ms. Schroeder submitted her number to First Call, she was told to get in line with the rest of Wall Street or face having her estimates thrown out. "The majority of analysts covering Chubb have updated their estimates for the guidance to exclude any charges in 4q02," according to a note from First Call to Ms. Schroeder. "Please update your estimates on this basis." The consensus estimate: $4.57. When Ms. Schroeder refused to budge, First Call first changed her numbers to exclude the charges and later dropped her estimates entirely. For its part, First Call contends it is merely trying to provide earnings estimates that are consistent in terms of what items are included. Without such uniformity, the consensus numbers published by the company "are meaningless," says Chuck Hill, director of research at First Call. But critics say that First Call, in its quest for statistical relevance, isn't giving its subscribers what they need: the often unpleasant reality about a company's prospects. For corporate earnings reports -- both by the companies themselves and the Wall Street analysts who follow them -- the practice of excluding whole hosts of recurring expenses to arrive at more attractive looking so-called pro-forma earnings figures remains the prevailing one. What is at issue here isn't Chubb's earnings presentation, but First Call's handling of analysts' estimates over a range of industries. The point: Some charges that are brushed off by analysts as "one-time," "special" or "unusual" can hold vital clues to companies' prospects. And when a well-regarded industry analyst like Ms. Schroeder is warning that such a charge is on the way, that is hardly something investors can afford to ignore.
Of course, fears of the millennium bug proved to be greatly exaggerated. Still, this latest day of reckoning has been greeted with a certain amount of trepidation by nervous investors, with just a bit of optimism coming from the positive thinkers. Here are the reasons for both types of thinking: Any company with even a hint of possible trouble will want to clear the decks before its top brass sign on the dotted line, making it entirely possible that the next scandal to rock Wall Street will come to light as the clock ticks toward 8/14. Companies that miss the deadline or simply don't sign the forms - and it's unclear what legal penalties companies and executives face for not taking any action - could be in for a beating. The Wall Street cognoscenti will take the missing paperwork as a sign that something may be amiss, and will hammer any company that acts as if it has something to hide. That could add to the market's recent volatility. On the positive side, once chief executives put their seal of approval on earnings - opening themselves up to personal liability if things go kaflooey - some observers believe America will have a basis for increased confidence, which is one of the combustible fuels necessary to turn the market trend around.
There is no question that the Fed Model has what appears to be a good record of handicapping the stock market over the past couple of decades. According to Florida-based Ned Davis Research, when the model has shown stocks to be more than 5% undervalued since 1980, the average one-year gain in the S&P 500 has been 31.7%. When the model has been more than 15% overvalued, the market has dropped 8.7%, on average, in the ensuing year. Tech stocks continue to comprise 14% of the S&P 500 and yet are expected to contribute only 5% of overall earnings in 2003, according to ISI Group. Remove tech and the market P/E based on expected 2003 profits stands below 14 - well within the range of historical norms and arguably quite undervalued with interest rates so low. Using another indicator, the ISI Group last week highlighted an approach credited to Clyde Bartter of Boyd Watterson Asset Management, which holds that since the 1960s, the price-to-earnings ratio on the S&P 500 has tracked the inverse of the prime borrowing rate. With the prime now at 4.75%, and its inverse at 21, it implies that stocks should be trading at 21 times earnings, well above the present level of 17 times 2002 earnings.
Less than two weeks after option traders peered through the red sea of bleeding stocks to identify the green light of a buy signal, and even before stocks began to give back some gains late last week, the question has become: Did we get too bullish too fast? "We went pretty quickly from oversold to overbought," said Christopher Johnson, a Schaeffers' Investment Research analyst. Take the popular options on the Nasdaq 100 Tracking Stock, or QQQ. Brisk call trading drove the five-day moving average of its put/call ratio down to 0.49 at one point last week and to 0.59 Thursday, compared with an average of 0.90. Volatility fell in many indexes and stocks, and the VIX (the Chicago Board Options Exchange volatility index) promptly shrank 41% in four days, as the focus of investors' fear suddenly went from skidding stocks to missing the boat on any rally.
Consider the record as it stood just before the start of this bear market: From the beginning of 1926 through 1999, the stock market had an annualized return of 11.3%, according to Ibbotson Associates, using the S&P 500 since 1957 and the S&P 90 before that. Most important, however, is the extent to which the market's annual performances have varied from that mean. By checking the standard deviation, the most widely used statistical measure of that variability, we know the market's historical returns fell within a surprisingly large range - from minus 8.7% to positive 31.3% - in about two-thirds of those 74 years. The market losses in 2000 and 2001 were just slightly below that range, so they should not have been shocking. How about losses for several years in a row, as investors are now experiencing? Again, the market's recent performance has not been outside the mainstream. Consider research conducted in 1997 by Prof. Jeremy Siegel of the Wharton School of the University of Pennsylvania. Siegel calculated the proportion of holding periods from 1802 to 1996 in which the stock market failed to outperform a riskless investment: Treasury bills. For all the five-year holding periods over those 195 years, this proportion is 26.7%. That means that if you buy and hold stocks, and assuming the future is like the past, you have a better than a one-in-four chance of being worse off after five years than if you had invested in a money market fund instead. So it should not be particularly surprising that stocks have failed to keep pace with 90-day Treasury bills over the last five years. How about 10-year holding periods? The numbers are hardly more reassuring: Stocks have failed to outperform T-bills 20.4 percent of the time. In fact, the only way to be more than 90 percent confident that buying and holding stocks will outperform T-bills is to hold on for nearly 20 years. These statistics, of course, were widely available in the late 1990's. So why are so many erstwhile believers in buy-and-hold investing so upset today? Undoubtedly, they have myriad individual reasons. But most are symptoms of what psychologists call the belief in the "law of small numbers." Identified in the early 1970's by two psychologists, Amos Tversky of Stanford and Daniel Kahnemann of Princeton, the concept applies to those who exaggerate the extent to which a small sample represents the universe. After several years of rising stock prices in the late 1990's, for example, many investors started believing that the market goes up in almost all years. Not surprisingly, buy-and-hold strategies became the rage. But now, with the market in a third year of losses, some investors are going to the other extreme, doubting whether the market can ever go up. This explains why buy-and-hold is now so out of favor. Neither extreme is helpful. As recent experience illustrates, buy-and-hold strategies are not for the faint of heart. If two and a half years of losses are enough to make you retreat, you don't have what it takes. Buy & Hold Part 2 Jeffrey Zaslow & Shirley Leung WSJ 7-24 In the late '90s, Sue Maniloff's husband kept telling her how much money they were making in the stock market. "Get it," she'd say to him. "I want to see green. I want to see cash. I don't care what's on paper." Her father agreed with her. "He kept warning us over and over and over that it was time to get out," say Ms. Maniloff. But her husband, Howard, didn't listen to his wife or her dad. Now, with the Dow down nearly 18% in a little more than two weeks, the argument has gained new intensity. That conversation is everywhere now - at family dinner tables, in marital therapists' offices, in divorce-mediation sessions, in visits with the in-laws. Back in the good old '90s, millions of people said to their significant others, "Hey, sweetheart, maybe we should take our profits." These days, they're holding it over their loved ones' heads. Their six-word battle cry: "I told you we should sell!" These last few weeks have been especially harried for those involved in pending divorces. Unless they can agree on a course of action, their stock portfolios just sit there, shrinking. "You get hysterical letters from opposing counsel saying, 'We need to sell!' " says Nina Vitek, a divorce lawyer in Milwaukee. Some families cope with market losses by remaining in denial. Sheldon Cohn, has a "don't ask, don't tell" policy with his wife. "She doesn't ask how badly we're doing in the market, and I don't tell her," he says.
The last time we moved toward an RPO economy was around 1980. Inflation was high (13.3% in 1979, 12.4% in 1980). Money market funds peaked at yields around 21%. Oil was predicted to hit $70 a barrel. Credit card interest was tax-deductible. It actually made sense to pay 18% on credit because the after-tax cost was less than the price increase on whatever you purchased. Even canned food was a good "investment." It was easy to make a case for buying just about anything simply because it would cost more tomorrow. Gold soared. Stocks were sinking because, well, why bother looking for 20% in a growth stock when you can get 20% in a money market fund with a checking account feature? Skeptics will be quick to point out that we don't have high inflation or high interest rates today. We do, however, have something equally powerful. In the RPO economy, everyone doubts the future. No one is willing to pay for anything that isn't immediate and palpable. A change like this has investment implications. It also has political implications that are less clear but very possible. Investment implications Stock multiples will continue to shrink. This will happen as investors seek current income and discount the value of future earnings. It is possible that corporate earnings may grow but will be offset by shrinking P/E multiples. This is what happened in the 1970s. Financial services will shrink. When trillions of dollars are lost, it's difficult for brokerage and investment firms to generate revenue. Like the late '70s (when some feared the mutual fund industry would disappear) or the late '80s (when the number of stockbrokers took a major fall after the '87 crash), financial services firms will reduce their head counts. Savings will be radically redirected. After the market declines of 2000, 2001 and 2002, in which millions of workers saw their regular contributions to 401(k) and 403(b) plans disappear, the alternative of debt repayment will be seen in a new light. An extra payment that saves 18% credit card interest, 8% car loan interest or 6% or 7% mortgage interest now looks like a brilliant investment with immediate and certain benefits. Investment will be radically redirected. The value of a remodeled kitchen or bath compares favorably with an investment in WorldCom at zero percent of cost and zero useful benefit. New consumer commitments will be scarce. Although many will spend more and save less, assuming new debt and new monthly payments will be psychologically harder. One reason is simple demographics: As the boomers age, their "debt horizon" will shorten. Another is pure uncertainty. Political implications Labor will be radicalized. The long decline of labor unions is over. With no reason to trust corporate leadership, abundant evidence of a broken social contract and still more evidence of being sold out by both political parties, joining a labor union will look like the only way to wield some political power. Being an incumbent, whatever your party, will be a liability. The political center will move left. This movement will be faster than either party can conceive. Last year's tax cuts will be rescinded, the estate tax will be restored, discussion of privatizing Social Security is dead, George W. Bush will follow in his father's footsteps as a one-term president and Senate Majority Leader Tom Daschle will start to look like a Republican. Health care will be nationalized. With health insurance a major barrier to employment for older workers, it will be demanded. Deeply frustrated employers and workers will figure out that we're already paying for national health insurance but aren't getting it. It will pass like a hot knife through butter. Bottom line: Buckle up - it's a rough road ahead.
The trend since 1999 had been for companies to be stingier with dividends, as corporate profits declined. The number of dividend increases fell from 1,701 in 1999 to 1,496 in 2000 and 1,326 in 2001, S&P data show. But in the first seven months of this year 878 firms raised dividend payments, up from 864 in the same period of 2001. At the same time, the number of companies cutting or omitting dividends fell to 85 in the first seven months, down from 109 in the 2001 period, S&P said. Just the Facts Doing Laundry Online New technology from IBM and USA Technologies will allow college students to do laundry without hunting for quarters or sitting around in the laundromat waiting for their clothes to be done. The eSuds system will connect 9,000 washers and dryers at U.S. colleges and universities to the Internet. Students can check a Web site for available machines and add detergent that the machines dispense. When the laundry is done, the machine sends an e-mail notifying the student. Swipe cards are used to pay for the laundry instead of cash, and laundromat owners can use the system to monitor machines and perform limited maintenance. The system might also cut down on vandalism, since cash won't be collected by the machines. (Reuters, 8-29) Revenue Estimates Earnings estimates for the coming quarters are tumbling, but what about revenue forecasts? Thankfully, they aren't falling quite as fast. In the past four weeks, Q3 revenue estimates have inched down 0.3%, according to Multex's Stan Levine, who has data on estimates for 426 of the S&P 500. In the past eight weeks, the estimates have ebbed 1.3% and in the past 13 weeks, 1.9%. Q4 revenue estimates have slipped by roughly the same percentages. Companies are still expected to see revenue growth, which is good, since last year was so miserable. Analysts foresee revenue growth of 4.6% for Q3 and 7.3% for Q4. (Jesse Eisinger, WSJ 8-29) A Ruinous Circle As a nation, we are caught in the strangest and perhaps most perilous recovery since the Depression Ù featuring a dynamic that William Dudley, chief domestic economist at Goldman Sachs, characterizes as "the corporate paradox of thrift." "If everyone tries to cut costs and save more, no one saves more," he said. "If you and everyone else cut costs, costs do indeed go down, but revenue also goes down, so profits eventually go down, too. Collectively, we can't cut our way to prosperity." (Louis Uchitelle, NY Times 8-25) Bond Yields The 10-year Treasury note now yields about 4.2% annually. Yields on investment-grade corporate bonds have declined this year, but the "spread" between corporate yields and Treasury yields remains near record levels. A Moody's Investors Service index of the average annualized yield on AAA-rated corporate issues was at 6.37% late last week; on BAA-rated issues (still considered investment-grade, but lower down the quality ladder) the average yield was 7.58%. The average yield on a junk index tracked by KDP Investment Advisors fell to 11.63% on Friday, down from a 52-week high of 12.28% set on Aug. 14, but still far above the 8% to 9% yields that prevailed on junk in 1997-1998. (Tom Petruno, LA Times 8-25) Fed Forecasts Christina Romer and David Romer, a husband-and-wife team of economists at UC Berkeley, tried to measure whether the Fed's internal forecasts for GDP and inflation were more accurate than those of private-sector prognosticators. Their results, published two years ago, suggest that "commercial forecasters would find it nearly optimal to discard their forecasts and adopt the Federal Reserve's." That is, the private-sector forecasts offer almost no useful information once one has access to the Fed's internal forecasts. (Daniel Altman NY Times 8-18) Bond Risk "I think buying high-quality, long-term bonds today is extremely risky," said Robert Rodriguez, manager of the FPA New Income fund. He also said investors should think carefully before buying intermediate-term bonds. Based on the 4.09% yield on a 10-year Treasury note on Tuesday, an investor would lose 1.73% of his capital over the next six months if interest rates rose by just one-half of 1%, Mr. Rodriguez said. Interest rates are now so low that even a tiny drop in the price of a bond can eliminate a bond fund's return, he said. "You just don't have any coupon to protect you." (Virginia Kahn, NY Times 8-18) Home Prices Over the past five years, home prices have risen an impressive 38%, according to mortgage company Freddie Mac. But investing in residential real estate can be plenty risky, just like the stock market. In Houston, median home values dropped from a peak of $81,000 in 1985 to $59,000 in 1988, after an oil bust sent thousands of property owners packing in search of greener pastures. In Los Angeles it took nearly a decade for prices to recover after the early 1990s recession toppled home prices from their 1991 peak of $221,000. At the trough, in 1996, the median home price in Los Angeles was $168,000. Over the long haul, home prices usually grow only about one to two percentage points faster than inflation. (Patrick Barta, WSJ 8-18) Pimco Becomes #2 In a development that seemed impossible just a year ago but has looked inevitable for the last few months, Pimco Total Return - a bond fund - has surpassed Fidelity Magellan as the second-largest mutual fund in terms of total assets. Magellan is down more than 20% thus far this year, and redemptions clearly play a role in Magellan's $6 billion worth of shrinkage over the last month. Meanwhile, Pimco Total Return is up about 5% thus far this year. (Charles Jaffe, Boston Globe 8-14) Income Stats In the 12-month period ended in June, personal income was up 3.4%. There is no mystery why the consumer has been the standout of an otherwise lackluster U.S. economy. Even in a lackluster job market, overall wages and salaries grew moderately. Moreover, pension income and other government transfer payments soared nearly 10%. And one subcategory, inflation-adjusted disposable income, has been increasing. It rose at a 9.1% annualized pace in the first half of 2002, which Richard Berner of Morgan Stanley calls the fastest growth rate in two decades. These big gains in real purchasing power owe their strength to low inflation, low interest rates that cut mortgage payments, and lower tax burdens on Americans. (Bernard Wysocki, WSJ 8-12) CreditGrades.com An easy way for investors to check on the solidity of their stocks [specifically - high dividend stocks and their future ability to pay those higher dividends] is a new, free service on the Web, called CreditGrades.com, that analyzes how bond investors view the risk of default in a particular company. The service, launched by RiskMetrics in May, looks at the action in the bond market and gleans from it the probabilities of default at most large American companies. Companies with no publicly traded debt are excluded, as are financial institutions and real estate investment trusts. (Gretchen Moregenson, NY Times 8-11) Contrarian Investing Investing in a lagging sector can pay off. But swimming upstream doesn't guarantee boffo gains, either. Yes, if you'd bought shares of the average fund in the worst performing sector-fund category at the end of each year from 1985 through 1999, you'd have been in the black over the following three years every time, according to Lipper data. But you would've trailed the S&P 500 eight times and lost money the first year. Consider the plight of an investor who bought shares of a tech fund after the category fell more than 31% on average in 2000. Since then tech funds average a 48% annualized loss, more than double that of the S&P 500, according to Lipper data. (Ian McDonald, WSJ 8-7) Junk Bond Stats Over a five-year period, a company rated Ba1 [the highest-grade junk bond] by Moody's has a 16% chance of being upgraded to Baa or higher. Single B-rated bonds [a lower grade] have about a 4% chance of making it to investment grade. And C-rated bonds [the lowest grade] have a 2% chance of making it. Similarly, over a five-year period, 8% of Ba-rated bonds went into default. Twenty percent of B-rated bonds defaulted and 42% of C-rated bonds were in default within five years. (Martin Fridson, chief high-yield strategist at Merrill, NY Times 8-4) Index Funds Even if index funds fared no better than actively managed funds, I believe indexing would still make sense. Why? Indexing erases much of the uncertainty of investing, thus giving folks the courage to stick with their strategy. You may even have the courage to rebalance. Rebalancing keeps your portfolio's risk profile in check and it can boost returns, by forcing you to buy into depressed areas that might be due for a rebound. But despite these benefits, rebalancing isn't for the faint of heart. It takes a lot of courage to buy into a fund that has just lost 20% or 30%. Perhaps owning index funds will give you that courage. (Jonathan Clements, WSJ 8-4) Profits & Wages The latest report from the Bureau of Economic Analysis says that profits, rather than peaking in 2000 as everyone thought, actually hit their high point in the third quarter of 1997, and have been bumping lower since, especially outside the financial sector. Instead of going towards profits, the benefits of faster productivity growth flowed out the door to workers and managers as higher wages and lucrative stock options. The wage increases continued even into the recession. From 1997-2000, real wages rose by 5%. And since the end of 2000, real wages have risen by another 3%. All told, from the first quarter of 1997 to the first quarter of 2002, compensation to workers and executives, including exercised stock options, rose by $1.4 trillion. By comparison, corporate profits were flat. (Business Week 8-2) Quick Facts, Stats & Opinions According to Multex, shares of 1,741 out of Nasdaq's 3,775 listed companies (46%) were trading at less than $5 each as of the close of business Monday. In March 2000, just 958 of the market's 4,726 companies (20%) traded below $5. On the NYSE, 248 Big Board companies traded for less than $5 a share as of Monday, more than 11% of the 2,163 listed companies. That compares with 217 stocks below the $5 mark in March 2000, or 9% of the 2,341 listed companies. (Ken Brown, WSJ 8-28) Revolving credit was up 2.7 percent in June from a year earlier, says Scott Hoyt, director of consumer economics at Economy.com. That growth figure was over 10% as recently as June 2001, he says. (Pamela Yip, Dallas Morning News 8-26) The options market is a zero-sum game. For every winner, there is a loser. Either a stock takes off, and the call-option buyer enjoys big gains at the expense of the seller, or it doesn't, in which case the seller painlessly pockets the buyer's option premium. If all this seems like a bit of a crapshoot, it gets worse. Because option investors fork over money for commissions and trading spreads, they collectively lose more money than they make. (Jonathan Clements, WSJ 8-25) The annual rate of change on the S&P 500 just dipped below 30%. In the last 40 years, there have been only three occurrences where the S&P 500 was 30 percent lower than the previous year . . . in September 2001 and August 1974, near the end of the devastating bear market of 1973-74. As a rule, markets this oversold should produce a decent trading rally . . . [Still,] in our opinion, the bear market has further to run, which dictates that we remain on the sidelines in a 100 percent cash . . . position. (Dan Sullivan, The Chartist Via Wash Post 8-25) August has been the best month for the Dow Jones Industrial Average over the years, says WSJ Market Data Group. (Since 1990, however, August is the worst.) The average monthly gain for the Dow in August is 1.39% since 1896. Next best is the average gain of 1.22% logged in Julys. Before you get too excited, realize that the worst month is September, with an average loss of 1.14%. Looking at the median monthly change, September is the only month where stocks traded down. (Jesse Eisinger, WSJ 8-20) According to InformationWeek's 2002 National IT Salary Survey, 25% of staff workers and 31% of managers received stock options during the previous 12 months. However, 21% of staff workers and 26% of managers expected to receive options in the next 12 months. (Victor Godinez, Dallas Morning News 8-18) In the bull market of the late 1990s, everything seemed to be going up. Today, nothing seems to be going up. Neither perception is entirely accurate. The market rise was led by a relatively small group of well-known stocks, while the average stock languished. More recently, market indices have been dragged down by the same large companies that previously led it up, but the average stock has experienced only modest losses. (Matthew Peterson, Capital Management Strategies via Wash Post 8-18) While the indicators are definitely in bullish mode, upside gains may be limited. A number of important support levels were broken during the recent decline [and] will act as resistance areas on the way back up. (Dan Sullivan, Chartist Mutual Fund Letter via Wash Post 8-18) According to Ibbotson Associates, since 1926, the worst 20 years for stocks (1929-48) produced a total return of 85%. The worst years for long-term bonds (1950-69) produced a total return of just 15%. The best 20 years for stocks (1980-99) produced a return of 2,592%; the best 20 years for bonds, a return of 864%. (James Glassman, Wash Post 8-18) You should tell your broker, on a permanent basis, if the stock drops 15 or 20 percent, just sell. That will stop a lot of the disasters that take place in portfolios. This is one part of the investment business that a lot of people, whether they are institutional or individual investors, tend to neglect. (William Rhodes, chief investment strategist at Rhodes Analytics in Boston, NY Times 8-18) The NYSE recently voted to change listing requirements to increase board independence. New rules will require boards to have a majority of outside directors instead of the current rule requiring three. Audit, compensation and nominating committees will consist entirely of outside directors. About a quarter of company boards do not have a majority of outside directors, according to the Investor Responsibility Research Center, a proxy-advisory organization. (Stephen Dunphy, Seattle Times 8-11) S&P's Investment Policy Committee feels that since valuations are now at or below historic norms, that earnings are likely to increase in the coming quarters, and that the technical picture has improved, equities now have greater upside potential than downside risk. (Investment Policy Committee Notes, Standard & Poor's, via Wash Post 8-11) Stock options eventually may be recognized as the ultimate shareholder swindle. . . With S&P 500 profits 22% lower after expensing stock options, investors now worry (rightfully) about huge future dilution from options. Low stock prices mean far more options granted, and shareholder dilution soars off the chart. This virtually guarantees a market which plunges over the cliff. (Charles Allmon, Growth Stock Outlook, via Wash Post 8-11) Forensic accountants are now finding that large-cap companies are restating at a faster clip than their smaller brethren, if their total population is factored in. Companies with less than $100 million a year in revenue account for 51% of the restatements, yet make up 58% of the publicly traded universe. Companies with annual revenue of $100 million or more account for 49% of the restatements, yet compose just 42% of publicly traded companies, according to forensic accountants at Huron Consulting Group in Chicago. (Lynn Cowan, WSJ 8-9) According to Brightmail, which monitors junk e-mail,June of 2001 saw 879,000 spam attacks; June of this year saw 4.8 million. The company also reports that the percentage all e-mail that is spam has risen from 7% a year ago to 12-15% today. (NewsFactor Network via EduPage, 8-8) Monday evening, U.S. officials issued a warning of possibly imminent hacker attacks on the Internet, but those attacks seem to have had little impact on Web traffic and service. Richard Clarke, President Bush's cybersecurity advisor, said data showed spikes in Internet traffic, between five and seven times the normal amount of traffic, but service was not interrupted. (AP via EduPage 8-7) Many investors have been cutting back on their exposure to risk, pushing down the prices of junk bonds. As a consequence, junk-bond yields are up. At the end of last month, the yield on the Merrill Lynch High Yield Index was 13.3%, 8.84 percentage points above that for on 10-year Treasuries. Merrill Lynch figures that the risk premium should be substantially lower, 7.77 percentage points. (Kennth Gilpin, NY Times 8-4) Over the 10 years ended June 30, Uncle Sam has eaten up 2.6 percentage points of the 10.37% average annual return for U.S. diversified equity fund investors outside retirement accounts. (Theo Francis, WSJ 8-5) An investment of $1,000 at the height of the stock market in March 2000, would be worth $1,501 today if the money had been put into real estate mutual funds, for example, compared with $639 if it had been placed in a fund mimicking the Standard & Poor's 500-stock index, or $211 if invested in the Nasdaq composite, according to Lipper. (Leah Ward, NY Times 8-4) Quick Tips nirsoft.multiservers.com/ offers several freeware Windows utilizes. The latest offering is IECookiesView. As you might expect, IECookiesView allows you a way to view the cookies stored by your trusty copy of Microsoft Internet Explorer. IECookiesView doesn't just show you a list of cookies, it displays all the information possible about the cookies. (Emazing 8-21) A new modem standard, V.92, offers the hope of accelerating that slow lane of the Internet. Although V.92 hardware arrived this spring, ISPs and computer manufacturers have been slow to adopt it. V.92 has four major new features: (1) "Modem on-hold" lets you take an incoming call when you're online, then return to the Internet connection - (you'll need call waiting and the right software for this to work): (2) "quick connect," which should cut in half the time a modem takes to establish a connection; (3) better compression for faster downloads of HTML and text files; and (4) upload speeds of 48 kbps, up from 33.6 kbps in older modems. (Kevin Savetz, Washington Post 8-11) It is important to keep your modem drivers maintained in order to get a more rapid response from your computer. To find the latest updates, tips, and support information for you driver you can visit Windrivers.com. Or visit your modem manufacturer's Web site to find out if there are any new updates. (Prodigy Tips 8-4) You can use the Outlook Express Messages Rules feature to add some color to your messages. Let's suppose that you want to make sure you don't miss messages from certain addresses. Just choose Tools|Message Rules|Mail. Click New and then select the check box labeled "Where the From line contains people". Move down to the "Rule Description" section and click "contains people". Type in an address, click Add and then click OK. Now, move to the "Select the actions for your rule" area and select the "Highlight it with color" check box. Move to "Rule Description" and click "color". Select your color and click OK. Back in New Mail Rule, click OK. Now click OK in Message Rules to close it and save your settings. Any mail from the specified sender will appear in your selected color. (Emazing 8-8) Home Page Previous Factoid Top Sites
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