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As part of the effort to clean up the image of the securities industry, both the NYSE and the National Association of Securities Dealers, which regulates the Nasdaq, have presented proposals as to appropriate public disclosure standards. The NASD's proposal applies disclosure rules to articles written by analysts or where analysts are interviewed in a question-and-answer format; it does not try to dictate what a newspaper or Web site must print as part of a news article. The NYSE proposal goes quite a bit further. The NYSE wants any investment recommendation made by an analyst or corporate executive on any medium to be accompanied by the following information: [1] Whether the analyst or corporate executive is an officer or director of the company being discussed. [2] Whether the company being covered is an investment banking client of the analyst's brokerage firm. [3] Whether the analyst has any current position in the stock. Technically speaking, the NYSE is not trying to regulate the media, nor tell anyone what to report; instead, it is controlling the actions of the representatives of its member firms. As a consumer of financial news, I don't necessarily think those disclosures go far enough. I'd like to know how long the analyst has followed the company, what his or her current rating is on the stock (buy, sell, hold), and how long that rating has been in place. In practice, the NYSE proposal will have a chilling effect. Penalties, according to Edward Kwalwasser, head of regulation for the exchange, run from a letter of admonition to being put out of business. To a securities firm, those penalties create a dilemma: Either get the press to guarantee the minimum disclosures or shut up. The unintended consequence of the rule, therefore, is that it gives financial firms a reason not to answer media questions. Last summer, William Blair & Co. wanted journalists to sign a form agreeing to make basic disclosures; fail to sign the form, forget about access to the analysts. Last week, Prudential Securities barred its analysts from talking to the media. This rule proposal is new; expect other firms to follow suit. Remember, too, that roughly one-third of all publicly traded companies are followed by one analyst, or none at all. For journalists covering those companies, that one brokerage firm can be a key source of information. One upside to the rule is that it might make the media less reliant on analysts and more dependent on doing its own analysis, tapping into the academic community and finding other relevant resources. However, the bottom line is this: When a firm cuts itself off from the media - or the journalist refuses to sign a disclosure agreement, as most will - the flow of information will be impeded. At a time when the financial community needs to let the sun shine in on how it is operating in order to regain public trust, anything that will wind up limiting disclosure is bad medicine.
Stocks: With stocks still richly valued, many experts are looking for long-run stock returns of around 8% a year. Subtract 2.5 percentage points for inflation, two points for investment costs and 1.5 points for taxes, and you are left earning a paltry 2% a year. Bonds: If stocks look grim, consider bonds. Today, a bond fund that owns a mix of corporate and government securities might collect a 5% yield. From that 5%, knock off 2.5 percentage points for inflation, one point for the fund's expenses and a little over one point for taxes. Result: You are barely ahead of inflation. Money-market funds: This is the real eye-opener. Admittedly, yields are exceptionally low right now, thanks to the Federal Reserve's campaign of rate-cutting. Still, start with today's 1% average yield, which already reflects the impact of fund expenses. Next, deduct 2.5 percentage points for inflation and 0.3 point for taxes, and you are effectively losing almost 2% a year. After taxes, investment costs and inflation, most investors won't make much money from their investments. That's not just a forecast that reflects today's rich stock valuations and lowly bond yields. It also has been true historically. If you had invested $1,000 in stocks 50 years ago, you would have amassed $212,000, based on the market's return of over 11% a year. But Vanguard Group founder John Bogle contends that number is grossly misleading. He notes that, if you adjust for inflation, you would have accumulated just $31,000. Next, subtract two percentage points for investment costs from each year's return and you are down to $11,600. Finally, subtract another two percentage points a year, this time for taxes. That leaves you with just $4,300. In other words, in this dazzling period for stocks, 98% of the market's apparent gain disappears once you figure in all these real-world drags on investment performance. Instead, investors probably earned less than 3% a year. So what should you do? Rather than trying to add to returns by beating the market, look to limit the subtractions by holding down investment costs and taxes. But while holding down costs is important, I would argue that the focus on performance is a big distraction. So what should you be looking at? In all likelihood, the biggest driver of your portfolio's growth won't be your investment performance, but rather the amount you save. Related article: Average Investor Stats - Ian McDonald, WSJ, The Case for Lowered Expectations - Scott Burns, Dallas Morning News
The expansion is still uneven, relying mostly on the whims of the consumer. Real consumer spending rose 4.1% last quarter, contributing 2.9 percentage points to GDP growth. Business fixed investment was a small drag (.07 percentage point) - the smallest in two years. The 0.59 percentage point subtraction from structures (the `plant' part of plant and equipment spending) was offset by the 0.52 percentage point addition to GDP from equipment and software. Spending on equipment and software rose 6.6% last quarter, the biggest increase since the second quarter of 2000. That follows a 3.3% increase in the second quarter after six consecutive quarterly declines. What's odd is that the perception persists that there is no capital spending going on. If one looks at a graph of the quarterly change in equipment spending, the pattern looks like what traders call a `V' bottom. This component of capital spending went from a 15.5 percent increase in the first quarter of 2000 to a 16.7% decrease in the second quarter of 2001. From that point, the declines decelerated before turning positive in the second quarter of 2002. Real final sales (GDP less inventories) rose 3.5%, while domestic final demand, which measures what we consume, not what we produce (it includes imports and excludes exports), rose 3.4%. The one piece of today's GDP that was not optimistic - even confusing to some economists - was corporate profits. Profits from current production, which adjusts for the value of inventories and depreciation allowance, fell 1.8% in Q3, the third small quarterly decline following Q4-01's 18.1% surge. Since Q4-01, prices per unit of real gross product of nonfinancial corporations have been falling while unit non-labor costs have been inching up, squeezing margins. Given the strong Q3 productivity, economists had expected more of the growth to be reflected in the bottom line.
Related articles: When Will Stocks End Slide? E.S. Browning, WSJ, Luck or Skill at Legg Mason - Jonathan Clements, WSJ, Lessons from History - Jonathan Clements, WSJ, Ten Reasons To Be Bullish - Marshall Loeb, CBS.MarketWatch
A 4 percent raise may sound good, given the paltry raises of recent years. But it can easily be eaten up by burgeoning health care costs, said Steve Harris, Atlanta-based leader of Mercer Human Resource Consulting's practice in the Southeast. Already, many companies are passing along higher health care costs to workers in the form of higher premiums and deductibles. His firm surveyed 1,600 companies nationwide in April about their pay intentions and followed up with 400 of them last month. Health care costs are expected to jump more than 14 percent next year - the third year of double-digit increases, according to the Segal Health Plan Cost Trend Survey. "At the current rate of increase, the cost of health care coverage will average nearly 25% of wages in less than five years for many plan sponsors," according to Segal, a benefits consulting firm. Mercer's survey indicates top employees can expect their pay to increase an average 5.2 percent next year. Average performers can expect a 3.5 percent boost, with weak performers getting just 1.2 percent more. Only a small number of employers told Mercer they planned to give no raises next year.
More on Health Care Benefits R Lieber & B Martinez, WSJ 11-26 Because of higher premiums and co-payments, workers already are paying 27% more for health-care coverage than they were in 2001, according to the Kaiser Family Foundation, a health-care philanthropy. In other cases, companies are scaling back benefits that they added in better days. Wal-Mart will stop covering employees' visits to chiropractors next year. Acuity Brands will no longer cover in vitro fertilization. With the economy limping along and unemployment up, corporations are turning their focus to slashing labor costs. Benefits typically represent about 27% of total labor costs, according to U.S. Department of Labor statistics. Although small companies often trim benefits in slow times, most big companies have continued to improve their benefit packages until recently. Now the tide may be turning, starting with companies in industries that are under relentless pressure to reduce costs. Nationally, the average deductible for a preferred-provider organization, a popular type of health plan that lets you pick your own doctor, increased 37% to $276 this year, according to Kaiser. The average monthly worker contribution for family coverage has more than tripled in the past 14 years; it is now $174 vs. $52 in 1988. Related article: 'Legacy' Costs & Steel - Robert Matthews, WSJ, More Firms Self-Insure Health Costs - Ronald White, LA Times
Whatever initiates a typical recession, falling paychecks ultimately push spending below production, and inventories jump. To reduce those inventories, production lines are turned off while goods are sold from the warehouses. Once the warehouses begin to empty, production slowly picks up. This normally leads to overtime hours and some renewed hiring. The result is rising purchasing power along with higher production. Indeed, this early phase of a rebound usually shows above-normal rates of growth. (Five percent GDP growth in the first quarter of 2002 was the result of this process.) At some point, the amount of inventory, current production and sales is restored to some balance. This is normally where a rebound suffers a pause. Also, recessions normally cause consumers to delay replacement of autos and appliances. Housing sales slow because falling paychecks more than offset falling mortgage rates. When the recovery begins, these deferred purchases reappear. Thus, housing and auto sales usually are still surging upward when inventories are restored to balance with sales. Thus, the pause in industrial activity usually is not very long. Because of aggressive interest rate reductions during the latest recession, however, autos and housing began rebounding even while paychecks were falling and inventories were spinning out of balance. By the time the pause, caused by restoration of inventory balance, occurred, housing and autos were stabilizing from their own rebounds. Of course, the interest rate declines shortened and diminished the magnitude of the recession, but they also lengthened and intensified the pause after the inventory rebound. That is where this economy is now. Can the pause undermine confidence and push the economy back into recession? This did occur in 1960 (following the 1958 recovery) and 1982 (after the 1980 plunge and rebound). However, both those "double dips" were accompanied by restrictive government spending policies and monetary restraint. With government spending up 8% in the past year, money growth near double-digit rates, interest rates at 40-year lows, and $130 billion in reduced tax liability for households in the past year, this is not likely to develop into another "double dip." Certainly, the Federal Reserve was concerned about just that prospect when it pushed its interest rate targets down another half point. Just like me, they must have found this "soft patch" too squishy for their tastes.
A second way to drag down longer-term rates, he said, would be for the Fed to announce it would keep short-term rates low for a fixed number of years. This would work because longer-term rates are influenced by investors' speculation about what short-term rates will be in the future. Bernanke said the U.S. economy was probably resilient enough to recover without such extreme measures. And the very fact that the Fed has these weapons in reserve may help provide the marketplace with the reassurance it needs to avoid another deep downturn.
When you buy stocks or purchase mutual funds through a broker, how much does the broker make? At bigger firms, reasonably productive brokers might keep 37% or 38% of the commissions they generate, while top producers can retain as much as 45%. For instance, if brokers generate $500,000 in annual commissions, their earnings might approach $200,000. Related article: Real Estate Commissions - Kenneth Harney, Washington Post
His argument is that investing is fraught with uncertainty, with real risks. The world of business is complicated and unpredictable, and, as Mitchell writes, "the attempt to develop accurate forecasts of earnings or market prices is a fool's errand." Successful investors figure out strategies, not to overcome risk, but to live with it. Here are five Marshfield aphorisms to cut out and stick on your refrigerator door: 1. Attempts at precision are futile (this means that 90% of what Wall Street tries to do is a waste of time). 2. Buying a stock when investors are optimistic increases the probability of failure (and vice versa). 3. There is no way investors can avoid the possibility that the value of their investment will plummet shortly after purchase, no matter how careful they have been. 4. Success or failure is random in the short run (a couple of years, minimum), and lack of patience is a recipe for failure. 5. Fear is just as deleterious to wealth building as greed.
Stock and bond investors ended the cycle with almost exactly the same results. An investment of $1,000 in stocks would have grown to $2,710 while the bond investor's account would have grown to $2,652, according to data provided by Kanon Bloch Carre, an investment consulting firm in Boston. Stock performance is measured with a blend of two indexes. The Wilshire 5000 index counts for 80% of the measure, and the EAFE international index makes up the balance. Bonds are measured by a Lehman Brothers aggregate index that includes many kinds of fixed-income securities. Measure the stock market's performance by the S&P 500 index and the story changes. This time the stock investor ends up in better shape with $3,287.
Suppose we lived in a simple society with no investment returns. Suppose also that we worked until age 65 and then lived in retirement for 12.6 years. That was the life expectancy at age 65 when Social Security was created. How much of our income would we have to save? Easy. Working for 40 years, we'd have to put aside 24% of our income each year, leaving only 76% for consumption. At age 65, we'd have 12.6 years of consumption put aside. Life expectancies, however, have been increasing. By 2000, expectancy at 65 was 17.6 years. By 2040, it's expected to be 20.6 years. Without a return on investment, you'd need to save about 31% of income to provide 17.6 years of income. You'd need to save 34% to put aside 20.6 years of income. Fortunately, investments earn returns. The higher the return on investment, the smaller the portion of our income we need to save. The 34% of income that young people need to save today if they earn no return falls to 25% if they earn the historical 2% real return of bonds. It falls to 15% if they earn the 5% real return that a 60/40 stock/bond portfolio is likely to earn. It plummets to 9% of income if they earn the 7% real return of common stocks.
Mr. Arnott believes it is likely that the pattern that he and Mr. Asness found at the level of the overall market applies to the individual firm as well. He notes in this regard another study that appeared in last December's Journal of Finance by two Columbia Business School accounting professors, Doron Nissim and Amir Ziv ("Dividend Changes and Future Profitability"). This other research found that between 1963 and 1997, earnings per share grew for two years at an above-market rate for the average company that increased its dividends. Mr. Arnott and Ms. Asness believe that the primary cause of their surprising result is the poor job that the average company does when investing the cash that it would pay out as dividends. Therefore it is better for the company to distribute its earnings to shareholders. With less cash on hand, a company interested in building its empire is forced to resort to the debt or equity markets to secure needed financing. That directly subjects its business to market discipline, reducing the likelihood that management will pursue unprofitable ventures. Their research provides strong evidence in favor of a theory first advanced in 1986 by Michael C. Jensen, currently an emeritus professor of business administration at Harvard Business School. Writing in The American Economic Review, Professor Jensen speculated that the more cash that companies have now (beyond what is needed for current projects) the less efficient they will be in the future.
What could possibly be wrong with growth? Most of the time, absolutely nothing. But former growth companies that continue to aggressively invest shareholder money after the growth opportunities have dried up are dangerous to shareholders. When a company stubbornly continues to sink its earnings into investments with less than market returns, that company is actually making bad investments with shareholder money. All companies mature. Their markets reach saturation. Newer products cut into the growth opportunity. Sheer size makes it tough for the company to grow very quickly on a percentage basis. The case of McDonald's On Nov. 8, the fast-food chain announced that it would shut or transfer ownership on 375 of its international restaurants. That's out of 17,000 existing international units and a total of more than 30,783 worldwide. The reason? Lagging growth and poor profits. Same-store sales dropped 2.8% in Q3-02 and then dropped another 0.8% in October. That's especially troubling, wrote Salomon Smith Barney, because the company had boosted ad spending to promote its new $1 menu and was facing very easy year-to-year comparisons against weak sales in Q3-01. But I think the place to focus is on the growth that preceded this announcement. After growing by an average of 300 restaurants a year in the 1980s, the company gradually increased its rate of new openings to 1,000 a year in the mid-1990s. And in 2002, the company was targeting 1,300 to 1,400 new restaurants. There's good evidence that part of McDonaldÌs growth problem results from a significant number of customers who don't like the way they're treated at the restaurant. About 70% of the complaints on the new McDonald's 1-800 complaint line are about service, according to an analysis by Salomon Smith Barney. (22% are about quality; 8% regard cleanliness.) Complaining customers think the service is rude, slow and unprofessional. Rude service has been the No. 1 complaint of McDonald's customers for 11 years running. When significant numbers of customers find the service at your restaurants rude, I'd say you have a quality-control problem. When you can't fix that problem in better than a decade, I'd say you have a management problem. Operations at the world's largest fast-food restaurant company resulted in net cash flow of $2.7 billion. Investments in property, plant and equipment came to $2.2 billion. No wonder McDonald's had to borrow a net $600 million in 2001 to buy back $1.1 billion in stock and pay out $288 million in dividends. That $288 million is spread out over 1.3 billion shares, so it comes to 24 cents a share. That's a yield of 1.4% at current share prices. What would happen if McDonald's suddenly admitted that the fast-food market was saturated in most of the world and that it didnÌt need to open 1,400 new restaurants in 2003? Cutting new openings to just a few hundred in 2003, spending just $1 billion on expansion and maintaining current units results in free cash flow of about $2 billion, according to calculations by J.P. Morgan. That would be enough to buy back 6% of existing shares or to pay a dividend of 8.5% on the stock. That's not likely. But that scenario does provide a benchmark for what McDonald's could do for shareholders and a way to judge the efforts of other mature companies.
And if it doesn't? Then neurons in emotion-processing regions fire like crazy, generating a sense of anxiety and dread, researchers at Duke report. Result: When a nice, reliable stock misses its earnings target by even a little, investors abandon ship in a fury. Often, the longer a stock has held up, the worse the beating, because the longer a pattern has persisted the more alarmed the brain gets when it's broken. Not surprisingly, the same brain system that responds to sensory rewards also perks up at the prospect of monetary ones. The reward circuit runs on the neurochemical dopamine. We get a dopamine surge when we anticipate a nice, healthy 4% return on a money-market fund. But dopamine neurons get extra juiced when a long shot comes in - and the addictive nature of dopamine makes us willing to take financial risks for those long shots. We whip out our checkbooks for managed mutual funds even though, historically, few beat the indexes. Neuroeconomists have also looked at brain activity during an extended (simulated) financial losing streak. A string of losses ramps up activity in brain regions that process emotional memories, swamping mere reason. That may partly explain why markets tend to linger near lows. [Info for future google searches: Daniel Kahneman helped create behavioral economics. Neurobiologist Paul Glimcher of New York University and Paul Zak at Claremont Graduate University are early stars in this field.]
Both of these strategies are dependent on the market reacting slowly to new information. Might Regulation FD speed up that reaction time, rendering these strategies less profitable? It's been more than two years now since the SEC instituted Regulation FD. Enough time has elapsed to assess its impact. Two well-known newsletters rely heavily on earnings momentum and earnings surprise. The first is the Value Line Investment Survey. Though Value Line's famed stock ranking system is proprietary, Value Line does reveal that three of that system's inputs are the 10-year trend of relative earnings, recent earnings changes, and earnings surprises. The other newsletter that is relevant is Zacks Advisor. Zacks assumes that companies are good bets to outperform the market if recent analyst earnings revisions have been upward. How have these two newsletters fared under Regulation FD? Both services have beaten the Wilshire 5000's 21.0% annualized loss between August 1, 2000, and September 30 of this year: Zacks' so-called "Focus List" lost just 9.1% annualized while Value Line's top-ranked Timeliness stocks produced a 15.1% annualized loss. On the basis of just over two years of results, therefore, the outlook remains positive for earnings momentum and earnings surprise strategies. There is no evidence that Regulation FD has erased their profit potential. This conclusion fits in nicely with the leading academic explanation for why earnings momentum and earnings surprise strategies work. That explanation focuses on investor psychology - specifically investors' tendency to disbelieve new information. If investors have fallen in love with a company, for example, they will be slow to give the proper credence to new data showing the company to be slipping. Similarly, once investors have become disillusioned with a company, they initially won't believe new data showing that it is turning itself around. Since Regulation FD does nothing to alter investors' psyches, it stands to reason that strategies based on investor psychology would remain just as profitable. Related article: Market is Slow to Recognize Value - Jim Jubak, MSN Money
Because free checking sounds wonderful to consumers and is fabulously profitable for banks, it's become America's trendiest banking service. Strunk & Associates says 540 banks use the free-checking program it designed, more than three times as many as did three years ago. Haberfeld Associates, which pioneered free checking, has more than 300 clients. When there are no customers around, bankers call free checking "fee checking." That's because free checking attracts customers who are more likely to overdraw their accounts, generating fat "nonsufficient funds" fees. Strunk says its banks average $150 of overdraft fees a year per free checking account, and Haberfeld clients average $110. It's those fees that Strunk and Haberfeld use to sell this idea to banking clients. Banks will generally honor your overdrafts at the cost of a bounced-check charge. If you ask an ATM for $100 when you have only $50 in your account, the machine usually laughs at you. With "fee checking," you get the cash. And an overdraft charge. More on Free Checking Riva Atlas, NY Times 11-12 Banks make money from free-checking customers in three ways. Because such accounts generally pay no interest, they provide a cheap source of money for the banks. The banks also use the accounts to attract new customers who will then buy their other products, like insurance or mortgages. Banks also charge many fees, particularly for covering bounced checks. "You get into the theater for free, but we make money on the pop and the popcorn," said William A. Cooper, chief executive of TCF Financial in Wayzata, Minn., which was one of the first banks to promote free checking aggressively. TCF can charge free checking and other accounts 36 different fees, Mr. Cooper said. Half of TCF's checking-account customers avoid paying any penalties in a given month. But the other half pay so much that more than a quarter of the bank's operating revenue last quarter, or $59 million, came from such fees. The fees helped push earnings up 16% at the bank from the previous year. The second-biggest fee that banks collect is for debit cards, which many banks offer to any free-checking customer. Banks are paid by retailers each time a debit card is used. Last year, retailers paid $2 billion in such fees to banks, up 35% from the previous year, said David Robertson, publisher of The Nilson Report, which tracks the credit and debit card industry.
On Wednesday, Northwest Airlines said it expected to reduce shareholder equity by at least $700 million at the end of 2002 to cover rising pension costs. Pension information is published only once a year, in a company's annual report. The impact of a pension's performance at a company is relegated to a footnote. Investors who want to know how much a company may have to kick into a depleted plan are out of luck. Plan obligations, and the contributions they may require, vary by participant and are not reflected in financial statements. Trusting corporate management to disclose bad news has not rewarded investors in recent years. A better idea would be to require companies to provide more information about pensions more often. Investors already know that pensions contributed a good deal to companies' earnings in recent years. According to David Zion, a tax and accounting analyst at Credit Suisse First Boston, 12% of the earnings growth registered by S&P 500 companies in 2000 came from pension income. Now that those gains are vanishing, companies should not be allowed to keep investors in the dark. In investing, ignorance is not bliss. It's oblivion. Pensions & Earnings at SBC Shawn Young, WSJ 11-14 SBC Communications said the rising cost of providing pensions and benefits to retired workers, combined with falling returns on the investments it uses to meet those obligations, will dent next year's earnings by $1 billion to $2 billion, which is more than analysts expected. The disclosure is likely to lead analysts to sharply cut 2003 operating-earnings forecasts. SBC estimated that payments to retirees will reduce earnings by 20 cents to 40 cents a share in 2003. In recent reports, several analysts had estimated the impact to be between 15 cents and 25 cents. SBC hasn't given an earnings forecast for 2003, but the Thomson First Call analysts' consensus was that the company would post operating earnings of $2.17 a share, excluding items like charges. Pensions & Earnings at EDS AP via Dallas Morning News 11-17 Higher pension costs due to the weak stock market will shave 15 to 16 cents per share off EDS's earning next year. The company says it expects pension costs to rise about $120 million next year. In a filing with the SEC on Thursday, EDS said the pension plan will probably have a $350 million liability in the fourth quarter because of the falling value of fund investments, and shareholders' equity would be reduced by the same amount. Pension Deficits Cassell Bryan-Low, WSJ 11-17 David Zion, an analyst at Credit Suisse First Boston, estimates that companies in the S&P 500 with traditional [defined-benefit retirement] plans will have to contribute $29 billion to pension plans in 2003, nearly double the payments made in 2001. So which sectors are most at risk because of concerns related to pension funds? "Generally old-line, heavily unionized companies could experience a decline in earnings, a deterioration in the balance sheet and, for some, a drain on cash flow," says Mr. Zion. These include the automotive, airline, steel and telecommunications industries. These types of companies have been among the hardest hit because they tend to have large, traditional work forces with unions. That means the employer is largely responsible for investing pension assets and guaranteeing payments. Other companies have dropped these more traditional plans in favor of so-called defined-contribution plans, such as 401(k) plans. The waning health of pension plans also means some companies might face a reduction in shareholder equity, which basically is the net worth of a company once its debts have been paid. A number of companies [including American Airlines' parent AMR and Delta Air Lines] have already warned that they may have to reduce shareholder equity if actual returns on investments remain weak. Pension Deficit [in Millions] of Some Major Companies Cassell Bryan-Low, WSJ 11-17
The sky isn't falling Ellen Schultz & Anne Squeo WSJ 11-26 Most large company pension plans aren't even close to being in peril. "The sky isn't falling," says Jack Ciesielski, who publishes the Analyst's Accounting Observer, and who has been analyzing pension expenses since the early 1990s. For one thing, merely being underfunded doesn't automatically mean that companies must dump money into their pension plans. "People jump out of their skin when they hear that a pension plan is X-billion underfunded," says Jeffrey Applegate, former U.S. market strategist at Lehman Brothers. "There's this notion that the company is going to have to write a check in the next nanosecond." Companies, following a web of complex government and accounting rules, typically have years in which to make the required contributions. During that time, the underfunding can vanish. Back in 1993, companies in the S&P 500 index collectively posted a shortfall in their pension plans. Then came the bull market and year after year of strong investment returns, leading to vast overfunding just two years ago. A Merrill Lynch report this month found that companies in the S&P 500 won't exhaust their pension assets for another 12 years, and that is with no further asset appreciation or company contributions. Investor expectations also play a role in pension panic attacks. During the 1990s, many pension plans were so overfunded that companies didn't have to contribute to them for years. Investors got used to this anomaly - and forgot that companies used to make frequent contributions to pension funds. Now, some shareholders wonder whether a company's cash flow will be harmed if the pension plan is underfunded. In most cases, the answer is no. Federal pension law requires companies to contribute additional assets if the plan's funding status falls below an average of 90% over three consecutive years, or 80% in any one year. What's more, companies have three to five years to make up the shortfall and can often contribute stock instead of cash. Merrill Lynch concludes: Only a handful of companies are likely to have liquidity problems despite growing liabilities. The fact that a company is contributing cash to its pension plan an automatic red flag. Some companies with strong cash flow are contributing more than they need to. Related article: Funding Pension Plans - Scott Burns, Dallas Morning News
European companies, especially, have become much cheaper than American. Greg Jensen and Jason Rotenberg of Bridgewater Associates, recently wrote to clients: "On a relative basis" - that is, compared with American stocks - "European equities may be the cheapest they have ever been." For example, they point out that if you add up the market caps of all U.S. stocks, you get $9 trillion. That's 58% of the market cap of all the stocks of major industrialized nations. Over the past 12 months, the earnings of U.S. stocks have amounted to $411 billion - or 53% of global earnings. In other words, when you consider their profits, U.S. stocks are slightly overvalued compared with stocks worldwide; that is, American prices are high in relation to profits. Now look at European stocks. British companies account for 11% of global market cap but 15% of global earnings, so they appear to be undervalued. With France and Germany, the differences are even more dramatic. Together, their firms account for about one-tenth of the world's market cap but nearly one-fifth of the world's earnings. But before you rush out and buy any French stock you can get your hands on, understand that there may be a good reason for this discrepancy: in a word, growth. European profits have been growing more slowly than U.S. profits. Still, the difference is so extreme that it's hard to resist. Japan, even after the sickening slide of the past two decades, still accounts for 13% of global market cap but just 7% of earnings. But don't ignore Japan. Thomas Tibbles, who manages the Forward Hansberger International Growth Fund, cites Honda Motor (HMC), which trades at a P/E of 9, based on earnings projections for the fiscal year ending in March 2003. "Honda is gaining market share in the U.S.," he says. Earnings last year set a record, despite the economic slowdown, and cash flow is impressive. Value Line reports that Honda earnings have risen an average of 19% for the past five years and are projected to rise 12% for the next five. Related articles: International Mutuals - C Currier, Bloomberg / Others, Home Bias - Mark Hulbert, NY Times
Only the Fed knows what signal or signals it wanted to send with the rate cut, the central bank's first reduction in 11 months. But for savers and investors, one message is loud and clear: Your only chance of earning higher returns is to take more risk with your money. As low as savings yields have gotten, they arguably aren't as bad as in some previous eras, when adjusted for inflation. In the 1970s, inflation, as measured by the Consumer Price Index, rose at a rate of 7.4% a year, according to data tracker Ibbotson Associates. In the same decade, the average annual return on three-month Treasury bills was 6.3%. So adjusted for inflation, the return on T-bills in that decade was a negative 1.1% a year. The current yield on three-month T-bills is 1.21%. CPI inflation over the last 12 months has risen 1.5%. If inflation stays at that rate, the annual after-inflation return on T-bills is approximately negative 0.3%. That's lousy, but it could be a lot worse.
On the demand side, it is the most expensive of the parking lots The Times has for its employees. So if it begins to look a little empty, I figure the economy is going down because my fellow employees are trying to save a few dollars by parking farther away from the front door. As it fills up, the reverse is true. On the supply side of the equation, I also look at the quality of the cars, with my 1988 Honda Accord a benchmark. Looking at the rest of the cars in the lot, I would have to conclude that car dealerships did fairly well in the past six months. The parking-lot index has leveled off in the past few weeks, with few new entrants to help push it higher, and occupancy rates seeming to hold steady. Right now it is saying the economy is perhaps a little better than we might expect. The point to all of this is to show you how you can be your own economist. Just look around. Find some piece of the economy and watch it change. More Stephen Dunphy Seattle Times 11-17 Several other readers sent me their versions of the same idea. Bob Richards, retired chief economist for the National Bank of Alaska in the 1970s, found great validity in his Honey Bucket Index. "On the way to work each day I passed the yard where the local porta-potty company stored their potties. When the lot was full, economic activity was slow. When the lot was empty, economic activity was strong," wrote Richards. Another reader, Barbara Travers, watches the parking lot at Costco on Saturday mornings. "While waiting for a spot you can get a good read on real-time economy by watching the shopping carts go by," she said. "Good week equals stereos, TVs. Bad week equals toilet paper and dog food."
In light of those developments, the report suggests a possible future for higher education: an academe dominated by freelance instructors selling their services to many institutions, which in turn compete for students who buy courses a la carte from many different colleges. The report predicts that information technology, by allowing students to learn both at a distance and at their own pace, will undercut two commonplace features of undergraduate instruction: lectures and a common reading list. Rather, students will collaborate online with one another and their instructor. The report says that research universities subsidize their research and graduate training with profits made from large lecture courses and from professional training - areas into which for-profit universities are likely to expand. "Their success in the higher-education marketplace could therefore undermine the current business model of the research university and imperil its core activities."
Overseas, Japan is in its fourth year of declining prices even with interest rates near zero, a result of a decade of economic stagnation that followed the bursting of its real-estate and stock bubble. China has experienced intermittent deflation since 1999 and a few economists think Germany may be close. The 1930s demonstrate that deflation is most dangerous when debt burdens are heavy, as they were in the 1920s and are today. A company borrows on the assumption that rising sales volumes and prices will enable it to repay the debt. As prices fall, it becomes more difficult to make payments on debt. The corporate debt burden, which has also doubled since the 1950s to 89% of revenue, is worrisome. One indicator of investors' concern about companies' ability to pay back the debt is that yields on medium-quality corporate bonds are 2.7 percentage points higher than those on safe Treasurys - the widest spread since 1986. "Companies simply aren't coming up with the cash flow they thought they would when they took on the debt," says John Lonski, chief economist at Moody's. Automobiles illustrate the pressures. In the 1950s, car prices rose about 0.5 percentage points a year faster than inflation, says Sean McAlinden, chief economist at the Center for Automotive Research in Ann Arbor, Mich. Car makers' productivity was rising rapidly, and sales were advancing 3% to 4% a year. In today's dollars, manufacturers earned about $1,500 per vehicle. Today productivity is growing more slowly, the world is awash in idle auto factories and a strong dollar is holding down the price of imported vehicles. As a result, Mr. McAlinden says, new car prices have fallen 0.2% a year since 1996 and profits per vehicle are down to about $400. That is making investors increasingly nervous about auto makers' ability to repay huge debts, which are mostly to finance customers' car purchases. As recently as 1980, Ford Motor Co. had the highest available credit rating; now, its bonds trade as if they were junk. In the 1930s, Mr. McAlinden says, "we had both deflation and absolute falling demand. This time we just have falling prices." So far. A renewed recession, which would drive down auto sales, is "the most frightening prospect this industry cares about," Mr. McAlinden says. [I post the above because it got me to thinking - it is not just the auto industry. It is technology, pharmaceuticals, tele-communication, financial services, the print and broadcast media, etc. It is hard to think of an industry that does not have over-supply, a lack of demand and a sizeable debt load. ] Autos & Deflation Danielle DiMartino, Dallas Morning News 11-15 Automakers have not been able to raise prices on new cars since 1997. New car prices have dropped 2.8% since then. Indeed, some economists say that the last year's surge in car sales will play out as a temporary fix that delayed an inevitable decline in overall consumer spending. "The only reason automakers can offer zero-percent financing is because rates are so low - the Fed has allowed them to do this," said William Wilson, senior economist at Ernst & Young. To make matters worse, the Big Three were hit with a steel price hike this week, a jugular blow in their weak financial position. Steel producers can make these demands, thanks to insulating tariffs. Economists warn that other industries will also seek tariffs to shield them from foreign competition. "Tariffs might help an industry temporarily, but ultimately the industry will suffer - automakers hurt by this will be forced to produce fewer cars and therefore buy less steel," said Mark Zandi [chief economist at Economy.com], explaining the dangers that tariffs pose to ultimately trigger further layoffs by cost-squeezed manufacturers.
In August, according to the department's closely watched monthly survey of business payrolls, the number of payroll jobs rose by 96,000, a small net change when the number of workers on private and government payrolls was 130.9 million. The self-employed and some other workers are not on payrolls. But last week the department's BLS released the August results of its new Job Openings and Labor Turnover Survey, which painted a far more dynamic picture. According to the survey, 3.7% of those at work at the end of August were hired that month. At the same time, 4.1% of those at work on the last day of July left their jobs during August. Of those who left, three-fifths quit and only one-third were discharged or laid off for more than a week, with the remaining fraction departing because of retirement, disability, death or transfer to another location. The survey showed that 4.85 million people were hired and 5.37 million "separated" from their jobs, which includes the 3.22 million who quit and 1.78 million who were discharged or put on extended layoff. The figures may even understate the amount of change. Fed economists Bruce Fallick and Charles Fleischman, found that labor market turnover was so great over a seven-year period ended in 2001 that, on average, 6.7 percent of all workers employed one month were not employed by the same employer the following month. In 2000, for example, with employment around 135 million, that meant that roughly 9 million employees left their jobs in an average month, with most of them moving from one job to another. The churning of the labor market belies the impression of little month-to-month change. Given all the hiring and firing going on, it seems that the more than 8 million jobless in September were not necessarily the same 8 million unemployed in August or October. According to their study, the Fed economists concluded that in an average month, slightly less than half those counted as unemployed one month were still unemployed the following month. Their data suggest that in September, about 4 million workers who could not find employment in August either got a job or dropped out of the labor force, while a different 4 million joined the ranks of the unemployed. Even with all the churning, a substantial number of people are remaining unemployed for months. Last month, 1.66 million unemployed people had been jobless for 27 weeks or more. And 355,000 people had stopped looking for work because they believed none was available, the Labor Department estimated. The survey also offers one figure that does not appear in the regular monthly statistics: the number of job openings. In August there were 3.49 million job openings for which employers were actively searching for workers. The services industry had the largest number of openings, with 1.5 million. Retailers had 642,000 openings. Manufacturers, which have been shedding employees for more than two years, trailed with just 295,000 openings. Governments, both federal and local, had 501,000 openings. The industry with the greatest turnover was retail; 5.9% of employees left during August, 4.3% of whom quit. Meanwhile, 5.7% of retail employees at the end of August were hired during the month, according to the survey. Unemployment Stats Sam Zuckerman, San Francisco Chronicle 11-17 The Labor Department calculates that the nation's unemployment rate was 5.7% in October. The department also figures that 1.4 million people who weren't actively searching for a job - and therefore were not counted as unemployed - wanted jobs and were available for work last month. If such people were included among the unemployed, the department calculates that the nation's jobless rate in October would have been 6.3%, and even higher if the figure had been seasonally adjusted as the official unemployment rates were. The rate rises to 9% if those people who are involuntarily working part time are included. Since October 2000, the number of civilians 16 or older who are not in the labor force has risen by 2.3 million to 71.8 million.
1. The gap between stock and bond funds is wide by historical measures. Stocks might just be looking so bad that they're starting to look good. In the five years ending Oct. 31, the S&P 500 trailed the Ibbotson Intermediate Government Bond Index by more than seven percentage points annually, according to data from the Charles Schwab Center for Investment Research. That's pretty rare. Since 1930 that stocks have topped bonds in monthly rolling five-year stretches almost 80% of the time. Historically, it's been a good idea to buy stocks when they're eating bonds' dust. The last time stocks trailed bonds by this wide a margin was the five-year stretch ending January 1978. Over the following five years stocks beat bonds, averaging a more than 16% annualized return. 2. "Growth" stocks are turning up in value portfolios. More and more traditional growth-fund holdings like technology, media and pharmaceutical stocks have slid onto bargain-hunting value manager's radar screens. This means at least some highfliers appear to be trading at or below their true value. We last saw this trend in 1994 when many value types scooped up drug stocks battered by the specter of price caps and a national health-care plan. That blue period presaged a 46% gain for the average health-care fund the next year, the start of six consecutive positive years for the category according to Morningstar. Since the end of 1999, the percentage of large-cap value funds owning shares of drug maker Merck has risen from 37% to more than 56%, while the percentage of funds owning Schering-Plough has more than doubled to 39%, according to the latest portfolio data from Morningstar. Over the same stretch, the percentage of bargain-hunting funds holding shares of cable firm Comcast and Microsoft have more than doubled to 24% and 27%, respectively. 3. Fund investors and fund marketers are loving bonds. Sadly, there are few contrarian indicators as reliable as fund investors and fund marketers. By flitting from one market-leading sector or style to the next, investors consistently end up in the wrong place at the wrong time. Fund managers' cash stakes can have a contrarian bent too. Stock funds' cash stakes dipped to 4%, their lowest point in nearly 30 years, in March 2000. In other words, portfolio managers made their biggest commitment to stocks when equities were at their peak. Today, we're seeing the inverse of the late 1990s mania. Thanks to sales-chasing, fund companies have a similarly bleak record with the timing of new-fund launches. The number of tech funds has nearly tripled to more than 150 since the end of 1998 and the average offering sports a 29% annualized loss over the past three years. Today, fund companies are slimming their ranks of growth and tech funds and slapping together leveraged closed-end bond funds at a furious pace. OK, these three points are intriguing, but they don't mean the pain is over. There are still legitimate questions about stocks' valuations and the economy. Stock prices are far lower than they were two years ago, but that doesn't mean they're cheap. The average stock in the S&P 500 trades for about 19 times it's expected earnings. That's higher than equities' historical average price-to-earnings multiple of 15. These figures might also be too low given that some companies' earnings estimates include expected pension-fund gains, exclude stock options or might be science fiction. Then there's this "brother can you spare a dime?" economy. Still, while bonds have a place in most portfolios, it's getting harder and harder not to think folks slugging money into stock funds will earn a higher return than they would in bond funds over the next five or ten years. It's tough to write the check. But most vets will tell you, that's when they've made the most money. Related articles: Time Tested Patterns - Sandra Ward, Barrons, Ten Reasons To Be Bullish - Marshall Loeb, CBS.MarketWatch
One conclusion was that bargain hunters should look for stocks that have low P/S (that is, price-to-sales) ratios rather than low P/E (price-to-earnings) ratios. O'Shaughnessy used Compustat data to find the 50 stocks with the lowest P/S ratios each year from 1952 to 1994. If you bought a portfolio of such stocks at the beginning of each year, then sold it and bought a new portfolio of the lowest-P/S stocks at the beginning of the next year, your average annual return would have been a spectacular 18.9%, compared with 14.6% for the entire Compustat universe and 14.7% for the 50 stocks with the lowest P/E ratio. Why does this strategy work? O'Shaughnessy didn't try to explain. He just crunched the numbers. My own guess is that, first, sales are much harder for a company to manipulate than profit, so they are a more accurate indication of how a company is doing, and, second, that sales are the raw material from which profit is derived, so that a company that produces strong revenue will eventually, with good management, produce strong profit.
David Ikenberry of the University of Illinois at Urbana-Champaign, and Sundaresh Ramnath of Georgetown, have developed a theory that does explain it. They believe that when management lacks confidence in its company's stock, it is more likely to use a reverse split. By contrast, they say, if management believes that the low price is just temporary, it will be more likely to leave the stock alone. Confirmation of this confidence factor comes from the performance of stocks undergoing the opposite type of split in which a company increases the number of shares while reducing their price. The shares of such companies fare particularly well. From 1926 to 1991, according to Professors Desai and Jain, the average stock undergoing a forward split outperformed the market by 6.8% over the year after the split's announcement. More Stock Split Stats Bill Deener, Dallas Morning News 11-10 In the late 1990s and early 2000, hardly a day went by without an Internet company announcing a forward stock split. In 1998, for example, 353 public companies completed forward stock splits, according to Standard & Poor's. Slightly more than 200 forward splits are expected this year, but the number of reverse splits has increased from 76 in 2000 to 210 so far this year. [Martha Smilgis, San Francisco Examiner 10-25-02: Last year 109 companies on the Nasdaq offered reverse stock splits. We are up to 114 this year - so far. The NYSE has fared better, with 14 companies offering reverse splits in 2001 and only 10 this year. ] A recent study by Credit Suisse First Boston showed that almost all 800 companies that had reverse splits in the last five years underperformed their peers over the long term. Since 1993, about 25% of the companies involved in reverse splits had higher stock prices a year after the transaction, according to a study by Coffin Communications Group, an investor relations company.
Measured in dollars, the 12.93% annualized return of the Vanguard 500 Index fund (excluding any taxes) would have turned $10,000 into $113,811. Not a bad trick for being cheap and passive instead of active and clever. The result brings up a tough question: What are the odds that anyone would have been able to pick a better-performing fund? My answer: not very good. Of the 45 domestic equity funds that did better than the Vanguard 500 Index, only 18 were load funds. So there was about a 6% chance (18 out of 306) that a load fund would have done better than the mother of all index funds. Those aren't very good odds. The American Funds group looms large on the list. Four of their funds did better than the index - Washington Fund, 22nd at 14.16%; Fundamental Fund, 26th at 14.01%; Growth Fund, 29th at 13.94%; and Investment Company of America Fund, 31st at 13.84%. All four of the low-load funds were Fidelity offerings: Fidelity Select Health Care, No. 1 with a 17.87% return for 20 years; Fidelity Select Financial Services, No. 3 with a 16.39% return; Fidelity Contrafund, No. 9 with 15.43%; and Fidelity Magellan, No. 10 with 15.42%. Be Index Selective Scott Burns, Dallas Morning News 11-5 At the end of September there were 544 index funds that specialize in domestic stocks, including the new exchange-traded funds. There were 678 index funds of all kinds. To put those figures in some perspective, the number of index funds available today exceeds the total number of mutual funds that investors could choose from 20 years ago. Query: So which index funds do we invest in? Answer: the funds that retain the most powerful advantages of index funds - low expense ratios and cost-efficient low portfolio turnover. Today, the 544 domestic equity index funds have an average annual expense ratio of 0.76%. This may seem reasonable at first glance - it's nearly half the expense ratio of the average managed fund. But there are 600 managed funds with lower expense ratios than that. Similarly, the annual portfolio turnover rate for the domestic equity index funds averages 95%. This isn't far from the 111% turnover rate of the average managed fund. As a result, an index investor who doesn't discriminate incurs virtually all the portfolio trading costs - and possible tax consequences - of the typical managed fund. Fortunately there are 32 domestic stock index funds that have annual expenses of less than 0.2% and portfolio turnover of less than 10%. Here are some good examples: (1) Vanguard Total Market Index Fund, (2) IShares Russell 1000 Index and (3) IShares Russell 1000 Value Index. Related articles: Defending Indexing - Clements, WSJ / Jaffe, Boston Globe, Passive Investing - Burns, Dallas Morning News, The 'Right' Index is No Longer the S&P 500 - Santoli, Barrons / Blake, Institutional Investor
But starting in 1993, American companies began issuing a new 'fully taxable' preferreds, which are fully taxable for both individual and corporate customers and offer higher yields than the older variety. The market for fully taxable preferreds now amounts to $185 billion, dwarfing the market for the older type, according to Spectrum Asset Management, which specializes in preferreds. Fully taxable preferreds pay quarterly dividends. Fully taxable preferreds may be bought directly on the major exchanges. They are generally issued at a more accessible price of $25 a share, rather than the $1,000 price of a new corporate bond. They have set maturities that often extend to 30 or 40 years and, at maturity, the investor receives the par value. And the dividends on preferreds, like bond coupons, aren't subject to routine revision by management if a company's earnings change significantly. Preferred shares are also like bonds in that their value declines when interest rates rise or credit quality falls. Rating agencies like Moody's Investors Service and Standard & Poor's review preferred shares, just as they do long-term corporate debt. The main benefit of preferred shares is the size of their cash payouts. the main benefit of preferred shares is the size of their cash payouts. A class of Citigroup preferred shares recently yielded 7% a year, versus 5.7% for 10-year senior debt of the company. A class of Virginia Power preferreds yielded 7.2%, versus 6.5% for a 10-year senior note of the company. Yields on preferreds tend to be higher than those for corporate bonds because they have slightly longer maturities and are generally subordinate to corporate bond issues. Because of that risk, the yield on the average preferred is now 3.27 percentage points higher than a 10-year Treasury note. Generally, preferreds have far less price volatility than common stock, but they also tend to be slightly less volatile than corporate bonds. This can be attributed that to their holders: ownership of preferred shares by individuals tends to be higher than it is for bonds. Individuals tend to hold on to a preferred longer than institutions, who are both more credit and interest-rate sensitive. Still, investors need to be cautious about investing in preferreds, which carry substantial interest rate risk, as do all long-term fixed-income investments. Investors might also want to pick a preferred that pays "cumulative" dividends. This condition, stated in the prospectus, means that if the company defaults on its quarterly cash payments, it is required to resume payments, including those that are overdue, with added interest, provided that it gets its feet back on the ground.
The $1.3 billion Nuveen Quality Preferred Income Fund is yielding 8.28%, for example. Another preferred-stock portfolio, the $900 million John Hancock Preferred Income Fund is carrying a yield of 8.85%. The Eaton Vance Insured Municipal Bond Fund is sporting a tax-free yield of about 6%. Meanwhile, open-end muni-bond funds, which typically don't use leverage, are yielding an average of 4.1%. Because of their yields, leveraged closed-end funds have been selling like hot cakes. Sixty-six such funds have been launched since the start of 2001 - more than three times the total number of leveraged funds brought to market during the preceding seven years, according to Lipper. So far this year, 35 closed-end funds with the ability to leverage have been opened, raising $7.2 billion, according to Lipper. That is the most since 1993, when 75 funds raised $7.1 billion. However, there is a catch: When interest rates rise, investors in these funds are likely to lose more money and see their dividends slashed faster than those in funds that don't use leverage. According to Lipper, from the time the stock market hit its recent low Oct. 9 until it reached its recent high Oct. 21, the price of the average leveraged closed-end fund investing in municipal bonds or preferred stocks lost 5.2%, while nonleveraged closed-end funds lost 2%, both based on their share prices. Between the bond market's top in October 1993 and the bottom in November 1994, the average leveraged closed-end fund fell 22% in price, while nonleveraged closed-end funds fell 13%, according to Lipper. If interest-rate increases produce losses at leveraged funds, that is likely to lead some investors to dump their fund shares - further depressing results for remaining investors. Bond Bull Market is Over Jim Jubak, MSN Money 11-8 The 20-year bull market in bonds is drawing to a close. We do know that it's coming, as sure as we can measure the distance from today's Federal Reserve Fed Funds rate of 1.25% to 0%. Investors who have only been in the bond market for the last 20 years may not know exactly how unusual this period has been. From 1926 through 1980, the average annual total return (that's interest plus capital appreciation in the price of the bond) for intermediate-maturity U.S. Treasurys came to 3.7%. But that average went out the window in 1981 when intermediate Treasurys returned 9.5%. The year after that, they returned 29%, and in 1983, 1984 and 1985, they posted total returns of 7.4%, 14% and 20%, respectively. For the 10 years that began in 1981 and ended in 1990, these low-risk intermediate Treasurys returned 12.5% a year on average. And bonds haven't turned off the jets yet. For the last 10 years, the Vanguard Total Bond Market Index, a mutual fund that tries to match (roughly) the Lehman Brothers Aggregate Bond Index of all types of bonds, has returned 7.2% annually on average, or almost twice the long-term historical average total return on intermediate U.S. Treasurys. Bill Gross, the star bond fund manager at PIMCO, has said that bond investors should now expect that their total return will equal the interest rate paid by the bond. And nothing more. With interest rates unlikely to sink much lower, bond investors shouldn't be counting on much capital appreciation from their bond holdings. The Case for Buying Bonds Now Chet Currier, Bloomberg 11-5 Through the first nine months of 2002, the ICI reports, investors bought $119.8 billion more of bond- fund shares than they cashed in. That eclipses the full-year record for `net new cash flow' of $102.6 billion set in 1986. Bond-fund investors have a long-standing reputation for buying heavily at the wrong time. The three biggest years for inflows into bond funds in the 1990s were 1992, 1993 and 1998. The two worst years for bond-fund performance in the '90s were 1994, when the Salomon Brothers 10-Year Treasury Index fell 7.6%, and 1999, when it dropped 8.7%. There is a case to be made for the publice buying bond funds now. Bond funds can be good sources of income, plus valuable diversification that lends stability to one's investment plan. Looking in that long term light, we might view recent flows into bond funds as a move to right an asset-allocation imbalance that arose during the 1990s and needs fixing now. A decade ago, the ICI numbers show, fund investors tended to keep their money in roughly even proportions - a third in stocks, a third in bonds, a third in money markets. By the end of the 1990s the proportions had tilted drastically, and bond funds' market share had shrunk to a meager 12%. Stock funds had five times bond funds' assets, money funds more than twice as much. Now bond funds are back up to 18%. It's anybody guess whether that share will keep rising, or what an appropriate `equilibrium' amount would be. Maybe not 33% again, but surely more than 12%. If fund investors' short-term judgment is flawed, they still may have made an adjustment in the longer-term allocation of their money that's quite appropriate to the age in which they live. Timing isn't everything. Related articles: Snag Looms in Bond Funds - Charles Jaffe, Boston Globe / Others, Bond Mutual Funds Not Bad - J Clements, WSJ / Bonds ETFs Coming - A Schultz, NY Times , Treasurys are a Bad Bet Now - Clements, WSJ / Baum, Bloomberg Just the Facts Risk & Volatility Investors are becoming less fearful. When investors are confident, they are willing to buy volatile growth stocks; when they are nervous, they retreat to value. Our quantitative group's work indicates a likely turning point favoring growth over value in October. Also, the risk priced in the market seems to be abating. . . . One-month implied volatility has been significantly greater than 12-month. The two tend to converge over time, and the best time to buy is when short-term volatility begins to move down toward long-term. This began to happen in October, but the two are not quite congruent yet." (Byron Wien, Morgan Stanley via Washington Post 11-24) Holiday Shopping Forecasts According to an annual shopping forecast from market researchers RoperASW, 14% of shoppers said they intend to finish their holiday shopping before Thanksgiving, compared with only 7% who did so in 1990. Of course, the finding may reflect wishful thinking and good intentions. Early shoppers aren't necessarily splurging: An analyst survey from the International Council of Shopping Centers, a trade group, concludes shoppers on average will spend only 2% more than in 2001. (Shelly Branch, WSJ 11-18) Holiday Shopping Forecasts 2 A Deloitte & Touche survey of consumer holiday shopping intentions found that 36% of the 13,000 consumers who were contacted plan to spend less than last year. [D&T forecasts a 3.5% sales increase.] One sentiment can hold holiday sales down - About a quarter of consumers told a recent American Research Group survey that they don't expect to get a pay raise any time soon. Typically, that number is about 5%. (Chris Reidy, Boston Globe 11-22) Stocks Are Cheap Ed Keon, an investment strategist at Prudential Securities, makes the case that the true earnings that will be generated by S&P 500 companies this year will be equal to what they generated in 1997, though down sharply from the results reported in 1999 and 2000. If earnings are back to 1997 levels, where are share prices? The S&P 500 index, at 909.83 on Friday, is 6% below its 970.43 closing level at the end of 1997. Meanwhile, Keon notes, interest rates are far below their levels of 1997, and inflation also is lower. If the world as we know it doesn't end, and even allowing for slower earnings growth in the next few years than during the boom years, if stocks are judged against interest rates and inflation they are "very cheap," Keon contends. (Tom Petruno, LA Times 11-17) The Case for Investing in Asia They have done a lot of substantive restructuring since the late-1997 currency crisis. They now have pretty solid earnings growth, a healthier banking system and low valuations. In Korea, Taiwan, Hong Kong and Thailand you have stocks with 20% earnings growth trading between 8 and 15 times earnings. You're not seeing as many earnings disappointments in emerging Asian markets as you are here and in Europe partially because they cleaned their financial systems up. (Eric Ritter, manager of Driehaus Asia Pacific Growth Fund, WSJ 11-15) Section 531 There are many reasons for stock buybacks. Some reasons: (1) to send a message to the market when they feel their shares are underpriced; (2) to reduce dilution, particularly dilution caused by excessive option grants; and (3) when they have cash on hand. Internal Revenue Code section 531 frowns on the "unreasonable accumulation of earnings" by corporations. If a company is deemed to have unreasonably accumulated earnings, the IRS slaps them with a penalty tax equal to the highest individual tax rate on the excess amount. (Art Berkowitz and Richard Rampell, WSJ 11-14) Blue Chip Economic Indicators Survey According to the latest Blue Chip Economic Indicators survey, Q4 growth in the November survey declined to a 1.6% annual rate from the 2.2% pace they had estimated in October. The economy will probably grow 2.8% next year, down from the previous estimate of 3%, the survey found. The economy is forecasted expand by 2.3% this year. The economists who contributed to the survey project a second-half rebound in 2003, with annualized growth rates of 3.6% in Q3-03 and 3.7% in Q4-03. (Siobhan Hughes, Bloomberg News 11-11) Improving Economic Stats Business investment, commonly portrayed as sick and ailing, has shown improvement. One lasting effect of 9/11 has not only been a weakened travel sector, but plunging investment in civilian aircraft. Plant and equipment spending overall rose by only 0.6% in the third quarter, but excluding civilian aircraft, investment growth ran closer to 5%, and equipment spending alone about 12%. GDP growth has averaged an annual rate of 3% over the past four quarters, and not so long ago that rate of growth would have been fast enough to push the unemployment rate lower. Only in this era of higher productivity does 3% growth mean that joblessness holds about steady. (Gene Epstein, Barrons 11-4) A Reason for Being Optimistic After an overall gain of about 7% in operating earnings in Q3, the companies in the S&P 500 are expected by analysts to boost earnings at a 17% clip during Q4 and at a 15% rate next year. Companies may not quite live up to those expectations, and these numbers don't suggest the kind of strong gains that normally would accompany an economic rebound. But they do suggest a continuing economic recovery. 'Right now, it doesn't feel like an economic expansion, and the recovery is sluggish,' acknowledges Tim Hayes, global stock strategist at market-research firm Ned Davis Research. 'But what will drive the market is the prospect for future earnings growth. And at this point, the economic numbers and everything we have related to corporate profits and earnings are looking pretty good' for the coming months. (E.S. Browning, WSJ 11-3) Nondiversified Index Funds Vanguard has sent out proxies that ask fund holders to allow some index funds to become 'nondiversified.' This sounds fishy because indexes represent lots of stocks, so index funds should be inherently diversified, and because the typical nondiversified strategy can lead to a focused portfolio with above-average volatility. Vanguard's request, however, is based on the SEC's standard for 'diversified.' Without delving too deeply into fund arcana, the issue here is that certain indexes sometimes get big concentrations in their top stocks. If a stock tops 5% of the index, it could make a fund run afoul of the SEC's diversification standard, forcing management to veer from the index or break SEC rules. (Charles Jaffe, Boston Globe 11-3) Inflation Update Prices tend to be falling in industries that face brutal global competition. Prices are still rising in industries where offshore production isn't such a big factor. Examples: Cable TV service is up 6% but TV sets are down 11.2%. Child care costs are up 5.70% but toys are down 9.0%. Laundry/dry cleaning is up 1.90%, but clothing is down 1.7%. Sporting event admissions is up 4.00%, but sporting goods are down 2.1%. Household repair is up 4.00%, but tools and hardware is down 2.0%. Rent is up 3.50%, but furniture and bedding is down 1.6%. Car insurance is up 9.50%, but new cars are down 0.9%. Dining out is up 2.30%, but dishes & flatware are down 4.7%. (Jon Hilsenrath, WSJ 11-3) Quick Facts, Stats & Opinions We've seen 800 fund mergers so far this year, compared to 490 in 1999, according to figures that don't exclude multiple share classes from AMG Data Services. (Ian McDonald, WSJ 11-26) If you buy a $1,000 stereo, how much will it cost you if you use a credit card and then make the minimum payment each month? To find out, go to www.bankrate.com and click on the calculator labeled "the true cost of paying the minimum." According to the calculator, if you fork over 18% in annual interest and you make the minimum payment, it will take almost 13 years to pay off the $1,000 and you will incur $1,115 in interest charges. (Jonathan Clements, WSJ 11-24) According to the Social Security Administration Web site, the average retired worker now receives $882 a month. The average couple - both receiving benefits - receives $1,463 a month. About 70% of all workers start taking Social Security benefits at age 62. (Scott Burns, Dallas Morning News 11-24) The cash sitting in plain old savings accounts totaled more than $2.7 trillion last month, up more than $490 billion, or 22%, from just a year ago according to the Federal Reserve. (Ian McDonald, WSJ 11-20) According to the Manpower Inc. quarterly survey of 16,000 businesses, about 20% of the companies surveyed expect to hire more people in the January-March quarter, and 12% plan to cut workers. Employers also are a bit more optimistic than they were for the first quarter of 2002, when 16% expected to hire more workers and 16% planned to reduce staff. (AP via LA Times 11-18) Only about 10% of U.S. households still use wire antennas to draw in TV signals over the air. More than 70% use a cable connection, while 17-20% use satellite dishes says A. Michael Noll of the Annenberg School of Communications at USC. Data suggests that if households are hooked on cable, not all televisions are. The second, third or fourth television in a house often still wears rabbit ears. "Forty percent of the sets are not hooked up to wires that fix the set in place," said Cox Television president Andrew Fisher. (Jim Landers, Dallas Morning News 11-17) Gary Chapman, chairman and CEO of LIN TV, said that 14 stations compete for $600 million in annual advertising revenue in the Dallas-Fort Worth television market. The Fort Worth Star-Telegram and The News compete for an advertising pie worth $1.2 billion. Forty percent of that $1.2 billion is for classified advertising. (Jim Landers, Dallas Morning News 11-17) A Business Roundtable survey of 150 CEOs of major companies, reported last week, showed that 60% expect to cut jobs in 2003 -- even though an even higher percentage expect that their companies' sales will rise. Higher sales with lower costs set the table for more money to fall directly to the bottom line. (Tom Petruno, LA Times 11-17) Earlier fears about Q3 earnings have not come to fruition. . . . Cost cutting and tightened controls, which have helped to counter the soft demand, have provided the underpinnings for the better-than-expected showing. Overseas, the threat of war with Iraq still looms. We think that the global uncertainty will carry over into 2003, with an attendant effect on the financial markets. . . . Volatility will remain high until the economy strengthens and global tensions moderate. (Selection & Opinion, Value Line Investment Survey via Washington Post 11-17) As far as we're concerned, the chances for moneymaking opportunities have never been better in years for equities. However, to exploit the situation, one has to step up to the plate and take a swing. In business and in the market, when costs decrease, the chance for profits increases. Well, stock prices are selling for significantly less than memory can recall. (Irwin Yamamoto, The Yamamoto Forecast via Washington Post 11-17) Prior to the Fed's rate move, according to imoneynet.com, the average money market mutual fund was earning 1.21%. In the first week after the rate cut, money fund yields dropped to an average of 1.05%. By the end of next week, the average money fund will be earning in the neighborhood of 0.75%. Bankrate.com shows the average return nationwide on money market accounts beating the yields on certificates of deposit that are shorter than 6 months. (Charles Jaffe, Boston Globe 11-17) Remember, bonds also suffer rough spells. Historically, a portfolio consisting of 80% longer-term government bonds and 20% blue-chip stocks has been 6% less volatile than an all-bond portfolio. The 80% bond-20% stock portfolio has also been more rewarding, clocking 9.8% a year over the past 30 years, compared with 8.9% for the all-bond alternative. (Jonathan Clements, WSJ 11-17) Keep in mind that there is a difference between 'buy-and-hold' and 'buy-and-hope.' If you have lost faith and confidence in an investment and don't hold out much hope for a rebound, a change may be the best thing. (Charles Jaffe, Boston Globe 11-14) Marc Andreessen, co-founder of Netscape and now chairman of Opsware (formerly LoudCloud) says that routers, servers and corporate software all will face "10-X price reductions over the next three years," because of commoditization of routers, cheap Intel Corp. computers and "open source" databases -- threatening the profits of Cisco, Sun and Oracle, respectively. (Ann Grimes, WSJ 11-14) ADR offers peaked in 2000, when foreign firms raised $30 billion in U.S. listings. Last year, that number plunged 70%, to $8.4 billion, and for the first 10 months of this year, the figure has tumbled again, to $4.4 billion, according to Citigroup Inc., which tracks the annual figures. The overall IPO market is down 77% since 2000, in terms of capital raised, according to Dealogic LLC. (Craig Karmin Kate Kelly, WSJ 11-12) Business inventories peaked in January 2001 and declined for 15 consecutive months before inching higher since April. The inventory-to-sales ratio is at an all-time low of 1.34 months, which means it would take about 5 1/2 weeks for businesses to unload their existing inventory at the current sales pace. `Businesses are living hand-to-mouth,' says Joe Carson, an economist at Alliance Capital Management. This `lowers the odds of a double-dip recession' since any increase in demand will have to be met by increased production. (Caroline Baum, Bloomberg 11-12) Although corporate earnings expectations for the fourth quarter of 2002 and the first half of 2003 are more realistic than they were even a few weeks ago, there still need to be reductions made before earnings expectations and stock prices are more closely aligned with the economy. . . . Until economic growth can meet or exceed expectations, the bear market will continue. (Roger Tweed, The Tweed Update via Washington Post 11-10) This bear market will be over by late November. Thereafter, we expect a sustained nine-month advance to 10,000 [Dow], 1060 [S&P 500] and 1560 [Nasdaq], as the bull market resumes. We continue to believe the technology sector will lead this rally. (Steven Frenkel, Frenkly Speaking via Washington Post 11-10) If you are retired, spend a little time each year thinking about how you would pay for living expenses if you couldn't touch your stock-market investments for five years. As the recent market slump has made painfully clear, stocks can suffer prolonged downturns. You don't want your need for cash to force you to sell stocks at a market bottom. (Jonathan Clements, WSJ 11-10) Investor confidence in securities professionals has fallen to its lowest point in seven years, according to the industry's own survey. (Steve Gelsi, CBS.MarketWatch 11-8) During the third quarter, business productivity grew at a seasonally adjusted annual rate of 4%, up from 1.7% in Q2. Higher worker productivity caused unit labor costs to grow only 0.8% -- slowing from a sharp 2.2% increase in the second quarter. Average hourly compensation for nonfarm business employees rose 4.8%. Surging output partly reflected a 0.1% rise in employees' work hours - the first increase in more than a year. The strong productivity numbers also may explain why the economic recovery hasn't noticeably strengthened the U.S. jobs market. (WSJ 11-7) The 'word' on the street: "Iraq-nephobia" - meaning a companies' unwillingness to commit to capital spending and hiring because of the threat of war, coined by Diane Swonk, chief economist at Bank One. (Jennifer Ablan, Barrons 11-4) "We believe restructurings are a part of doing business," said Howard Silverblatt, an S&P equity analyst who sits on the agency's Core Earnings Committee. "This is not the 1960s anymore," he added, recalling an era when corporations and their workforces were much less nomadic. "Reorganizations happen all the time - it's not an 'unusual' activity to fire people. They are not one-time charges. It's just part of doing business." (Danielle DiMartino, Dallas Morning News 11-4) The ICI reported that a net $16.1 billion left stock funds in September, compared with a $3.1 billion a month earlier. The September outflows were larger than fund-tracking firms had forecast. And it looks as if October was the fifth consecutive down month. TrimTabs.com estimates outflows last month hit $16.5 billion, based on a projection of activity through Oct. 25. Total assets in equity funds took another hit in September, falling to about $2.5 trillion from about $2.8 trillion in the previous month. (Erin Arvedlund, Barrons 11-4) An August survey of more than 300 401(k) plans by the newsletter DC Plan Investing found that on average 28% of 401(k) assets were in employer stock. In a dozen plans workers had more than 75% of their money in company shares. (Eileen Ambrose, Baltimore Sun 11-3) Here's yet another reason to root for a stock-market recovery: It may save you money on auto-insurance premiums. State Farm Mutual Automobile Insurance, the nation's largest auto insurer, has seen its net worth drop by $5.7 billion in the past year. A big reason: State Farm, unlike most auto insurers, keeps as much as 50% of its investment dollars in the stock market. Those losses don't just mean bad news for the one-in-five drivers who carry State Farm policies. With State Farm forced to raise premiums to cover its losses, other insurers are less concerned that their own rate increases will chase away policyholders. (Jonathan Clements, WSJ 11-3) It is still a bear market until proven otherwise, and there really is no reason to rush back into stocks at this point of the cycle. If a bull market does indeed emerge from this carnage, there is going to be ample time to take some very worthwhile positions in the emerging leadership. . . . Our goal is to buy . . . stocks at the most opportune time. What is required is a combination of boldness and patience. Now is the time for patience. (Dan Sullivan, The Chartist via wash Post 11-3) Almost all of my favorite and most respected value-stock fund managers are enthusiastic about the large number of quality bargains they are finding. In addition, except for the large companies that dominate the market indexes -- especially technology companies -- earnings at many companies are increasing. The growth might not be as high as in the late 1990s, yet these are real, unmanipulated earnings, and they are growing. (Bob Carlson's Retirement Watch via wash Post 11-3) A recent survey, sponsored by the Securities Industry Association and the ICI, tells us the number of American households owning stock mutual funds in employer-sponsored retirement plans rose by 4.7 million, or 16%, in the last three years. (Chet Currier, Bloomberg 11-1) If you want a high-yielding investment, be prepared to take a high risk. If you want safety, be prepared to live with low returns. It may not be pleasant, but it's the way capitalism is supposed to work. (Andrew Cassel, Philadelphia Inquirer 11-1) `Bear markets concentrate the mind just as bull markets lead to sloppy thinking.' Shelby M.C. Davis, founder of investment manager Davis Selected Advisers. (Chet Currier, Bloomberg 10-29) Tech Tips & News Grokker Search Interface Grokker lets you browse search results by clicking on a graphical map, rather than making you scan lists of text. It searches the Web, your computer's hard disk and other data sets, then presents information matching your query as a group of spheres. Each colorful sphere bears a subject label and contains smaller spheres inside representing subtopics. You zoom in and out with mouse clicks. The bigger the sphere, the more documents it contains. Eventually, you reach a flat circle that leads you directly to an individual Web site. The idea is to help you visualize related concepts and explore information in ways you can't, say, with a linear list of 1 million Web pages such as what appears when you search a term at Google. Grokker goes on sale next week for $99 as a downloadable software product. While I'm not predicting this crude tool will knock Google off its throne as the king of Internet search, I do think Grokker shows where computer interfaces are headed - toward increasingly graphical designs. A parade of private companies already has released visual search software, including products such as Kartoo, Vivisimo, Visual Net and 3D Miner. But Grokker represents one of the more elegant attempts at taming the overwhelming frontier of search. In its initial release, Grokker searches the Web through the private Northern Light search engine. Grokker isn't really a search engine, you see; it is navigation software that works in conjunction with other programs. While Northern Light provided access to its Web search for Grokker, Grokker doesn't have similar access to Google's Web index. (Leslie Walker, Washington Post 10-31) Home Page Previous Factoid Top Sites
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