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Of the 48 North American stock indexes tracked by Bloomberg, all but three (gold, oil services, and bank stocks) show losses year-to-date, with 35 of those benchmarks posting downturns greater than 15%. The 16 indexes tracking Europe and Africa are all off a minimum of 23% this year, according to Bloomberg data, while the 18 Asia and Pacific Rim indexes all show double-digit losses, too. Investors pulled nearly $20 billion out of stock mutual funds through November. [From John Kimelman, NT Times 12-29: ETF's assets grew from $36.8 billion in March 2000, the peak of the last bull market, to about $100.7 billion at the end of October, according to the ICI.] According to ICI, it was the first net outflow for stock funds since 1988. Savings deposits at US commercial banks - the hallmark of conservative investors - rose by $325.4 billion, or 19.2%, from June 2001 through June 2002, according to the most recent data from the FDIC. Savings deposits at domestic savings-and-loan associations were up nearly 7%, or $51.2 billion, during the same period. Nearly half of the stock fund categories tracked by Morningstar now show the average fund as having lost money over the last five years. Of those categories that are positive, just two show the average fund with an annual gain of more than 5%. While the investment industry can't quantify how individual investors acted, many industry watchers believe that it has been older investors who bailed out of the market in 2002.
No one is yet saying that capacity will not grow in the next 12 months. But to get growth in capacity now, we will need to have significant increases in capital spending. The current level of capital spending is doing no more than maintaining the current level of U.S. capacity. Two reasons account for this major restraint to capacity. First, so much idle capacity exists that technology embedded in the new capital must be dramatic to justify new spending. Otherwise, operating existing equipment remains more cost-effective than building and operating new equipment. Second, corporations are not convinced that they will be paid for their investments. Corporate profits remain anemic. After-tax profits fell nearly 21 percent in 2001. In 2002, after-tax profits may show a gain, but only in the higher single-digit range. The trend is encouraging, but the level of profits remains low. However, I already alluded to a reason capital spending should begin to improve even before profits show stellar gains or capacity use rises. The technology embedded in the new equipment may be so much better than existing processes to make those idle production lines obsolete. When we measure capacity, we ask whether the resources are available, not whether they can be cost-effective at or near prevailing price. To a great extent, they are not cost-effective. As the latest equipment continues to lower production costs (a natural result of capital spending in all sectors except health and the military), that unutilized capacity becomes less and less likely to ever be used again. Capacity utilization currently is 75.6%. Past cycles show that price pressures will begin to surface at a rate of slightly over 83%. When capacity use hit 90% for industrial materials, the economy was headed toward a decade of double-digit inflation. It will take some time for economic growth to be strong enough to push utilization into that inflation range, but only small amounts of growth will be needed to create profitability for new investments. My own guess is that when utilization becomes higher than 77%, new capital with embedded technology will become a must for U.S. industries competing with the lower labor costs of international competitors. In short, what was overlooked in the industrial production report was the early foundations for significant expansion in capital spending. Some real estate investors already are aware that similar opportunities may soon confront them. Occupancy is down, forcing current rents down. This, in turn, has reduced the ability to finance new construction. But the lower interest rates have allowed those able to refinance to lower costs faster than rents are falling. Indeed, a nationwide study showed that despite a 9% reduction in rental rates, sellers of office buildings are getting 8% more per square foot than a year ago. While the real estate example is not completely analogous to conditions facing investors in industrial equipment, it demonstrates that use and profitability are two different conditions. In the end, profitability is the more important factor in determining future economic activity. A Bear on Cap Spending Says Jacqueline Doherty, Barrons 12-30 Wall Street's bulls are also depending on a rebound in capital spending, which was notably sluggish in the past two years. With inventories lean and confidence rising, albeit slowly, among CEOs, the prevailing hope is that more companies will loosen their purse strings next year. Richard Bernstein of Merrill Lynch fears too many companies will face competing demands on their capital, however. Companies in many industries are under pressure to improve their balance sheets, boost dividends and increase spending, all at once. "I think the rating agencies are going to win, forcing companies to repay debt to shore up their balance sheets," he says. Bernstein acknowledges that business fundamentals are improving, but "not as dramatically as everybody wants." He expects S&P reported earnings (including one-time charges) to rise 15%, to $36.50, in 2003, although a continued contraction in P/E multiples could leave the S&P at 860 and the Dow at 8200 - both below current levels - by next December.
For his study, Professor Zitzewitz examined all earnings forecasts in the database of Thompson First Call, for the period from 1-1-93, more than seven years before Regulation FD took effect, to 6-30-001, almost a year after the new rules. [Zitzewitz eliminated data on stocks with share prices of less than $5 or market capitalizations of less than $100 million becuase of their relative volatility - and stocks with fewer than five analysts forecasting because of the need to best measure the 'herd effect'.] Over the entire eight and a half years, that database contained more than 680,000 earnings forecasts from more than 6,000 different analysts for more than 4,000 companies. A telling variable is the number of "multiforecast days" - meaning days when more than one analyst following a particular company issues or revises his forecast. Before Regulation FD, the study found, 30% of analyst forecasts for a given company came on multiforecast days. Over the 11 months after that rules took effect, that portion grew to 50%, and analysts increasingly just redistributed corporate earnings guidance. To determine whether an analyst's forecast was repetitive, Professor Zitzewitz looked at a number of factors. One of the more revealing factors was the extent to which a forecast diverged from the consensus estimate. The study found that on those increasingly rare occasions after Regulation FD when an analyst issued a report on a non-multiforecast day, his opinions seldom veered much from received opinion. Over all, Professor Zitzewitz concluded that herd behavior approximately doubled after Regulation FD. Before the rules, according to the study, about 65% of new earnings information reached investors from forecasts of analysts acting alone. Under the new rules, that portion dropped to just 27%. From Eric Zitzewitz Regulation Fair Disclosure and the Private Information of Analysts, April 2002 [Zitzewitz's study comes to the defense of FD. He argues that previous studies were flawed in their methodology. The following are some of Zitzewitz's findings and arguments, which start with a recounting of the anti-FD argument.] A survey of sell-side analysts presented at a congressional hearing in May 2001 found that 69% believed that Reg FD had adversely affected the advice they provide to institutional clients. Another survey [also by PriceWaterhouseCoopers, if I am reading the footnotes correctly] of analysts and institutional investors found that more than 80% believed Reg FD gave companies an excuse to minimize communications and more than 50% claimed that conference calls and private discussions were less useful than before Reg FD. [See New Public Disclosure Standard Impedes Information Flow - Charles Jaffe, Boston Globe for more info.] A previous study by Mohanram and Sunder [Mohanram, P. S. and Sunder, S. V.: 2002, 'Has regulation fair disclosure affected financial analysts' ability to forecast earnings?'] found that forecast accuracy has decreased and forecast dispersion has increased after Reg FD. Their methodology suggests that this is due to less public information and more private information after Reg FD. Agrawal and Chadha (2002) and also report that average overall forecast accuracy has declined since FD; but they do not distinguish between short and long-term forecasts. This study instead concludes that the share of new information that is private has fallen dramatically, suggesting that the decline in forecast accuracy and increase in forecast dispersion after Reg FD are due to the increased arrival rate of information about earnings as the economy entered recession. Forecasts on multiple days tend to be close to one another, with a standard deviation of 6 basis points of market cap, and far from the prior consensus (standard deviation = 22 basis points). The information content of forecasts on multi-forecast days is also much higher, both before and especially after Reg FD. This is all consistent with multi-forecast days being symptomatic of the public release of a significant amount of information, and not with analysts forecasting using private information coincidentally forecasting on the same day. The share of multi-forecast days did not change very much after Reg FD; what mostly changed was the amount of information embodied in forecasts made on those days. Analysts at larger brokerage (which are usually the more prestigious) exaggerate less and are less optimistic than analysts at smaller brokerages. Analysts are more optimistic when forecasts are disperse (Ackert and Athanannos, 1997 - 'Prior uncertainty, analyst bias, and subsequent abnormal returns'), and they exaggerate more when forecasting immediately after another analyst. Analysts also exaggerate positive news more than negative (Zitzewitz, 2001 - 'Measuring herding and exaggeration by equity analysts'). The share of new information embodied in forecasts made on single-forecast days has declined from 65% before Reg FD to 27% after Reg FD. Multi-forecast days typically indicate a public announcement or event about earnings, since most analysts tend to update their forecasts after such announcements. Accordingly, the dramatically increase in the share of information released on multi-forecast days suggests that much more information is being disclosed through public announcements, which was the intended effect of Reg FD. Businessweek Survey Lewis Braham, BusinessWeek 12-27 The 67 prognosticators, who responded to the BusinessWeek questionnaire, show an average 17% rise in the Dow by yearend to 9871, an 18% boost in the Standard & Poor's 500-stock index to 1049, and a 25% leap in the NASDAQ Composite Index to 1703. These expectations may turn out to be tame if the bear goes back into hibernation: The last great bear market ended in 1974, and the Dow rose 39% and the S&P, 31.5%, in 1975. "The key is profit-margin expansion," says Jeffrey Kleintop, chief investment strategist of PNC Advisors. That will happen, he says, as companies use increased productivity to contain labor costs. He forecasts 12% profit growth on a 6% increase in sales. Kleintop's prediction is right in line with the average forecaster, who expects a 12.3% earnings gain. But within that average is wide variation, from as little as 3% to a plump 40%. James Paulsen, chief investment officer at Wells Capital Management, projected the biggest gain because of the economic policy stimulus of lower interest rates and increased fiscal spending. By contrast, Richard Pell, CIO of Julius Baer Investment Management Inc., who sees only a 5% increase, thinks profits will be held back by the costs of funding pension plans drained by the bear market. Just because the prospects for bonds look bad doesn't mean stocks are a fat pitch. "During the 1990s there were tremendous forces that came together to drive stocks up that are not likely to reappear for quite some time," says Laszlo Birinyi of Deutsche Bank. The decade started with high interest rates and a weak dollar. As rates fell and the dollar strengthened, it was a boon to the U.S. markets. It was also a relatively peaceful time, so the government could focus on domestic issues, says Birinyi. "We're not blessed with that today." Without powerful macro forces behind the stock market, strategists stress stock selection, and health-care stocks are among seers' top picks. Drug titan Pfizer was the most popular health-care stock. Technology and financial services were the second and third favorite sectors. Hugh Johnson of First Albany says he is buying Cisco, which is sitting on $20 billion in cash and is reasonably valued. Independent strategist Jeffrey Applegate says MicroSoft is valued at the low end of its historical p-e range. Many strategists think banks will do well as credit quality improves during a recovery, and they can speed their lending. For this reason, Citigroup seems cheap to many. Merrill Lynch also cropped up as a company that has trimmed costs through staff cuts and business reorganizations. Consumer staples stocks are the least popular. One-third of the strategists agree that steady food, beverage, and tobacco stocks aren't cheap and often trail other sectors in a bull market. Utilities and retailers also are out of favor. The Odds & Other Numbers "The market is still overvalued and still in the aftermath of the biggest bubble since 1929," says Robert Shiller, professor of economics at Yale University, who adds there's a greater than 50-50 chance stocks will fall for the fourth-straight time this year. Others agree, saying the excesses from the bull market haven't been unwound yet. After all, the bull market from 1982 to 2000 far exceeded the one in the 1920s, so the hangover should be worse, says Gibbons Burke, editor of MarketHistory.com. That hasn't been the case, though. The Dow Jones industrials have fallen only 39% from the 2000 high to the October low, well below the 85% inflation-adjusted loss from 1929 through 1932 and 75% drop from the 1966 peak to the 1982 bottom. (Matt Krantz, USA Today 1-1) The Consensus View Global Insight's forecast is in line with most for 2003 with GDP growth of 2.9%, but growing strongly at a 4.2% rate in 2004. Most forecasts are "backloaded" - they expect the second half of 2003 to be much better than the first half. Inflation remains under control at 2.4%. (Stephen Dunphy, Seattle Times 12-22) The Bearish View Unfortunately, lower [interest] rates are not going to restore pricing power or eliminate excess capacity, which is obviating the need for companies to increase capital spending. As layoffs mount and the unemployment rate edges higher in the first half of next year, consumers will spend less. Money managers are overlooking these issues, afraid they will miss the new 'bull market.' The current rally is raising expectations for 2003 that are unlikely to be met. The secular bear market in stocks is not over. (E. James Welsh, The Financial Commentator via Wash Post 12-22) Another Bear "If interest rates should begin to climb, look for the New York Stock Exchange advance/decline line to take a real nosedive. This, in turn, will scare the daylights out of investors, mutual funds, and the Wall Street crowd. The reason will be obvious. Today, the NYSE is heavily skewed by numerous closed-end bond funds, preferred stocks and other vehicles influenced by interest rates. . . . If you think the market had jitters in 2002, wait until declines begin to dominate the Big Board for months on end." (Charles Allmon, Growth Stock Outlook, via Washington Post 12-29) The Bullish View At some point in the next 12 months, I think the U.S. and world equity markets will have a 50 percent rally, but the timing of that recovery and what happens after the rally will depend on the state of the U.S. and world economies. Both factors are highly unpredictable. I tend to be an optimist about both, particularly when there are so many pessimists, but I could be wrong. A double-dip and deflation would cause stocks at least to test the lows of last summer and perhaps break them. The new year will be one in which to stay open-minded: Be ready to change both your mind and your [asset] allocations. (Barton Biggs, Morgan Stanley via Wash Post 12-22) The Sheepish View According to the Chinese calendar, 2003 is the year of the sheep. David Rosenberg, Merrill Lynch chief economist, sees that as fitting since he expects a "sheepish recovery" in 2003. He expects the same choppy/sloppy pattern of quarterly growth as this year when growth ranged from 5.5% in the first quarter to less than 1% in the current quarter. (Stephen Dunphy, Seattle Times 12-22) The Third Year Charm "The third year of a presidential term has been positive for stocks each time it has occurred in the last 60 years, with an average gain of around 20%. I'm not predicting double-digit gains for stocks in 2003, but after the past three years I will welcome gains in the 8% range." (The Tweed Report via Washington Post 12-29) More Forecasts "We believe the S&P 500 and Nasdaq may advance in the range of 8% from current levels by midyear 2003 and approximately 15% by year-end," said Sam Stovall, S&P's chief investment strategist. On average, Wall Street's largest investment firms recommend a stock allocation of nearly 70%, a bond allocation of nearly 23% and a cash allocation of about 7%. Investors should keep in mind that not all of Wall Street is so gung-ho on stocks. This week, Merrill Lynch strategist Richard Bernstein lowered his recommended stock allocation to 45% from an already low 50%. (Amy Baldwin, AP via Washington Post 12-22) Money Manager Survey Ried, Thunberg & Co., a financial advisory firm, recently surveyed 54 money managers and found a wide disparity of views about what the new year will bring to fixed-income markets. For instance, forecasts of the Federal Reserve's target for overnight interest rates, currently 1.25%, ranged from 0.75% to 3% as of the end of 2003. The money managers at the low end obviously were predicting that the U.S. economy would remain weak throughout the year. At the high end, they were looking for sufficiently solid growth that the Fed would be taking back a lot of the monetary stimulus it has pumped into the economy over the past two years. The average of the 54 forecasts was 1.85%, suggesting that a majority of the money managers expect moderate growth at best for much of 2003. (John Berry, Washington Post 12-29) A Quick War Jim Paulsen, chief investment officer at Wells Capital Management, argues that a short war in Iraq will send oil prices plunging to as low as $18 a barrel from the current level of around $30. If that happens it would be a boon for consumers and companies alike, helping the economy and stock market. And even bonds would get a boost because lower oil prices would keep a lid on inflation. "Lower oil prices would really juice the consumer sector," Mr. Paulsen says.(Gregory Zuckerman, WSJ 12-22) Hope for Tech Even though technology and telecommunications stocks have been tumbling for almost three years, there actually is reason to think that maybe some of them will stage strong rebounds in 2003. For one thing, most start at very low levels. Sun Microsystems, for example, trades at about $3, down 75% in the past year. Joseph McAlinden, chief investment officer at Morgan Stanley, argues that many companies need to upgrade much of the infrastructure they purchased in the late 1990s, and he urges investors to buy up these stocks now. "Between now and the end of 2004 there will be a significant recovery" for these beaten-down sectors, he predicts. "The move off the October lows [for these stocks] will continue."(Gregory Zuckerman, WSJ 12-22) No Surprises After a string of years featuring outright tragedy, tumbling financial markets and shocking corporate corruption, some say the biggest surprise of the year would be relative calm and stability, enabling the economy to heal. "Just to get through one year without any big surprises would allow the economy to get back to normal," says Martin Barnes, managing editor of the Bank Credit Analyst.(Gregory Zuckerman, WSJ 12-22) Economy SHOULD Lead Market Thomas McIntyre of Dessauer & McIntyre Asset Management noted that 2002 marked the first time in 90 years where the economy recovered from a decline but the stock market kept falling. 'We've seen very unusual circumstances,'' said McIntyre, ''but we have reason to believe that things will change. Personally, I think that when you start a new market cycle, you don't go up a little bit, you zoom off. That's how you know you're in a bull market, and I think it's possible that we could get to that point [in 2003].' (Charles Jaffe, Boston Globe 12-29) A Timid Bull "Our methodology shows the market continues to look moderately attractive from a fundamental perspective, and dividend yields are higher than cash [i.e., three-month Treasury bill] yields for the first time since 1993. The move to eliminate or reduce the double taxation of dividends appears to be growing in Congress, and any move to increase dividend payouts could enhance the market's attractiveness. Companies that have low payout ratios and strong cash flows should benefit, as could select stocks from high-dividend sectors such as financials, consumer staples and telecommunication services." (Clark Winter, The View, Citigroup, via Washington Post 12-29) Negativity Will Not Last Scott Nelson, Boston Globe 1/1/2003 Neither Ned Riley ( chief investment strategist at State Street Global Advisors) nor Kim Goodwin (chief investment officer at State Street Research & Management) believes the negativity will last. Both forecast gains of 10% or more for the major stock indexes in 2003, thanks to improving profitability, continued low interest rates, economic growth legislation likely to come out of Washington this year, and the possible resolution of the Iraq and North Korea situations that are weighing on the market now. Both also expect investor confidence to return, if tepidly at first. First Summation Tom Walker, Atlanta Journal-Constitution 12-29 Occupants of the White House - and Baghdad - probably will have more to do with what happens to the stock market in 2003 than anyone on Wall Street. With a new senior economic team in place and Republican majorities in both houses of Congress, President Bush is expected to submit an ambitious package of tax proposals aimed at stimulating a still sluggish economy and a still wobbly stock market. Meanwhile, the Federal Reserve's 12 interest rate cuts over the past two years, coupled with still low inflation rates, have created a positive environment for business firms and investors alike going into the new year. With a new chief in place, the watchdog SEC is expected to vigorously lead the charge to restore that confidence in Wall Street. The recent massive settlement between the SEC, state regulators and Wall Street's leading firms aimed at separating research from retail operations was designed to restore credibility to analysts' stock recommendations. Conventional wisdom has it that the fighting [in Iraq] will be short and successful, that any increase in oil prices will subside. The key [to recovery] is what happens to corporate profits, and that depends on an economic rebound. Here again, with restraint, the executives who run corporations and the pundits who make forecasts are looking for improvement. In a December survey by Duke University's Fuqua School of Business and the Financial Executives International research group, corporate chief financial officers said they look for increased hiring, stepped-up capital spending and improved earnings in 2003. The nation's purchasing managers, through their Institute for Supply Management, said in their year-end survey that the two-year slump in business spending on new equipment and plants will end next year. Economists polled by the Blue Chip Economic Indicators research group forecast an improvement in business investment next year, leading to annual economic growth of 2.8% following the anticipated growth of 2.4% in 2002. In short, maybe the best that can be said about the economy and the stock market on the threshold of a new year is that the recovery has gone too far not to be optimistic, but not far enough to feel that we're home free. Second Summation Chet Currier, Bloomberg 12-24 If at first a financial forecast doesn't succeed, try it, try it again. That's the theme that dominates this yearend market predictions season. No, the stock-market revival so many pundits trumpeted predicted a year ago didn't happen. Hey, maybe it was only postponed until 2003. To keep current forecasts in perspective, it's instructive to review how past ones played out. Bloomberg News reported this week that all but one of 15 Wall Street strategists surveyed a year ago failed to predict the market decline of 2002. `Investors are beginning to see that stocks aren't going to go down forever,' says Fred Taylor, chief investment officer at U.S. Trust Co. in New York. `The economic fundamentals continue to improve gradually. It doesn't pay to hold cash - and yet everybody holds cash right now. That's going to shift.' Barring any new disruptions on the worldwide geopolitical stage, 2003 should be a less tumultuous year than 2002. Barring any new business scandals, confidence in corporate managements should begin to recover. Barring any other unexpected events, the things we expect to happen might actually occur. `Barring,' by the way, is a favorite formulation of forecasters, providing a handy alternative to constantly repeating `unless.' As my fellow Bloomberg columnist Caroline Baum wrote six months ago, `the economy's natural tendency is to grow.' For unsophisticated reasons like that, I'm going to side with Dallas financial planner James Whiddon, who says investors should fear missing a rise to 15,000 in the Dow more than riding stocks down to 5,000. `One is inevitable, the other is not,' he insists. Third Summation Richard Bernstein, is chief United States strategist at Merrill Lynch, Landon Thomas, NY Times 1-2 We recently lowered our equity allocation. Previously, we were recommending 50 percent stock, 30 percent bonds and 20 cash. Now we are at 45 percent, 35 and 20. We think the equity market is very speculative. Equities remain the asset class of choice, and that does not bode well for their future performance. You hear people all the time say, "Where can you get higher returns than in equities?" That was the correct thing to say in 1982 when everyone wanted to look at money market funds. Or 1994, when everyone was in bonds. Call it the paradox of investing. If everyone thinks equities are the asset class of choice, the odds are they are not. We have the S&P at 29 times trailing earnings. My point is that the only sure thing we have these days are announced earnings. According to our research, forecasting earnings growth is the least predictable and most volatile it has been in 60 years. So why would we value the market on somebody's forecast if this is true? People are assuming that earnings growth is a given. My argument is this: Wait a minute, future earnings are the least predictable in our lifetimes. With regard to the Fed, its repeated easing shows that the economy is not making the transition from the early phase to the middle phase of the economic cycle. Continued easing is keeping the economy on life support. The Fed is basically admitting that things are not working. Our belief is that the next bull market begins only when the Fed starts to tighten. That will tell you that we have moved beyond this deflationary environment.
WSJ: Why are mutual funds a trap? For one, many have the ankle weights of high fees and expenses. When you total them up, they're about 3% of your money year in and year out. There's also a trap where we have this human instinct that tells us we can somehow beat the market or pick the expert who can. The third trap, which few focus on, is that we think mutual funds are looking out for our interests. Mutual funds are really looking out for their interests. WSJ: The fund industry's trade group, the Investment Company Institute, says fees have been coming down over time. What's your response? Annual management fees have come down only very modestly. And if you take total fees, including the [sales charges or] loads many people pay, you don't see much of a decline. Two professors, [John Freeman of University of South Carolina and Stewart Brown of Florida State,] found that the largest 10% of pension funds [with average assets of $1.6 billion] had average advisory fees of 0.2%, while the largest 10% of mutual funds [with average assets of $9.7 billion] had advisory fees that were 2.5 times those of pension funds. While the ICI points to a very modest decline in mutual-fund fees, it's data isn't fully inclusive of loads and other costs. The ICI is an advocacy group for mutual fund companies, not an advocacy group for mutual fund investors. WSJ: In what ways is the media complicit in the fund world's foibles and investor's missteps? I think we should watch CNBC like we watch ESPN - for entertainment and information, but not to take action. When you watch ESPN you shouldn't go out on a field and think you can do what players are doing in a football game. Same thing with CNBC, watch it to get some information but don't think it's all tradable. The lessons of Enron are not to trust celebrity CEOs or fund managers or analysts you see on CNBC. WSJ: You've said the fund industry has been too quiet on post-Enron reforms, why do you think that's the case? One of the fascinating things of the 2002 political debate post-Enron is how quiet mutual-fund companies and their executives have been. I think it's a tremendous opportunity for them to stand up for investors. However, I'm enough of a political realist to understand that it's difficult for any one mutual-fund company to do. The reasons are many, but one is that they're all competing to run corporate America's 401(k) plans. WSJ: How would you tell investors to avoid the traps you highlight, and should most investors use an adviser? Just like corporate America is hunkering down a bit, you should do the same. Lower your costs, broaden your [portfolio's] diversification, and [follow a] buy-and-hold strategy. How do you do these things? Through broad market index funds or similar exchange traded funds [or ETFs]. As for financial advisers, they can help you think through asset allocation, as well as complex issues like estate planning and insurance.
Meanwhile, the Insurance Institute for Highway Safety, a coalition of auto insurers, has started a series of side-impact tests to see how cars and small S.U.V.'s stand up when hit by bigger S.U.V.'s. The first results are expected in April. But the insurers' group concedes that without supplemental testing or standards imposed by the government, their testing could actually lead manufacturers to make small S.U.V.'s bigger and worsen the problem. What, exactly, is the problem? There are two related issues, known in the industry as compatibility and aggressivity. The first involves how different vehicles match up in a collision, and the second involves one vehicle's ability to inflict damage on others. S.U.V.'s ride higher off the ground than passenger cars, and their bumpers, engines, frame rails and hoods are higher. This mismatch puts the occupants of cars at a disadvantage because a colliding S.U.V. can skip over many protective features, like the sill of the passenger door. Big S.U.V.'s are built on stiff steel frames and are more unforgiving than cars in collisions. The results can be seen in statistics. When a light truck hits a car in the side, an occupant of the car is 29 times more likely to die than a person in the truck, Dr. Runge said. When a car hits a light truck in the side, occupants have an even chance of dying. The industry has started, slowly, to address these issues. Ford has lowered the frame rails and front bumper of its 2002 Explorer by about two inches so it is closer in height to car bumpers. But lowering a bumper does not necessarily lower the spot where force is centralized - a far more important factor, Dr. Runge said. "They can plot where the maximum force is being delivered," he said, adding that some standard is needed to make cars and light trucks match each other better. SUV Satefy Stats Karen Lundegaard, WSJ 1-15-03 SUV drivers are especially vulnerable to fatal rollovers because the vehicles' high center of gravity makes them more likely to tip during sudden maneuvers. Rollover accidents accounted for just 3% of all U.S. motor-vehicle accidents in 2001, but they caused nearly a third of all vehicle-occupant fatalities, said Dr. Jeffrey Runge, head of the National Highway Traffic Safety Administration. An SUV occupant was three times as likely to die as a result of a rollover than an occupant of a passenger car, he said. Moreover, fatalities in single-vehicle rollovers increased in 2001 by 22% to 8,400 deaths, with pickups accounting for the biggest gain, an increase Dr. Runge called "astounding." Dr. Runge said that among his top priorities for rule-making are rollover prevention and crash-compatibility issues. Crash compatibility refers to the mismatch between tall-riding SUVs and pickups and lower-riding cars. When a large pickup broadsides a car, for example, the car's occupants are 26 times as likely to die as the occupants of the pickup. That is more than three times as high as the rate in car-to-car crashes. Defending SUVs Joseph Lehman & Peter VanDoren, Mackinac Center for Public Policy 5-29-01 In the current issue of Regulation magazine, Douglas Coate and James VanderHoff of Rutgers University examine the relationship between traffic fatalities and "light truck" use from 1994 through 1997. In their initial analysis they found a positive correlation between light truck registrations and motor vehicle fatalities: The greater the number of light trucks in a state per licensed driver, the greater the fatality rate per licensed driver. But when Coate and VanderHoff examined the vehicle registration and fatality data more carefully, they noticed that both light truck use and motor vehicle fatalities are more common in rural states. And sure enough, once they accounted for the characteristics of rural states, not only did the positive relationship between light truck use and fatalities disappear, it became negative. In other words, more SUVs mean fewer traffic deaths. All told, the United States has experienced a nearly 50% drop in traffic fatalities per vehicle mile traveled during the past two decades. SUV critics are quick to dismiss the notion that larger vehicles deserve any credit for the decline. They point to stiffer penalties for drunk driving, increased seat belt use, the reintroduction of the 55 mph speed limit in some states, and safety-enhancing technological changes. But even after controlling for all those factors, Coate and VanderHoff find that SUVs have helped reduce fatalities. More Harm to Their Owners? National Highway Traffic Safety Administration data show that SUVs are involved in the bulk of rollover fatalities, which comprise nearly a quarter of annual U.S. traffic deaths. More than 60% of SUV fatalities are rollovers. Just 40% and 22% of pickup and car deaths, respectively, involve rollovers. [From Danny Hakim, NY Times 12-22: S.U.V.'s roll over three times as often as cars.] SUV's & Pollution whatwouldjesusdrive.org (1) Federal law allows vehicles in the "light truck" category (e.g. SUVs) to emit 75% more smog forming emissions than cars. (2) Tailpipe pollution from cars and trucks accounts for almost a third of outdoor air pollution in the United States, including approximately half of the pollution that creates smog. (3) Production and distribution of gasoline causes half of toxic air pollutants released (e.g. benzene). (4) In 1996 health care costs due to transportation pollution totaled $56 billion.
Small companies don't have the clout to bargain for better deals. Insurers complain the market is expensive to serve and not very profitable. Many insurers have abandoned the field, a decision that has made it tougher still for small firms to get a break. In better economic times, when profits were fatter and workers harder to attract, small companies overcame all these hurdles and paid up for health insurance. In today's sluggish economy, those same companies are saying enough is enough. Only a few are throwing in the towel completely. Many more are finding ways to limit what they pay. Some employers have converted their health plans into de facto defined contribution programs. The employers pay a fixed amount - say, the cost of a single person's policy - and tell employees that if they want family coverage, they will have to pay the difference. Health Care & Mr Mom Sue Shellenbarger, WSJ 12-26 Driven by accelerating change in business, moms and dads will move in and out of the work force and swap bread-winning and nurturing duties more often. The need for health insurance, in particular, will emerge as a driver of work-life decisions. The number of people covered by employer health insurance fell by more than 700,000 in 2001, the Census Bureau says. Which parent will work in the future? The one who can get benefits. [Jeff Madrick, NY Times 12-26: Currently, fully two-thirds of mothers with small children now work - that figure including single mothers. In 60% of families, both mother and father work.] Retiree Medical Accounts Kelly Greene, WSJ 12-15 Some big companies are trading in their insurance programs for retiree medical accounts. Two percent of large employers are using such medical accounts for current retirees, 7% have them in place for future retirees, and 13% have them for new hires, according to a recent survey of 56 companies with at least 5,000 workers apiece by Watson Wyatt Worldwide. The annual credits in the accounts range from $750 to $2,500. Retirees then use that money to purchase health-insurance benefits. The accounts generally aren't as valuable a benefit for retirees as company-sponsored insurance, but they're better than having benefits frozen or dropped altogether. Watson Wyatt Survey LA Times 9-16 Companies are expected to pay less than 10% of total medical expenses for retirees by 2031 as the result of cutbacks already underway, according to the report by Watson Wyatt Worldwide, a human resources consulting firm. Large employers now typically pay more than half of total retiree medical expenses, a benefit that's particularly valuable to those who retire early. Those who wait until age 65 have the bulk of routine medical costs covered by Medicare and generally have retiree plans that provide supplemental coverage, such as reimbursement for prescription drugs. But increasing health-care costs - as well as an accounting change that makes companies set aside money to address the future cost of promised benefit plans - are forcing companies to scale back how much they are willing to offer. About 20% of U.S. employers studied have eliminated retiree medical benefits for new hires; an additional 17% will allow new hires to remain on the company plan but require that they pay the full premiums, the report said. Nine of 10 large employers that offered retiree medical benefits to workers older than 65 in 1984 required service of five years or less. Last year, only about a quarter offered that benefit, according to Watson Wyatt. For future retirees, only about 14% allow workers to qualify as quickly. The study is based on benefit plans of 56 large employers with at least 5,000 employees. Kaiser Survey Workers now are paying more as their benefits erode, a study released this month by the Henry J. Kaiser Family Foundation found. The average premium increase for employers was 13%, the highest since 1990--and marked the second straight year of double-digit inflation, according to the Kaiser study. Single premiums are now on average $3,060, with $7,954 for family coverage. The amount workers pay for coverage also has risen substantially. Employees now pay an average of $454 a year for single coverage, a 26% increase from last year. Family coverage averaged $2,084 a year, up 16%. For the first time in four years, more workers experienced a cut in benefits than an increase. Blame it on RX's Robert Dodge, Dallas Morning News 5-27 Rising prescription drug costs are the single-largest source of rising health care costs. Spending on outpatient prescription drugs rose a whopping 17% in 2001 to $154.5 billion, according to a report by the National Institute for Health Care Management. Since 1997, drug spending has nearly doubled from $78.9 billion. In 1999, doctors prescribed 146 drugs for every 100 office visits, up from 109 prescriptions in 1985, according to the health care management institute report. According to the Kaiser Family Foundation, drug manufacturers spent nearly $2.5 billion in 2000 on consumer advertising, up from just $791 million in 1996. "Certainly, advertising magnifies the increases in utilization," said Janet Lundy, a senior program analyst at Kaiser. Daniel Mullins, an associate pharmacy professor at the University of Maryland, said research shows the latest drugs are pushing up the nation's drug bill. A study co-authored by Mr. Mullins shows that new drugs represent 45% of those most-frequently prescribed but are responsible for 75% of overall spending increases. Related articles: May Pharmaceutical Update, April Pharmaceutical Update, March Pharmaceutical Update.
Despite the grim recent performance, I would argue that the stock market is now a safer place. No doubt we will still have financial crises, wars and political upheaval, and some smaller stock markets may end up getting shuttered. Still, it seems doubtful that U.S. stocks will get hit with the sort of severe economic turmoil that we have suffered historically. We are unlikely to see either a global economic depression, which devastated stocks in the 1930s, or rampant inflation, which hit stocks in the 1970s. "Those extreme events are just not going to happen," says Jeremy Siegel, a finance professor at the University of Pennsylvania's Wharton School. "I think there's been a drop in macroeconomic risk." Historically, U.S. stocks have traded at an average of 15 times trailing 12-month earnings. But Prof. Siegel figures that, in future, stocks will trade at price-to-earnings multiples of 20 and above. "We should be at a permanently higher P/E ratio," he argues. The stock market seems to agree with Prof. Siegel. Consider some figures from a study by Roger Ibbotson and Peng Chen. The study, which is slated to appear in January/February issue of the Financial Analysts Journal, notes that U.S. stocks clocked 10.7% annually over the 75 years through year-end 2000, while inflation ran at 3.1% a year. Of that 10.7%, some 1.25 percentage points a year came from the rise in the market's price-earnings multiple. What explains this rise in the market's P/E? One interpretation: As investors came to view stocks as less risky, they bid up share prices, so that shares now trade at higher levels relative to earnings. But while rising P/E multiples made stocks a handsome investment in the past, this is a one-time gain. Investors shouldn't count on continuing to collect that 1.25 percentage points a year. As a result, stock returns in the decades ahead are likely to be lower. How much lower? U.S. stocks whipped inflation by 6.9 percentage points a year over the past 200 years. I figure U.S. stocks might beat inflation by five percentage points a year, somewhat below the long-run average. Just the Facts The World Has It Backward The prevailing wisdom is that the Sept. 11 terrorist strikes triggered a stock market decline. That's wrong, says former rock-and-roll drummer turned stock market technical analyst Robert Prechter: The market's decline set the stage for the attacks. 'The market was going down for a year and a half, and the anger and fear culminated into sloppiness on the part of authorities who were supposed to identify these threats,' he says. Similarly, Prechter says, Enron didn't collapse because reports of scandals unsettled investors. Rather, the psychological climate of the bull market encouraged companies to mislead investors. In other words, it was the investors who brought on the Enron scandal, not the other way around. (Adam Levy, Bloomberg via AJC 12-27) [Note: It may be misleading putting the above in the 'Just the Facts' section.] Poor Leadership From the market's low on Oct. 9, the Dow has jumped nearly 19%, while the technology-heavy Nasdaq Composite Index is up almost 28%. But a new study from the market-research firm Birinyi Associates, indicates that the best-performing stocks during this period have been companies with the weakest earnings forecasts and the ones that look most expensive when their share prices are compared with earnings. "In the past eight weeks, the market has seen a momentum-driven rally, not one focused on the fundamentals," says Russ Koesterich, U.S. equity strategist for State Street Research & Management in Boston. "If stocks are to enjoy another leg up, it's unlikely to happen with just tech stocks as the leaders." [And he was right.] (Craig Karmin, WSJ 12-8) Quick Facts, Stats & Opinions Discount travel sites such as Priceline.com and Hotwire.com have become popular places to shop for cheaper airline tickets. But their deals on hotel rooms are even better. The savings are consistently about 40% cheaper than what you would get from the hotel itself, according to Priceline. (Ron Lieber, WSJ 12-31) Over the 1990's, the proportion of workers with paid holidays in companies with 100 or more employees fell from 99% to 89%. The proportion of those with paid sick leave fell from 89% to 56%. (Jeff Madrick, NY Times 12-26) Sales at stores open at least a year are forecast to rise 1.5% in the November-December period from a year earlier, the smallest increase since 1970, according to Bank of Tokyo- Mitsubishi Ltd., which tracks more than 80 retailers. (Greg Wiles, Bloomberg News via Boston Globe 12-26) Investors flocked back into mutual funds in November. They poured $12.1 billion into stock and bond portfolios in the month, after exiting stock funds consistently since May. As a group, US stock funds led the way in November, taking in $5.4 billion, according to a monthly report on the fund market issued yesterday by Financial Research Corp. High-yield bond funds were the most popular single sector in the month, attracting nearly $3.1 billion in new money. (Beth Healy, Boston Globe 12-25) There were 97 domestic IPOs, raising $26.84 billion, according to data from Thomson Financial in New York. Last year, the market had 107 IPOs, raising $38.99 billion. That doesn't seem like a steep drop, until compared with 2000, when there were 391 new offerings that raised $61.43 billion, according to Thomson. (Dow Jones News Service via AJC 12-25) There is a growing demand for alternatives to the factory-installed electronic chirps that are standard on most wireless phones. Ring tones have become big business in the past year, especially in Europe and Japan, where consumers spent about $1 billion to have their phones ring with shrill electronic versions of their favorite tunes. In Japan, an average of 80 million new ring tones are ordered every month, as fans constantly seek out new songs. Europe averages 60 million. (By Christopher Stern, Washington Post 12-25) The exodus from swell department stores to bare-bones discounters has accelerated in the last five years. In 1994, people polled by Customer Growth Partners, a research firm, spent 41.5% of their money in department stores. By this year, through September, that number had fallen to 16%. Meanwhile discount stores, which accounted for 41.4% of spending in 1994, have risen to 55%. Most of that growth has taken place since 1997. (Constance Hays, NY Times 12-25) The New York Stock Exchange had the busiest trading day in its history on July 24, with 2.8 billion shares trading. The curiosity was that in a down year, the direction of prices that day was up. (Caroline Baum, Bloomberg 12-24) This year witnessed another first: knighthood bestowed on a Federal Reserve chairman. While commoner Alan Greenspan had been unofficially knighted long ago, having proved himself worthy in battle with the financial system, Queen Elizabeth II made it official in August. (Caroline Baum, Bloomberg 12-24) A study from Datamonitor shows falling returns from dollars spent on marketing in the pharmaceutical industry. In 2001, according to the study, the largest drug companies saw $17 in sales for every dollar spent on marketing. That seems like a great return - except that it's down from $22 in 1998. (Jim Jubak, MSN Money 12-20) Stocks for 2003 Best Stocks 2003 - The picks are Dell Computer, Gillette, Hewitt Associates, Northern Trust, Northrop Grumman, Philip Morris, and Wyeth. (Money Magazine 12-19) From Robert Menschel, senior director of the Goldman Sachs Group: I still believe that if you invest in quality growth companies trading at sensible price-earnings multiples, one can do better than the market averages. Companies like Target, Johnson & Johnson, Kraft Foods and Home Depot understand where the future is and have real businesses. Abbott Laboratories and Kimberly-Clark are two more. I'd buy Wal-Mart on weakness. (Kenneth Gilpin, NY Times 12-29) Michael Farr of Farr, Miller & Washington has beaten the benchmark S&P 500 annually by an average of 4 percentage points, after fees over the last 5 years. Farr recently listed "10 Names for 2003" that his firm finds "interesting" (inexpensive and for long-term investing). Here are five I find particularly intriguing: Wendy's, the fast-food chain that's adding new brands such as Baja Fresh, recently trading at a p/e of just 15; Staples, the office-supply retailer, increasing earnings at 20% annually and primed to profit from economic rebound; Pfizer, the giant drugmaker, with a good merger in the works; Patterson Dental (PDCO), a dental-supply company with what Farr calls an "excellent financial history," now at a valuation that's attractive; and PepsiCo, the maker of snacks and soft drinks, with low volatility. (James Glassman, Washington Post 12-29) Intersil Holdings (ISIL) makes high-performance semiconductors, and contrary to what you might expect, is posting some amazing numbers. "Now expanded into flat-panel displays, CD/DVD recorders and wireless-networking applications, the company earned 19 cents per share last quarter on sales of $191 million. "To top it off, the company has no debt and $600 million in cash on hand. Wall Street estimates are for 68 cents in fiscal 2002 and 90 cents in 2003; the price does not reflect this company's growth rate. (Stewart McGehee, The McGehee Report via Seattle Times 12-29) Raven Industries (RAVN) is just the kind of stock we like to find. Founded in 1956, Raven is a neat little player in several niche businesses, including weather balloons, valves for agricultural-chemical applications and reinforced plastic films. Customers include both the military and industrial contractors. The best part of the story here is the company's continued profitability and growth, which has remained strong. In fact, earnings have averaged a 16 percent annual gain since 1997. With zero debt, paying 56 cents per share per year in dividends and trading for only 15 times 2002 EPS of $2.35, Raven will split 2-for-1 on Jan. 15, 2003. This is exactly the kind of high-value, low-coverage small-cap situation we love. (Neil Macneale. '2-for-1' via Seattle Times 12-29) There are other blue-chip stocks trading cheaper than Pepsico (PEP), but few are better. This stock should be considered a core portfolio holding by investors of all stripes and should be bought on any weakness. The company now owns Quaker Oats, which delivers the powerful Tropicana and Gatorade brands to the company. PEP now sports 12 straight quarters of double-digit EPS growth, while free cash flow should grow from $2 billion this year to $3 billion in 2003. Add a $5 billion share buyback, and this one rates 'buy and hold forever. (Roland Carter, Common Cents via Seattle Times 12-29) REITs have been on a roll. Morgan Stanley's REIT has returned an annualized 13% over the past three years to November 10. A REIT that missed the party, Crescent Real Estate Equities, looks especially compelling. Its stock boasts a jumbo yield of 10%. Crescent, which owns 74 office buildings, mostly in Texas, has suffered from an Enron hangover. As the economy in Houston (Enron's home) and other parts of Texas weakened, profits fell, and Crescent cut its dividend from an annual rate of $2.20 per share to $1.50. The stock, as high as $26 in December 1997, now trades at $15. But analysts see a recovery in Texas and higher profits in 2003. Crescent is buying back stock, and new managers are refocusing the business - pulling out of resort properties and weighing a move into Southern California. The stock's yield suggests above-average risk, but who says dividend fans can't take a chance now and then? (Josephine Rossi, Kiplinger 12-30) Raymond James has been producing this 'analysts best picks' list since 1996. Not only have the stocks made money every calendar year - including the last three years - but they have beaten the S&P 500 by an annual average of 46 percentage points. Their top ten picks: CBRL, CTX, FII, HD, PHCC, WLP, USB, RSG, PTEN and PDX. CBRL Group (CBRL), formerly called Cracker Barrel, operates more than 460 stores in 41 states and also operates 90 Logan's Roadhouses in 17 states. Analyst Bryan Elliott says same-store sales have risen in each of the last 11 quarters, and profit margins have increased in each of the last four quarters. Because of rising margins, he believes earnings will grow 20%, allowing it to earn $2.13 next yearÙhigher than consensus estimates. The P/E based on his estimate is just 13. The company is buying back shares. Centex Corporation (CTX). Critics keep predicting a housing collapse. But Centex, one of the nation's leading home builders, will continue to grow by acquiring smaller builders in a fragmented industry and because it's diversified nationally in an industry noted for regional booms and busts. This 15% grower trades at just five times his calendar 2003 earnings estimate of $9.03. Federated Investors (FII) has $180 billion in assets under management, most of it in load mutual funds. FII has a powerful sales force - the largest in its industry - as well as its broad product offering, consisting of 140 funds. The company is projected to grow 17% annually, and earn $1.78 next year, giving it a P/E of 15. Home Depot (HD) was a troubled retailer, but is beginning to see the fruits of a new management's labors. After just two years of coming aboard, the managers are growing profit margins, retooling existing stores, and adding new stores in the U.S. and abroad. We estimates the firm will earn $1.83 next year, giving it a P/E of 14. Priority Healthcare (PHCC) distributes specialty pharmaceuticals, largely for and to people with chronic diseases. We expect rapid growth in its Hepatitis C and infertility franchises, as well as in hemophilia. These are high-margin businesses. The company should have 2003 earnings of $1.28, making its P/E just 18. We predict long-term 30% annual earnings growth. WellPoint Health Networks (WLP), a managed care company, has been hurt along with the rest of its industry. We think the industry has been punished too harshly and that WellPoint should spring back the fastest. We estimate 2003 earnings of $5.13, giving it a P/E of 14. The company will increase earnings 16% annually in the coming years. (Steven Goldberg, Kiplinger 12-24) Note: The official 'Factoid 2003' portfolio (if there was one) would be 80% equities, 18% bonds and 2% cash. Sub-dividing that 80%: About 40% (of the total portfolio) would be in 'Vipers', 5% in 'Cubes', 25% in REITs (I still think of REITs as being a substitute for bonds - kind of a 'growth' bond) and 10% in other individual stocks from multiple sectors. No single stock should be more than 3% of the total holdings. The family's actual portfolio is nothing like that - being dominated by holdings in the American Funds group (which is not a bad choice due to decent performance and very low fees), a larger but shrinking percentage in bonds (called bonds being invested in REITs and bond mutual funds used for church donations) and a lower but growing amount of REITs (see October's REIT update for details). No single stock is more than 1% of our total holdings. The point here: (1) Do NOT over-do it on individual stocks; and (2) It is not bad to let inertia be the dominant force in our asset allocation, IF it is working. Of the stocks mentioned above, the only one that a family member owns is Gillette, but Phillip Morris is a top ten holding in more than one mutual fund that we own. Hope that meets the disclosure requirements that you would expect from a reputable web site. Tech Tips & News Low Tech Tip Most people use the standard 100-watt light bulbs. But there is another option that lasts up to 10 times as long and uses about a quarter of the energy: compact fluorescent bulbs. So why aren't CFIs jumping off the shelves? Twenty years ago, when they were invented, they were heralded as a great way to save electricity and money. But consumers hated their garish, "Night of the Living Dead" light. The new generation of CFIs give off an appealing, full-spectrum light. Because the quality is still inconsistent from brand to brand, look for brands that print the Color Rendition Index, or CRI, on the back of the package - over 80 is best. CFIs have also dropped in price recently (they cost between $5 and $8 (compared with about 75 cents for a regular bulb) and now fit into a wide variety of lamps. (Katy McLaughlin, WSJ 12-31) Search Stats Yahoo, which is trying to generate more revenue and fend off competition to its Internet search service from companies such as Google, on Monday agreed to pay $235 million for Inktomi Corp. A service where businesses bid for top placement in Internet search results helped Yahoo boost revenue by 50% to $248.8 million in the third quarter. Google's search sites were used by 41.3 million people in the United States last month, compared with 40.6 million for Yahoo's search page, according to research firm ComScore Networks. [That many people STILL use Yahoo for searching?] (Bloomberg News 12-24) Home Page Previous Factoid Top Sites
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