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Patience is a profitable virtue. Impatience is an expensive vice. - Mark Sellers, Morningstar
In response, some companies are rethinking their 401(k) offerings. Ford, for example, has trimmed its menu of funds nearly in half in an attempt to make investing less overwhelming for employees. Large retirement-plan administrators such as Vanguard Group, Merrill Lynch's Retirement Group and Manulife Financial all say they're seeing companies streamline their investment choices. Some clients have trimmed their offerings from several dozen funds to about 15 or fewer. Even participating employees rarely take advantage of all the choices they're offered. Most people end up choosing just three to four funds for their portfolio, according to several studies. Employees gravitate toward familiar investments, like company stock and large-cap equity funds. There is particular interest right now in professionally managed plans, where you can pay a pro to pick your funds. Fidelity Investments is launching its own professionally managed plan for a fee of about 0.35% to 0.60% of assets, depending on account size. Merrill Lynch is rolling out a similar program for about $40 a year.
In a low-return environment, it might seem tempting to avoid all these seemingly lame propositions and make outsized bets on a sliver of the stock or bond markets. Like most instinctive moves on Wall Street, that's likely a loser. Experts ranging from Robert Shiller, Yale economist and author of "Irrational Exuberance," to money managers and financial advisers on the front lines say the prospect of middling returns is more reason to diversify your portfolio, not load up on one asset class. "The wrong lesson to take from all this is that you need to make sector calls or stretch for high yield," says Russ Kinnel, director of fund research at Morningstar. "You'll only end up taking way more risk, raising your expenses and missing the modest returns that are out there." In a world of middling gains, a diversified, hum-drum stance makes the most sense since there's little expected payoff for taking on risk. In addition to locking in the modest gains available among various asset classes, a steadier ride can help you avoid bailing out in tough times and chasing the hottest fare in good times, twin strategies many follow to lousy results. Finally, the easiest way to boost your net worth in a time of listless returns is simply to save more each month. Over the past year, Americans have saved just 3.5% of our disposable income, compared with 9% in the 1980s, according to the latest figures from the Department of Commerce. So rather than bemoan lousy returns, break out your budget and save more money.
Many believe a reading below 20 may indicate investor overconfidence that makes the market vulnerable to future declines. The last time the VIX dipped below 20 was April 2002. "This is a market that's into the fifth month of the bull. It's tired," said Larry Wachtel, market analyst at Prudential Securities. He noted that the Dow has climbed more than 20 percent, and the Nasdaq has gained more than 30 percent since stocks hit a low on March 11. "You can't make a move of this nature and then continue upward," Wachtel said.
1. Retirees: Our fastest-growing population group can no longer count on safe, simple savings to provide retirement income. With money market accounts earning virtually (or literally) nothing, and five-year certificates of deposit earning an average of only 2.38%, retirees who were generous spenders only a few years ago are now cutting back. Worse, they're being forced to liquidate assets, putting further pressure on price levels. Higher interest rates would restore them as consumers and get them out of the yard sale business. 2. Near-retirees: Younger workers can avoid dealing with the implications of low interest rates. But workers who are 50 or older are following the retirees' lead. They are obliged to reduce their spending, save more and think about getting rid of things that were must-haves only three years ago. The combination is a heavy foot on the economy's neck. Higher interest rates would restore near-retirees as consumers today and enable them to continue as consumers when they retire. 3. Corporate pension plans: Most media stories about the $300 billion underfunding of corporate pension plans have focused on the damage done by the three-year bear market for equities. In fact, declining interest rates have done at least as much damage. Declining rates raise the cost of paying retired employees a lifetime income - the liability side of pensions. At a conference on pensions at the Wharton School last year, a Department of Labor official said an interest rate increase of 2 percentage points would make most pension plans fully funded - because it would lower the cost of their pension obligations. If low interest rates continue, many corporations will be required to make large cash contributions to their pension plans. Some, such as General Motors, already have. This will reduce their profits. That, in turn, will reduce their stock prices. Basically, low interest rates are putting us into a descending spiral. Ditto for state pension plans. 4. Homeowners: These are the surprise beneficiaries. Although home buyers might be inconvenienced by higher interest rates and inflation, 68% of all households already own their homes. They would probably rejoice at higher interest rates and rising inflation. Their low-rate mortgages would become treasured possessions, and they would continue to watch their houses appreciate through inflation. Do the remaining 32%, who might be "shut out" of the housing market by higher rates, drive the economy? I don't think so. The drivers are the 68% who already own their homes. And would higher interest rates and rising inflation eventually have a negative effect on homeowners? Probably not. Housing prices soared in the inflationary 1970s, and mortgage rates soared along with home prices. But people kept buying. In the recession of the early 1980s, a private economist named Alan Greenspan pointed out that consumer spending remained strong in spite of economic weakness. It isn't interest rates Ä high or low Ä that create the spending power. It's higher home values for homeowners. Inflation creates new homeowner equity daily.
The higher rates go, the more they affect stocks, though so far the impact has not been pronounced. Climbing rates put pressure on corporate and consumer balance sheets, discouraging spending. Retail and construction stocks are especially risky when rates go up, analysts say.
The average bond fund has only gotten nicked, down 1% during the past month, through Wednesday. Yet behind this humdrum average loss, some individual bond funds are getting hammered. American Century Target Maturities Trust 2025, with $175 million in assets, lost 9.6% during the past month. The $4 billion Vanguard Long-Term Corporate Bond Fund has lost 4.6%, according to Lipper. There are some signs that investors may be getting their fill of bond funds. In June, according to Lipper, new money going into bond mutual funds fell 25% from May to $6.5 billion, making it the lightest inflow since October 2002. Even so, investors have poured a net $306 billion into bond funds over the past two years, easily outpacing the $75 billion in new money garnered by stock funds, according to Strategic Insight. Avi Nachmany, research director at Strategic Insight, notes that most of the money going into fixed-income funds over the past 2.5 years has gone into portfolios with shorter durations, which means they are less sensitive to interest-rate movements. Since mid-April, the average long-term U.S. bond fund has returned 1.18%, with both price and yield taken into account, while the average stock fund has returned 12.36%, according to Lipper. (Jeff Brown, Philadelphia Inquirer 7-27) "A bubble in Treasurys is no longer a question for debate," said Paul McCulley managing director at PIMCO and a colleague of Bill Gross, the fund world's most prominent fixed-income manager. "Bill and I have been agnostic about it. But I think you can't be agnostic anymore." (Ian McDonald WSJ 6-29) Related articles: Bond Market Is Bubbling - Caroline Baum,Bloomberg, Reduce Your Bond Portfolio's Risk - Jonathan Clements, WSJ, More Bond Tips - Gregory Zuckerman, WSJ, Snag Looms in Bond Funds - Charles Jaffe, Boston Globe, Treasurys are a Bad Bet Now - Clements, WSJ / Baum, Bloomberg
They are: The $7.2 billion Intermediate Bond fund (minimum investment $2,500, expense ratio 0.63%, four stars from Morningstar). The $6.6 billion Ginnie Mae fund (min $2,500, exp 0.60%, four stars). The $5.8 billion Short Term Bond fund (min $2,500, exp 0.58%, four stars). The $5.4 billion Investment Grade Bond fund (min $2,500, exp 0.66%, four stars). Its U.S. Bond Index fund, the fifth-largest of its fixed-income funds, has $5.1 billion in assets, an expense ratio of 0.31 and four stars from Morningstar. Fidelity has nothing to be ashamed about in its four large managed funds. All outperform most of their competitive peers. Their expense ratios are nearly half the 1.11% average charged by other taxable bond funds. But a caution light goes on when you compare the performance of Fido's four big winners to the performance of its fixed-income index fund. The Fidelity U.S. Bond Index Fund beat all four over the last 10 years. And that tells you why Fido has a $100,000 minimum on its fixed-income index fund. Many of the Fidelity fund shareholders who make the same comparison would want to move their money to the better-performing but less expensive fund. Billions of dollars could migrate from generating 0.6% a year for Fidelity to generating only 0.31% a year. How much is that worth to Fidelity? I put the additional revenue as high as $76 million a year. Not a minor sum. And all of it is coming straight out of shareholder pockets. Query: If that's happening at Fidelity, with fund expenses nearly half the industry average and with superior performance, how much investor return is being wasted at the majority of the other 4,500 fixed-income mutual funds? Don't hold your breath waiting for them to tell you.
Morningstar found 57 index funds that charged more than the 0.18% - or 18 basis points - charged by Vanguard. The average fee at these funds last year was an astonishing 0.77%. The study reckoned that shareholders overpaid by $140 million to own these funds, which an orangutan could run. The study found 65 money market funds that charged more than the 0.33% fee for Vanguard's Prime Money Market fund. The average expense ratio among the funds was 0.97 percent; their shareholders overpaid by $160 million to own them. (Morningstar's data includes only a fraction of money market funds, so the overpayment is vastly understated.) With index funds coming off three bad years and returns on money market funds in the cellar, exorbitant fees like these should awaken shareholders.
As celebrated economist Paul Samuelson wrote in 1994, "We have only one history of capitalism. Inferences based on a sample of one must never be accorded sure-thing interpretations." Prof. Samuelson was referring to the belief that stocks will always outperform bonds. The same notion, however, applies to any grand conclusion drawn from market history. We may have 200 years of U.S. stock returns. But I am not sure anything before 1945 is really relevant to today's investor. Moreover, even recent history may be of little use, because the market is constantly evolving. Have you heard that small stocks tend to outperform larger companies? Have you heard that stocks that are cheap, based on market yardsticks such as share-price-to-earnings ratios and share-price-to-book value, tend to fare better than their pricier cousins? Unfortunately, a lot of other investors have heard the same thing, which means these insights might already be fully reflected in stock prices. Result: These market-beating strategies may have lost their edge.
The previous studies were conducted before the technology bubble burst in early 2000. The typical socially responsible fund has an outsized allocation to tech stocks, so its strong performance in the 90's might have reflected no more than that sector's strength. Three researchers at the Wharton School have found a way to analyze socially responsible funds that is less influenced by the performance of the tech sector. The study, by Christopher Geczy and Robert Stambaugh, both finance professors, and grad student David Levin, can be found at finance.wharton.upenn.edu/~stambaug/sri.pdf. The researchers analyzed socially responsible funds in light of market factors that historically have been most correlated with fund performance, like the average market capitalization of a fund's stock holdings or where its stocks fall on the value-growth spectrum. Within the universe of socially responsible funds, they found that there is a smaller range of meaningful choices among these factors. Over time, that reduces returns for investors who build a portfolio of such funds. Because socially responsible funds are more oriented toward growth stocks than value stocks, investors may find that their portfolios will suffer over time. According to separate research by Eugene Fama and Kenneth French, the average value stock outperformed the average growth stock by 3.5 percentage points a year, annualized, over the last 77 years. Even if you accept the study's conclusion that your returns will suffer if you invest in socially responsible mutual funds, you should not automatically avoid them. But investors in these funds need to be willing to bear an additional cost.
That's not what Congress intended when it approved the Sarbanes-Oxley Act a year ago, but that's what it has come to. Created to curb accounting fraud, the sweeping legislation carries expensive new rules that weigh inordinately on small and midsize firms, securities lawyers say. "It will cost us 50 percent more each year to be a public company because of what the act requires," said Frank Cinatl, chief financial officer of Abatix, which went public in 1989. "There is no doubt that as a percentage of net income, the burden falls more heavily on smaller companies." According to Mr. Cinatl, the bill for maintaining its status as a public company will go to $300,000 next year from about $200,000 this year, mainly because of increased auditing costs. No one is expecting a significant increase in public companies going private - and Abatix says it isn't currently considering it - because numerous other factors are involved in that decision. But the higher costs of going public will curb the number of initial public offerings, securities experts say. Because of Sarbanes-Oxley requirements, the average cost of small to midsize companies staying public will increase from $1.3 million a year to about $2.5 million, a 90% increase, according to a study by Los Angeles law firm Foley & Lardner. The study found that audit fees will increase 105%, legal fees will increase 91%, and insurance costs for directors and officers will rise by 94%. The study defined small and midsize companies as those with market capitalization - outstanding shares multiplied by the price per share - below $3 billion.
In other downturns since World War II, the Federal Reserve stepped in, cutting interest rates to encourage spending. As spending picked up and inventories disappeared, prices began to rise, which encouraged more production. Hiring resumed, as did capital spending. This time around, inventories have failed to diminish, so prices, production, hiring and capital spending do not rise. The difficulty is that companies have a choice that was not as available in the last downturn 12 years ago. Rather than halt production at home, they shift it abroad to cut costs, particularly labor costs. The nation's trade deficit, the excess of our imports over exports, has risen by 31% since the recession began in March 2001. The increase, totaling $114 billion, would add one percentage point to American economic growth - enough to turn a weak recovery into a strong one - if the rise in output were at home, not abroad. One-third of the total increase represents imports from China, Mr. Zandi says. Honing the figures, Steven Roach, chief economist at Morgan Stanley, finds that China's total exports have tripled since 1994, and that 65% of the $244 billion increase comes from foreign companies in China. "We are criticizing the Chinese as if they were cleaning our clock and the only part of China that is cleaning our clock is the part that we put there," Mr. Roach said. What is to be done? If we do anything, we are likely to pressure the Chinese to float their currency. A floating yuan would rise against the dollar, making Chinese exports more costly in the United States. Pressure is already coming from Congress for the Bush administration to negotiate the float.
By Dalbar's latest tally, stock-fund investors held their fund shares for a little less than 30 months from 1984 through 2002, on average. Along the way, they earned an average 2.6% annualized gain, compared with 12.2% for the Standard & Poor's 500-stock index. Bond-fund investors tended to be more patient, holding on for more than 34 months on average and earning a 4.2% annualized return. While that tops the average stock-fund shareholder, it trailed the 5.5% annualized gain for Treasury bills. The study's findings in previous years, including those before the start of the latest bear market, also showed investor futility in trying to time the market. For example, stock-fund investors posted an annualized return of 7.2% between 1984 and 1999, compared with an 18% average annual return for the S&P 500. [From Hope Yen, AP: In addition, investors' ability to time the market has diminished in recent years. According to Dalbar, investors' annualized return has progressively decreased since hitting a peak in 1992, largely because they churned their accounts with greater frequency.] Why are the results so bleak? Because investor money going into mutual funds consistently rises and falls with investment performance. But the data, often used as evidence of Main Street investors' poor instincts, might not be as damning as it seems. Dalbar uses figures on the cash flows going in and out of funds to determine investor holding periods, but these averages can be skewed by a minority of investors. But you could have a small percentage of people with a lot of turnover and the majority with none. Dalbar also uses stock- and bond-market returns as a proxy for investor returns, rather than the actual performance of funds. "You shouldn't take these numbers too far, but they do give investors some meaningful insight into the cost of bad habits," says Philip Edwards, managing director of Standard & Poor's global funds research unit. "These numbers might be from a 30,000-foot level, but they show how bad it can be if you're lured into market segments after they've been hot and scared out of them after they cool off." More Stats Chuck Jaffe, Boston Globe 7-20 The 1999 prebear market version of the Dalbar study showed that investors were crushing inflation, with the average equity investor earning about 7 percent a year, although the S&P 500 was returning double that. The good news is that the Dalbar study includes data through 2002 only, and that a 20 percent average gain for the market would probably bring average returns above the inflation bogey. The bad news is that matching inflation over a 20-year period - the probable results when the study is updated 12 months from now - is awful for equity investors. 'Everyone says they're not timing the market, that they're not chasing hot funds,' says Lou Harvey, president of Dalbar. 'But someone makes up these numbers. . . . The real problem is people think this story applies to someone else, that they're not a part of this, when in fact they're right in the middle of it and managing themselves into a poor return.'
Says Andrew Harding, director of taxable fixed-income securities at National City Investment Management: even amid the rise in Treasury rates, "what you really need is for credit spreads to stay narrow." The Merrill Lynch Master II High-Yield Index was 5.90 percentage points over Treasuries last week. The index's yield was 9.10% -- not far from the all-time low of 8.80% set in April 1998. Additionally, Moody's Long-Term Industrial Bond Index, a basket of investment-grade bonds with maturities ranging from 20 to 30 years, was trading Thursday at 1.09 percentage points over the 30-year Treasury, or 5.79%. The index's average yield continues to hover around the record average low of 5.37%, seen in 1967. As for the consumer, Stephen Smith, executive vice-president of Brandywine Asset Management, says that mortgage rates were "ridiculously cheap at 4.25% and they are still ridiculously cheap at 5.5%." The average rate on 30-year fixed-rate mortgages for the week ended July 12 was 5.52%, versus 5.40% the previous week, mortgage giant Freddie Mac reported Thursday. For 15-year fixed-rate mortgages, rates rose to 4.85%, up from 4.75%.
The tax legislation says that dividends paid by foreign companies whose securities trade on U.S. stock exchanges will be taxed at a new 15% rate. But causing confusion among experts about the new dividend treatment is a sentence in the new law reading: "Non-U.S. traded stocks may be qualified if certain treaty requirements are met." Since U.S. officials haven't yet spelled out which tax treaties meet the requirements, investors need additional guidance in determining exactly which dividends will qualify for the new tax rate, says John Battaglia, tax director at Deloitte & Touche LLP. An IRS spokesman said the U.S. Treasury plans to issue a list of countries with qualifying tax treaties, but he couldn't say when the list would be available or how many countries it would include. Fund managers at UBS Asset Management are leaning toward the interpretation that most countries will be considered to have comprehensive tax treaties with the U.S., except some emerging markets. The average dividend yield among companies in the Dow Jones Euro Stoxx Index is currently 3.26%, compared with 1.61% for the Standard & Poor's 500-stock index. "When the initial dividend yield is actually very low, the benefit of tax reform is relatively marginal," says Murdo Murchison, manager of the Templeton Growth Fund.
Investors also put $50 billion in new money into tax-deferred individual retirement accounts linked to mutual funds. If it weren't for retirement-plan investors, money flowing into mutual funds would have been negative last year, rather than the $75 billion net inflows reported by the ICI. In 1990, less than $210 billion was invested in funds through retirement accounts, compared with more than $2 trillion at the end of last year. Nearly 45 cents of every dollar that is now invested in a stock or bond fund is held in a retirement account. Fund money flowing to stock funds from all retirement accounts, including IRAs, did tumble last year, totaling $26 billion in new money, compared with $65 billion in 2001. But stock funds suffered $54 billion in net outflows last year from nonretirement accounts. At Fidelity Investments, the nation's biggest fund concern, retirement accounts constituted 59% of the firm's $699 billion in mutual-fund assets on March 31, up from 54% at the end of 2001 when Fidelity's funds held more than $815 billion. At T. Rowe Price Associates, two-thirds of the firm's $140 billion in assets resides in retirement accounts. Taken from 'The Usefulness of Aanalysts' Recommendations' by Vinesh Jha, David Lichblau, and Haim Mozes - Summer 2003. A. Dugar, and S. Nathan in 'The Effects of Investment Banking Relationships on Financial Analysts' Earning Forecasts and Investment Recommendations' [1995] and H. Lin and M. McNichols in 'Underwriting Relationships, Analysts' Earnings Forecasts and Investment Recommendations' [1998] find that analysts appear to favorably bias their recommendations for firms that have underwriting relationships with their brokerage firms. M. McNichols and P. O'Brien in 'Self-Selection and Analyst Coverage' [1997] find that consensus recommendations are biased because optimistic analysts are more likely to provide recommendations than are pessimistic analysts. S. Krische and C. Lee in 'Analyzing the Analysts: Are Stock Recommendations Informative?' [2001] and S. Stickel in 'Analysts Incentives and the Financial Characteristics of Wall Street Darlings' [2000] find that analysts tend to recommend glamour stocks, which have high market-to-book ratios, high price-to-earnings ratios, high past sales growth, and strong price momentum, although these stocks tend to underperform non-glamour stocks in the time period they examined. Krische and Lee further show that in and of itself, analysts' stock-picking patterns tend to reduce the effectiveness of their picks, because they fail to exploit systematic factors that lead to higher future returns. J. Easterwood and S. Nutt in 'Inefficiency in Analysts' Earnings Forecasts: Systematic Misreaction or Systematic Optimism?' [1999] conclude that analysts' earnings forecasts are systematically overoptimistic. S. Stickel in 'The Anatomy of the Performance of Buy and Sell Recommendations' [1995] finds that several recommendation effects on price, such as the effects of recommendations made by large brokerage firms and higher-ranked analysts, are temporary and quickly reverse. [An effect I have seen repeatedly in following REITs - but good to know my eyes were not deceiving me.] K. Womack in 'Do Brokerage Analysts' Recommendations have Investment Value?' [1996] and Stickel [1995] find that there is a significant price impact associated with new buy and sell recommendations. [Ditto my above comment. Wished Womack had studied the percentage of the impact and how it varied by a stocks' P/E ratio. I would guess the higher the P/E and the lower the yield, the higher the impact. Again, this comes from REIT observations.] B. Barber, R. Lehavy, M. McNichols, and B. Trueman in 'Can Investors Profit from the Prophets? Security Analyst Recommendations and Stock Returns' [2001] and Krische and Lee [2001] find that stocks favored by analysts out-perform stocks disfavored by analysts. [Tuff to square this with the S. Krische & C. Lee and the S. Stickel findings posted third from the top.] Vinesh Jha, David Lichblau, and Haim Mozes in 'The Usefulness of Analysts' Recommendations' find that rather than providing new, private information, analysts appear to use their information-processing skills to corroborate or reject other publicly available information. It is not that analysts have information signals that other investors do not have; they may simply better understand the implications of these information signals.
"The bear market has structurally encouraged the industry to take less risk," Portnoy said. "Large fund companies with tens of billions of dollars under management don't want to mess up anymore, so they've designed parameters that don't allow managers to stray too far from their benchmarks." As a result, many growth managers have scaled back their bets in the volatile technology stock sector and diversified by adding more health care and other holdings. It's a strategy that could lead to smoother long-term performance, but in many cases may have backfired in the first half. "In behavioral psychology they call it loss aversion," Portnoy said. "You want to avoid the fourth quartile at all costs, but as a result you make it impossible to finish in the first quartile." Of the 2,645 actively managed growth funds in the Morningstar database, only 789, or 30%, beat the corresponding Russell large-, mid- or small-cap growth index in the first half. Of large-cap growth funds, 36.5% beat the index, while 24.1% of mid-cap and 23.5% of small-cap growth funds did the trick. The average large-cap growth fund gained 12.7% in the half, compared with 13.1% for the Russell 1,000 growth stock index; the average mid-cap growth fund rose 15.9%, versus 18.7% for the Russell mid-cap growth index; and the average small-cap growth fund climbed 17.1%, against 19.3% for the Russell 2,000 growth index.
But investors may overlook the role played by the managers' employers - the fund companies themselves. These companies are responsible for the infrastructure in which the managers operate, including their research departments and trading desks. Klaas P. Baks, an assistant professor of finance at Emory University, draws an analogy to tennis: Imagine trying to rank tennis players according to their individual abilities if the only available scores were for their doubles matches. If the players never changed partners, this would be impossible. But when they do change them, statisticians can estimate how much each player contributes to the outcomes. Similarly, statisticians can learn a lot about the relative roles of fund companies and managers by analyzing how funds perform under different managers. There are many opportunities for such analysis, because many managers change jobs. In the average year from 1992 to 1999, according to Professor Baks, nearly 20% of domestic equity mutual funds had a change of managers. The professor compiled track records for each of the several thousand people who at any point from 1992 through 1999 managed a domestic equity fund. Professor Baks compared each manager's overall record over that time with the track records of the mutual funds he managed. He also compared each manager's record at a fund to a market benchmark that reflected the fund's style and investments. Very few managers, the professor found, beat their benchmarks at all the fund companies where they worked. In a large majority of cases, managers performed much better when paired with one fund company than they did with another. That suggested that manager changes, on average, had relatively little impact. The professor's findings reflect an average across several thousand funds. He does not deny that a few managers may have a greater impact than their fund companies on their funds' performances. But he says that those managers are the exceptions and that investors "intent on maximizing their returns should focus on fund companies rather than on managers."
Jonathan Murray, senior vice president for investments at Legg Mason Wood Walker, said, "From the late 90's through today, we continue to see very disparate returns among balanced funds. There are many more moving parts under the hood than in the typical mutual fund. `Balanced' is too often a misnomer, and this is the fund category that is most vulnerable to misrepresentation and confusion." The category was considered a one-stop shop: because the funds were conservative and diversified, advisers recommended them to young investors, who had limited capital, and to retirees, who liked their relative safety. But in recent years, some balanced funds have become much more aggressive than the traditional model. For example, the category's leader this year, Green Century Balanced, up 34.2% through the second quarter, has 70% of its portfolio in stocks, primarily small-capitalization growth stocks, and 30% in bonds, mostly junk bonds. In 2002, Green Century lost 37.1%. Advisers say the more traditional [and conservative] balanced funds include Dodge & Cox Balanced, Vanguard Wellington and Oakmark Equity Income. According to Lipper, 210 funds have balance as their objective. Inflows into balanced funds for the second quarter totaled $5.90 billion, according to AMG Data Services, up 28.1% from the comparable period last year. Morningstar recently tried to help investors by creating two new categories, moderate allocation and conservative allocation. "We were noticing that asset mix was really having a great effect on returns," said Josie Raney, a Morningstar fund analyst. How Fund Categories Fared Barrons 7-07-2003
The labor force swelled by 611,000 in June, but more than half of those new entrants failed to find work, according to a separate survey of households. The result was a 0.3 percentage point increase in the unemployment rate to a nine-year high of 6.4%. The Conference Board's monthly consumer confidence survey asks respondents about job availability. In June, 32 percent said jobs were hard to get, near the decade high of 32.9 in May. This measures has a decent correlation with the unemployment rate.
When the economy is growing, such news typically is welcomed because it suggests that there will be less pressure on the Federal Reserve to raise interest rates. But when the economy is in a recession, in contrast, unexpectedly bad unemployment news usually is taken at face value as, simply, bad news. [From the study's abstract: For stocks as a group, and in particular for cyclical stocks, information about interest rates dominates during expansions and information about future corporate earnings dominates during contractions.] During periods of expansion, the average daily reaction of the S&P 500 was to gain 14 basis points. During recession months, however, the S&P's average reaction was to lose 6 hundredths of a point. This spread of 20 basis points is statistically significant, since the rest of the time the S&P 500's average daily gain is less than 3 basis points. We can infer the underlying state of the economy by watching the stock market's reaction to unexpectedly bad unemployment data. This inference has been confirmed by at least one other study. What does all this mean for today's economy and stock market? The fact that the stock market dropped in the wake of Thursday's unemployment report makes it more likely than not that we're in a recession. Reality Check Paul Erdman, CBS.MarketWatch 7-3 The just-released unemployment rate of 6.4% for June - way above the expectations of any forecaster - represents a major reality check where investors are concerned. Where the stock market is concerned, it tells me that shares have gotten well ahead of the economy. The spring party that investors around the world enjoyed is now over.
"The run-up in the market has been mainly fueled by the stock market being the forecasting tool and seeing this second-half rebound," says Steve East, chief economist at investment bank Friedman, Billings, Ramsey in Arlington, Va. "When we do see these better economic numbers, we'll see a few more gains as people celebrate the fact that they were right, but not a lot. Most of the expected good news is already in the market." Gail Dudack, chief investment strategist at SunGard Institutional Brokerage, sees the S&P 500 ending the year somewhere between 808 and 1096 and expects 2003 GDP growth of 2.5%, which could propel stocks to the higher end of that range. Over the next couple years, annual economic growth of around 3.5% a year should generate earnings growth of 8% to 10% a year. A Wall Street Journal Online survey in May of 54 top economists pegged growth-rate expectations for the third and fourth quarter at 3.5% and 3.7%, respectively. That's up from 1.4% growth in the first quarter. Economists expect the unemployment rate to improve somewhat by November, predicting that it will slip to 5.9%. Strategists and economists say that because of consistent gains in productivity, GDP growth will have to reach 4% to stop the job hemorrhage while also encouraging employment growth as business spending kicks in to supplement the strong consumer sector. [From Erin Schulte, WSJ 6-28: According to Maxim Group, productivity has been increasing at 2.25% a year since 1995; meanwhile, the labor force increases about 1% a year. That means that GDP has to grow by at least 3.25% just to break even.] Overall, Wall Street seems to be saying that investors shouldn't brace themselves for crushing disappointment, but neither should they count on a moonshot. "Those who are looking for a rip-roaring bull market will be disappointed," says Ms. Dudack. "For those looking to make money, beat inflation and have a portfolio that looks for growth as well as total return, this is a pretty decent environment." Just the Facts Health Care was Sensitive to Economic Downturn Patient volumes at hospitals suddenly dropped off in the first quarter and remain weak. It's doubtful the world's become significantly healthier. One might have thought people get sick at more or less the same rates in good times or bad. On reflection, the slowdown makes sense. The more people who are laid off, the more who lose their health care. A pinched consumer puts off elective procedures. And companies are forcing employees to share health-care costs, which curbs spending. (Jesse Eisinger, WSJ 7-28) Durable Goods Orders Up America's manufacturers saw demand for big-ticket products rise in June by the largest amount since the beginning of the year, a fresh sign that the battered sector is making a comeback. Durable goods orders increased by a solid 2.1% from May, the biggest advance since January. Orders for automobiles went up by 2.2% in June. Excluding transportation, orders for all other big-ticket goods grew by 1.4% in June. For electrical equipment and home appliances, orders rose by 3.8%. But communications equipment plunged 9.6%. Orders for fabricated metal products dipped 0.4%. (AP 7-25) ETF Couch Potato You can build a Couch Potato Portfolio [an indexed 60/40 stock to bond portfolio] with exchange-traded funds by buying either the Barclays Global iShares 500 Index (ticker: IVV, expense ratio 0.09%) or their iShares Russell 3,000 Index (ticker: IWV, expense ratio 0.2%). To get the fixed-income index, buy iShares Lehman 7-10 Treasury Index, an approximation of the intermediate-term Treasury market (ticker: IEF, expense ratio 0.15%). If you want to take less interest-rate risk, buy iShares Lehman 1-3 Treasury Index (ticker: SHY, expense ratio 0.15%). (Scott Burns, Dallas Morning News 7-23) The Institutional Imperative "What Do I Do With My Money Now?" is a book of investment advice from some of the smartest minds on Wall Street, including Warren Buffett, Peter Lynch and John Bogle. In one chapter, "Mistakes of the First 25 Years" by Buffett, he admits his failure to recognize "the overwhelming importance in business of an unseen force that we might call `the institutional imperative,' " which dictates that companies generally will resist change, spend excess money, rationalize foolish ideas offered up by the chief executive and imitate rivals. Those tendencies have the potential to bring down even the most promising of companies. Bogle's chapter includes the Clausewitz maxim, "The greatest enemy of a good plan is the dream of a perfect plan", which is used to explain why not everyone would settle for an index-investing strategy. (Edward Wyatt, NY Times 7-6) More 'Sell' Ratings About 10.5% of the ratings from Wall Street firms are 'sells,' says Thomson First Call. That's well above the 2.7% level at the same time last year and 0.9% in 1999, just before the stock market crashed. Some larger investment banks have more sells than many smaller firms. Smith Barney, J.P. Morgan and Lehman Bros. have sell ratings on roughly a quarter of the stocks they cover, the highest level among the 12 firms analyzed by USA Today. Zacks Investment Research says larger firms are under more political pressure to show they're taking the reforms seriously. (Matt Krantz, USA Today 6-18) Mutual Fund Dividend Tax Bill Mutual fund dividends, passed along every year to shareholders, would qualify for the 15% rate, the new law says, if the fund earns 95% of that sort of income from qualified dividends. But there's the question of what happens if the fund has dividends that aren't qualified. That might be dividends that come from preferred stocks - which are considered interest. Or it might be dividends from stocks the fund hasn't held long enough for the payment to be qualified. And what, exactly, is going to be considered income for the fund? All of this is yet to be spelled out. 'There is no clear guidance at this point as to how mutual funds dividends will be treated,' said Jim Brennan, director of financial planning at KPMG's Tampa office. (Harriet Johnson Brackey, Boston Herald 6-8)Quick Facts, Stats & Opinions The improvement in investor sentiment in the past few months has been warranted, given recent developments, the prospect of a somewhat less-troubled global environment and the promise of a steadily brightening economic and earnings picture. Now, though, stocks may be at a level where they are discounting even greater improvement than the evidence merits. [Therefore], the Value Line Asset Allocation Model is becoming more cautious about the outlook for the stock market. (Selection & Opinion, Value Line Investment Survey via Wash Post 7-27) If you can go 10 years without making any major changes to your portfolio, you probably have the right investment strategy. (Jonathan Clements, WSJ 7-27) As a share of the economy, the 2003 and 2004 deficits represent 4.2% of GDP, below the record 6% registered in 1983. If everything goes according to Hoyle, with GDP growing at the administration's projected 2.8% in this calendar year and 3.7% in 2004, the 2006 deficit would represent 1.9% of GDP. (Caroline Baum, Bloomberg 7-22) The average junk fund is up nearly 19% over the past 12 months, according to Morningstar. Junk funds have taken in more than $13.4 billion so far this year, compared with $17.7 billion for all U.S. stock funds according to Financial Research Corp. (Ian McDonald, WSJ 7-22) Once the whole S&P 500 has reported, Chuck Hill of Thomson First Call says second-quarter earnings are likely to be up roughly 10% from a year ago. He says analysts' consensus for Q3rd is a nearly 14% increase in earnings, followed by about 21% in Q4. However, given the mixed guidance in the latest earnings announcements, Mr. Hill says he is unsure whether to expect that those second-half numbers will be downgraded, or if they will actually play out. (Peter McKay, WSJ 7-20) About 2.4 million people will be caught in the AMT's web this year, according to an estimate by Congress's Joint Committee on Taxation. That number is expected to rise to 2.9 million next year and 11.3 million in 2005, unless the law is overhauled. (Tom Herman, WSJ 7-17) The draft of the 2003 Schedule D, the form investors use to report capital gains and losses, offers a glimpse at how much more complicated the tax world has become. It has 53 lines, up from 40 lines on the 2002 form. (Tom Herman, WSJ 7-17) So far this year, 125 companies in the S&P 500 have raised their dividends, compared with 104 at this time last year, according to S&P. The general shift toward dividends is occurring in tandem with a shift in compensation plans away from stock options and toward giving employees restricted stock. Today the S&P-500 average yields 1.66%, up from 1.12% in early 2000. As recently as 1980, the S&P 500 yielded 5.68%. (Brown & Pacelle, WSJ 7-15) To speak of a "trade deficit" is misleading. There never is, or can be, a surplus or deficit of trade. There can only be a deficit in one line of trade - in this case, goods - with an equal and offsetting surplus in others -- in this case, services and financial assets. (GeneEpstein, Barrons 7-14) Of the 2.6 million jobs that have been lost in this cycle, just under 550,000 have been from reductions in temporary staffing. Historically, rising numbers of temporary workers are a leading indicator for the broader labor market. In general, temps are the first to be hired, and the first to be fired. And the June employment figures showed an increase for the second month in a row. That is a sign things could be starting to stabilize. (Greg Cappelli, business and professional services analyst at Credit Suisse First Boston, interview by Kenneth Gilpin, NY Times 7-6) A total of 96 companies boosted their dividends last month, up 10.3% from the 87 increases in June last year, according to Standard & Poor's. But roughly 95% of companies declaring quarterly dividends last month made no change in their payouts, continuing the same rate as in the previous quarter. (Tom Petruno, LA Times 7-5) If the theory of long-term investing in growth stocks is so great, why don't more people practice it? Thanks to the experience of the past few years, we now have a ready answer to that question. A monster bear market comes along at least once in every generation to cull the herd of would-be growth investors. Only the most tenacious survive. (Chet Currier, Bloomberg 7-4) "Money market fund assets as a percentage of the market value of all stocks is 28 percent," said Alan Skrainka, chief market strategist at Edward Jones. "It's at a 21-year high. That tells me that there is a tremendous amount of buying power that's sitting on the sidelines." (Pamela Yip, Dallas Morning News 7-1) Chuck Hill, director of research at Thomson First Call, estimates profits for companies in the Standard & Poor's 500-stock index will be up 8% to 10% for the second quarter, which ends Monday. That isn't bad, he said, but it still is below the surprising first-quarter growth of 11.7%. (Peter McKay, WSJ 6-30) Between 1956 and 1993, Americans never saved less than 7% of their annual disposable income, according to the Commerce Department's Bureau of Economic Analysis. But since then, there has been an alarming slump in the savings rate, which hit a low of 2.3% in 2001 before improving to 3.7% in 2002. (Jonathan Clements, WSJ 6-29) "The 15% [annualized] returns on stocks since 1981 are over," says Byron Wien, senior investment strategist at Morgan Stanley, who is known for often being bearish on stocks. "I'd expect 10% returns or less. That will still make equities very attractive relative to bonds." (Ian McDonald WSJ 6-29) Investment bank Crest Advisors says 88% of stocks that dropped below $5 between 1992 and last year never returned to double digits. (St. Petersburg Times 6-08) The Crest study also found that the longer the stock stays below $5, the lesser the likelihood of recovery. For stocks that fall below $1, the outlook is even more dismal: only 3% of such stocks ever recovered to double digits, and 82% stayed below $1 permanently. (Forbes 4-24) Home Page Previous Factoid Top Sites
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