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Month-to-month swings in stock prices are completely unpredictable. Anyone who tells you different is arrogant, confused, or trying to sell you something. - Mark Sellers, Morningstar
Although your long-term yield will not be 4.66% - it could be higher or lower - you have the assurance that your yield will be greater than the rate of inflation by 1.1% if you buy before November. You won't be losing purchasing power. It's about the same yield you would get buying a five-year TIPS, whose yield is currently taxable. Needless to say, this yield blows away most bank CDs, which are currently taxable. It also blows away most conventional Treasury obligations - according to Bloomberg.com, the yield on a 10-year Treasury note was recently about 4.4%, lower than the tax-deferred yield on the I Savings Bond. EE Savings Bonds - the ones that aren't inflation-protected - are currently yielding 2.66%. Any I Bond redeemed before five years will lose three months of accrued interest.
Pretax profits as a share of GDP rose to 8.4% in Q2, the highest since Q1-00, Glassman says. ``Throughout the 1980s, profits were about 7% of GDP,'' Glassman says. `With growth picking up, this supports analysts' optimistic forecast of a 20% increase in profits this year and a 15% increase next year.' It now appears that real GDP rose 3.1% last quarter, compared with the 2.4% increase reported last month. Final sales (GDP less inventories) rose 4% while final domestic demand (add imports and subtract exports to the previous mix) rose 5%. Inventories subtracted 0.87 percentage points from growth last quarter, about the same as in the first quarter. Companies have been reticent to build inventories, given the start-stop nature of growth the past three years. Once they're convinced the economy is on a sustained growth path and elect to build stocks so as not to lose sales, GDP will get an added boost. `In a more normal state, companies would be increasing inventories some $40 billion to $50 billion a quarter to accommodate domestic demand of 3-4%,' Glassman says. Based on today's report, labor productivity, or output per hour worked, will be revised by a full percentage point as well, from 5.7% to 6.7%, according to John Ryding, chief market economist at Bear, Stearns. With strong profits and capital spending filling in the missing parts of a recovery, `all that's missing is solid job creation,' Ryding says. Given the strength of productivity, `it could require better than 5% GDP growth in the near term' to get America working again, Ryding says. Revision of Q2 GDP Joseph Schuman, WSJ 8-28 The market value of the nation's output of goods and services in Q2-03 totaled $10.794 trillion. As with the initial report, the Commerce Dept said the biggest factors in GDP growth were increases in consumer spending, which rose 3.8%, after a 2% increase in Q1; business spending, which rose 8%, following a 4.4% Q1 increase; and the largest spree of government defense spending since the early 1950s, an increase of 45.9% that followed a 3.3% decrease.
The breadth of the rallies in each of the three major market gauges is heartening for many analysts and investors. Of the 500 stocks in the S.& P. index, 462 are higher than they were at the end of February. In the Dow, all but two of the average's 30 stocks have increased in the last six months. In the Nasdaq, all but three of the 100 biggest stocks in the index have risen since the end of January. History suggests that the pace of the rally will slow over the next six months. The S&P 500-stock index has had 19 rallies of six or more consecutive up months since 1941, not including the performance through yesterday. The average gain over the six months was 21.6%, slightly above the increase of the last six months, through yesterday. In the 19 succeeding six-month periods, the S&P index rose an average of 5%, and it had 6 declines. While a 5% gain through February would be disappointing for many investors, it still would be a little better than the average six-month gain for the S&P since 1941, which was 4.3%. The Dow has had only 11 periods since 1941 in which the average rose for six or more consecutive months. The average gain in the six-month rallies of the Dow was 23.8%, while the average for the six months that followed was 5.2%. There have been six times when the Nasdaq composite index rose for seven or more consecutive months since its inception in 1971. The average gain in the seven-month rallies was 41.9%, while the average for the following six months was an increase of 4.3%. But while the breadth of buying is good for the market, Laszlo Birinyi, who runs Birinyi Associates, a research and money management firm, said that investors may be a little irrational now because they are buying just about anything. The 50 stocks in the S.& P. index that had no earnings or the highest price-to-earnings ratio for 2002 are, on average, up 44.3% this year. On the other hand, the 50 stocks in the S.& P. index with the lowest price-to-earnings ratios, which would make them good value buys for many investors, have climbed, on average, just 9.5% this year. The 50 worst-performing stocks, which fell an average of 68% last year, are up an average of 44.7% this year. "The desire just to own stocks and the fear of missing an opportunity," Mr. Birinyi said, is driving this rally. Fund Flows & Market Breadth Josh Friedman & Tom Petruno, LA Times 8-29 July was the fifth straight month of stock fund inflows, according to ICI. The reversal followed a nine-month span in which a net $110 billion was redeemed from stock funds. Fund companies and private research firms say the inflows are continuing this month, with money piling into a broad swath of stock fund categories. Equity fund assets had shrunk from $4 trillion at the end of 1999 to $2.7 trillion at the end of 2002, before recovering to $3.1 trillion as of July 31. Investors are diversifying their portfolios, said Kristin Adamonis, research analyst at Financial Research Corp. She noted that all nine of Morningstar's equity-fund style categories had net inflows last month, as did foreign stock funds. At Schwab, all 10 of its stock fund categories have had net inflows for four straight months including August, a spokesman said. Market Breadth a Bullish Signal Byron Wien, U.S. Strategy Morgan Stanley Expanding breadth has brought more than 90% of NYSE stocks above their 10-week moving averages,' according to [analyst Ned Davis]. This has happened only nine times since 1967, and the stock market has always been higher over the coming year. The signal was given on June 13. Ned still believes we are in a cyclical bull market within a secular bear environment. Nevertheless, the Dow can still move up 51% over the 371 days after the June signal, based on past experience. If that were to happen, the Dow would exceed 11,000 by next March, or 20% appreciation from here.
"What if we can no longer be so confident that stocks are necessarily the best place to be in the long run" asks Mr. Bernstein. "What if moving around more frequently is now a necessity rather than a matter of choice?" "You do not automatically do well just buying stocks every month," says Ben Stein, the law professor, former White House speech writer who also holds a degree in economics. "When stocks get to a certain level of ridiculousness, it's time to get out." The emergence of that asset-allocation strategy as the dominant conventional wisdom has been largely coincident with the bull market in bonds and stocks during the past 20 or so years. During a time of extended rallies, jumping in and out of a market means more often than not that an investor will end up missing out on gains. And as bonds and stocks were both rising in overall value during this prolonged period of mostly bull markets, whether an investor held more or less in one asset class or the other didn't matter because over time the investor made money on both. But as the lengthy bond-market rally appears to have reached its limit and stock prices may bounce back and forth for an extended period, the difference between stock and bond returns could narrow, but without any decline in the volatility of those asset classes. In such an investing environment where the chances of losses are the same but the rewards are smaller, "the risks of being out of the market when it goes up are much less if the upswing is a short-run rather than a long-run development," Mr. Bernstein said. He stresses that he isn't advocating rapid-fire trading and doesn't dismiss the value of having an underlying asset-allocation strategy based on an investor's financial goals and tolerance for risk. Mr. Bernstein also concedes that it isn't easy for investors to time the market. But he counters with more questions: How easy is it to manage portfolios when market fluctuations drive asset allocations away from their targets? How easy is it to decide when to rebalance assets in a portfolio? How easy is it to make changes in long-term asset-allocation decisions?
Investors who supply incorrect information that can't be corrected quickly could find their fund accounts closed or their activity in those accounts limited under the rules. Firms also will be required to compare the names of new account holders with lists of suspected terrorists and terrorist organizations. These regulations required funds to review customer accounts with balances of $5,000 or more for suspicious trades. Government and consultant estimates of the cost for the industry to update systems and train staffers to handle these procedures total more than $100 million in the first year and could exceed $200 million. Spending in future years could total nearly as much, all of which could increase fund expenses for investors. The cost of opening a new account might nearly triple to $22 according to new Dalbar study. Given the SEC's estimate of 16 million new fund accounts a year, that would add up to nearly $230 million in extra costs a year for the industry or fund investors, if the costs get passed on. The impending Oct. 1 customer-identification standards have led some fund firms to limit those with whom they will do business. T. Rowe Price, for example, will stop accepting accounts from foreigners working in the U.S. without resident status. The reason: The firm believes it will be too onerous and risky to confirm the customers' identity with enough certainty to comply with the rules. "We're seeing a tremendous change in customers' relationships with financial institutions," says Charles O'Neill, who tracks rules against money laundering for Dalbar. "When someone gets a call from a fund company asking for their Social Security number or why he or she is making a certain transaction, it will drive home the fact that financial institutions are put in a position to spy on their customers."
Susan Hering, senior economist at UBS, said: "Parry seemed to be trying to warn markets not to mindlessly project earlier tightening cycles onto the current cycle, but his pleas fell on deaf ears." At its last meeting, on Aug. 12, the FOMC left its federal funds target rate at 1% and indicated that it will keep it there for "a considerable period." St. Louis Fed President William Poole, in a separate speech earlier Thursday in Philadelphia, said: "We are not on a hair-trigger situation in terms of starting to tighten policy." Poole is a non-voting member of the Fed's policy committee. And on Wednesday, Richmond Fed President Alfred Broaddus, a voting member of the FOMC, signaled that the Fed could remain "accommodative." Still, the bond market ignored all the assurances. The yield on the two-year note, the Treasury maturity most sensitive to expected Fed moves, settled Friday at 1.92%, up sharply from 1.799% the previous week. The yield on the five-year note also rose on the week to 3.46%, from 3.406% the previous Friday. But at the long end of the yield curve, the yield on the 30-year Treasury bond fell, closing Friday at 5.26%, down from 5.398% the previous Friday. Marc Seidner, director of domestic taxable fixed-income at Standish Mellon Asset Management, says the stagnant labor market and low inflation will keep the Fed from raising interest rates in the near future. Equally important, he says, financial conditions - rising interest rates, higher energy prices and a firmer U.S. dollar - have become "less accommodative" than three months ago.
But American investors in Europe should not despair. Q3 returns will be reduced by about six percentage points if the euro remains near its current level of $1.09, down from $1.15 at the end of the second quarter. But so far this year, the euro is still up nearly 4% against the dollar. That, coupled with a gain of 8.7% in Morgan Stanley Capital International's euro stock index through Friday, has given American investors a gain of 12.5%. Analysts predict that the dollar's rebound will not last. Forecasts for the next 12 months have the euro rising in value to between $1.15 and $1.40. That is a lot more of a currency bounce than American investors are getting in Asia, especially in Japan. The MSCI Japanese stock index is up 16% this year in yen terms and is up only a little more, 17%, in dollar terms because the dollar has barely slipped against the yen this year. Economists' main reason for the euro's rebound is the rise of America's current account deficit, which includes profits on investments as well as trade in goods and services with the rest of the world. Through the first quarter this year, the 12-month deficit was a record $510 billion Ù and it is growing. That deficit must be offset by money from abroad. If those foreign inflows slow or the deficit keeps growing, the dollar will weaken, and interest rates will have to rise to attract more foreign money. According to Treasury data though June, the 12-month net foreign purchases of American stocks and bonds totaled $697 billion, up from $585 billion for the 12 months ended in March, when the current account deficit topped $500 billion.
In the wake of the legislation, some companies that had not offered drips, such as financial-services giant Citigroup, recently announced plans to do so. And many more companies with these plans already in place are boosting dividend payouts. In July alone, 183 companies raised their dividend payouts, according to Standard & Poor's, compared with just 100 in July 2001. But drip investors can get soaked if they don't manage their portfolios wisely. Here are a few things to look out for. In addition to a one-time enrollment fee of between $10 and $15, you'll typically pay transaction costs every time you buy shares. Transaction fees can run as high as $5 to $6 per purchase, says Charles Carlson, editor of the DRIP Investor newsletter. Now tack on an additional couple of pennies a share to cover part of the company's broker commissions. Say, for instance, you buy $100 worth of stock in five drip plans each month. The average price of the stock you buy is $33. Thus, your $100 buys an average of three shares per company and your total monthly investment is $500. Your total purchase fees for each add up to $3 (the transaction fee), plus 12 cents per share (four cents per share purchased), or $3.12. So for all five plans, your fees on the $500 purchase average $15.60 a month, or 3% of your investment. For a typical equity mutual fund, by comparison, you'd pay an annual fee of 1.25% to 1.50%. There are ways you can come out ahead with a drip plan. If a drip investor bundles his investments and buys every quarter, instead of once a month - say $300 in five stocks, for a total investment every three months of $1,500 - the percentage commission rate drops to just over 1%, which is less than the average equity mutual fund. Also, remember that you'll pay those equity mutual-fund fees for as long as you hold the shares, regardless of whether you ever make another purchase. With drip plans, Mr. Carlson notes, you don't have those same "carrying" costs. Bottom line: "The smaller the dollar investment and the more frequent the purchases, the greater the impact drip fees will have on the investor," Mr. Carlson says. Vita Nelson, editor of the drip investment newsletter MoneyPaper, recommends investors look into the roughly 590 companies that offer no-fee plans. There are two other drawbacks to DRIP investing: No. 1: Getting in the door. Because drips are considered shareholder perks, you must already be a company shareholder to participate in these plans. Luckily most only require that you purchase one share of stock. A number of companies, such as Netstockdirect.com and Directinvesting.com, specialize in managing direct-investment accounts and can help you purchase that share to get you started. Drawback No. 2: Plans are typically structured to make periodic purchases over time, so while you're funding the plan you have no say in when the shares are purchased and at what price. Drawback No. 3: Because these plans are designed to attract and keep long-term investors, most impose hefty redemption fees to discourage short-term traders. Typical fees amount to 2% of the account balance if you sell in the first three years, but that percentage declines as you remain invested and typically disappears entirely after five years.
Most academic studies have found that the gains from momentum strategies more than make up for the transaction costs. Those studies have assumed, however, that the average transaction costs paid by momentum traders are no higher than for other types of investors. That assumption is wrong, according to a new study by Donald B. Keim, a finance professor at the Wharton. Keim found that momentum traders' transaction costs are significantly higher than average, and that, as a result, they make momentum strategies unprofitable. The study is at http://finance.wharton.upenn.edu/~keim/illusion(7-29).pdf. [I think the URL is no longer working.] Professor Keim studied transactions by 33 institutional managers over two 12-month periods from 1996 to 2000 - a total of 1.6 million trades with a value of $1.1 trillion. He also classified these managers into three categories: momentum, value and a hybrid group that was not particularly oriented to either momentum or value. The professor found that momentum managers moved the prices of stocks they traded to a far greater extent than did managers who used other strategies. If an attempt to buy a stock moves up its price before the trade is executed, the increase should be included in an estimate of that trade's costs. Momentum managers' trades have an inordinately large price impact because relatively few investors want to be on the other side of those trades. Investors tend to hold on to, or even buy more of, stocks that have performed the best in recent months, and are often eager to sell those that have declined. That often means that the momentum investor must pay a high price when buying and accept a low price when selling. Professor Keim found that for the average momentum investor in his group of institutional managers, the total round-trip transaction costs when buying and selling a domestic stock amounted to nearly 3% of its price immediately before trading. That was three and a half times more than the cost for the average value manager and nearly three times more than that for the typical manager in the hybrid category. Although Professor Keim studied institutional investors, he contends that his conclusion applies to individual investors as well. Momentum strategies can still be profitable [for the individual investor] if ways are found to keep transaction costs low enough. One possibility is to switch among no-load mutual funds rather than trade individual stocks, thus sharing the transaction costs of momentum stock trading with the other fund investors. This strategy shows promise, as illustrated by the performance of [newsletter] NoLoad Fund X. The model portfolio of NoLoad Fund X beat the Wilshire 5000 index by 1.9 percentage points a year, annualized, from June 30, 1980, to July 31 this year. Professor Keim's study may lead more fund companies to impose restrictions, as longer-term investors in their funds discover how much they are subsidizing momentum investors. 'The Illusory Nature of Momentum Profits' [by David A. Lesmond of Tulane University, Michael J. Schill of University of Virginia, Chunsheng Zhou of University of California, Riverside 7-12-01] A simular conclusion is reached in this paper. They conclude that "First, since trading costs exhibit substantial cross-sectional variation [Donald B. Keim, and Ananth Madhavan, see below], using a NYSE trade-weighted measure is not appropriate as a benchmark for a strategy dominated by small, off-NYSE, extreme performers. We show that the securities used in relative strength strategies are disproportionately drawn from among stocks with large trading costs. Second, a constant or single period measure is unable to capture the substantial time-series variation in trading costs [David A. Lesmond, Joseph P. Ogden, and Charles A. Trzcinka, 1999, 'A new estimate of transaction costs', The Review of Financial Studies]. Third, the Berkowitz et al. measure [a 1985 estimate of trading cost based on the trade-weighted mean commission and market impact] understates the full trading costs facing investors as it excludes a number of important costs of trading such as bid-ask spread, taxes, short-sale costs, and holding period risk. We conclude that the understatement of the trading costs associated with relative strength strategies has vastly overstated the respective expected profits." The following summaries of studies is by David New, CFA, Senior Consultant and Director of Research Wurts & Associates 4-27-01 Chan, Louis K. and Josef Lakonishok, 'The Behavior of Stock Prices around Institutional Trades,' The Journal of Finance, September 1995. Institutions tend to buy or sell a position over the course of a number of days. Unlike these earlier studies, Chan and Lakonishok studied the price impact of the entire sequence, or 'package', of trades. They found that buy packages are associated with a weighted average price change of almost 1% from the open on the packageÌs first day through the last day. Sell packages had a change of -0.3%. These numbers were quite a bit higher than those for transactions on an individual level (they estimate those at 0.34% for buys and -0.04% for sells). Keim, Donald and Ananth Madhavan, 'Transaction Costs and Investment Style: An Inter-Exchange Analysis of Institutional Equity Trades,' Journal of Financial Economics, December 1997. Keim and Madhavan, using Plexus data on 25,732 orders, took what is known as the 'implementation shortfall' approach. That is, they measured the actual return of the portfolio versus that of a paper portfolio. They found implicit trading costs to range from 0.18% for the smallest buys to 0.65% for the largest buys, and from 0.15% for the smallest sells to 1.13% for the largest sells. Total costs (including commissions) ranged from 0.29% to 2.63%.
The conventional way of looking at job totals is to look at the government's monthly payroll survey. And by that measure, this recovery is a jobless one. In July, that survey found 129.9 million jobs. But the payroll survey has limitations, and they may be important ones right now. If a person has two part-time jobs, that person is counted twice. If that person then gets one full-time job, the payroll total would fall. And the survey does not try to count self-employed people, a group that is growing rapidly. The alternative count is the household survey, which is used to compile the unemployment rate. The household survey can be volatile, and relying on month-to-month changes can be treacherous. But there is little volatility to worry about if one looks at year-to-year changes in six-month moving averages. Calculated that way, the number of working Americans in July was up 0.87% from a year earlier. It was the ninth consecutive month showing growth. Historically, the two surveys usually show similar trends, and there is a good chance that the payroll survey will start to show growth soon. Jobs for people with college degrees are rising at a rate of more than 2% a year. There are more jobs for managers and professionals, and fewer for workers involved in making and shipping goods.
Strategists from HSBC last week found that in the second quarter, sales for the S&P 500 excluding financials were up 8%. That appears strong, but is down from 13% in the first quarter. Excluding energy companies because of high energy prices, and financials because falling interest rates led to boom times, the figures are starker. By that measure, sales were up 5% in the second quarter, compared with 8% in the first. And then there is the weak dollar. Adjusting for the impact is tricky. HSBC calculates that the S&P excluding energy and financials had merely 1% sales growth, compared with 5% in the first quarter, dollar-adjusted. Sanford C. Bernstein's Vadim Zlotnikov, for his part, estimates sales growth for the S&P industrials was 4.2% adjusted for the weak dollar, compared with 8.2% in the previous quarter.
In this view, all news is bad news. I grant you, that is an easy mindset to adopt in the dismal-science world of economics and finance. But it fails the common-sense test. From 3.1% two months ago, the 10-year Treasury bond's yield climbed as high as 4.4% at the end of July. As stocks have lately pulled back from their June highs, we are told that investors are worried about rising interest rates. Well, maybe. Another possible explanation for the stock market's recent pullback is that investors have learned to stay cool in the wake of fast-moving rallies. Heads-I-lose, tails-I-lose thinking is nothing new in the markets. The 1980s and '90s were full of the same push-pull we see today between concerns that the economy was growing A) too fast or B) too slowly. It's reassuring to recall that such negativism can dominate the debate in the midst of rising as well as falling markets. The last time interest rates had a sustained rise, the stock market did just fine. From early October 1998 to mid-January 2000, the S&P 500 gained 51% and the Nasdaq composite 173%. During those same 15 months, the 10-year Treasury yield climbed from 4.2% in October 1998 to 6.8% in January 2000. Some drag on the market that turned out to be.
Substituting an index fund that casts a broader net, the Vanguard Total Stock Market Index Fund based on the Wilshire 5000 Index, fails to solve the problem. Total Stock Market shows a five- year annual loss of 0.6%, to rank in the 28th percentile, and a three-year annual loss of 9.7%, which lands in the 29th percentile. While all this puts a dent in index funds' shining armor, it by no means discredits them. Jack Bogle, the now-retired Vanguard founder and chairman, in his 1999 book `Common Sense on Mutual Funds', cites three earlier periods in which S&P 500 funds trailed many managed funds -- in the mid- to late 1960s, from the late '70s into the early '80s, and 1991-93. Each was a time that favored smaller stocks, in contrast to the big stocks that dominate most broad market indexes. Same story this time. Small-cap index funds monitored by Bloomberg averaged an annual gain of 4.1% over the past five years, and a 2% annual gain over the past three. Mid-cap index funds had a five-year annual gain of 6.5% and a three-year annual loss of 1.5%. If such periods aren't new, they still can be troublesome. Five years is a long time to cool one's heels waiting. One lesson they teach is that any market index is going to have foibles that may cause funds modeled on it to disappoint for a time. History permits us, however, to end this discussion on an upbeat note: After each of the past lagging periods, the S&P 500 rebounded with a sustained spell of performance superior to most managed funds.
The holding-period requirement clearly applies to investors holding individual stocks that pay eligible dividends. But what about mutual-fund investors hoping to pay only 15% tax on stock dividends passed along to them by their funds? Several tax experts, including Mr. Dickson of Vanguard, Martin Nissenbaum of Ernst & Young and Keith Lawson, senior counsel at ICI, believe fund investors must hold their fund shares for the requisite period. And they say that's the case even if the fund itself already has held a stock long enough to satisfy the new law. Asked for comment, a Treasury spokeswoman replies "we are in the process of working on guidance." [To qualify for reduced taxation of dividends] you have to hold a stock or mutual fund "for more than 60 days during the 120-day period that surrounds the relevant ex-dividend date," says David Hariton, a tax partner at Sullivan & Cromwell in New York. (The 120-day period begins 60 days before the ex-dividend date.) The holding period could be a tricky issue for investors who make regular purchases in a fund through a taxable account and who then sell those fund shares shortly after the most recent purchases.
According to Standard & Poor's, 44 companies in the S&P 500-stock Index raised their dividends this month, and six initiated new dividends. "We haven't seen this kind of dividend activity for years, maybe since the 1970's," said analyst Howard Silverblatt, an analyst at S&P who tracks dividend activity. Mr. Silverblatt said shares of dividend-paying companies in the S&P 500 have risen 2.5% since the beginning of June, compared with a 3.9% rise for nonpaying firms, and a 2% increase for the index itself. For the year to date, dividend payers in the S&P 500 are up more than 13%, nonpayers up almost 33%, and the index is up 11.7%, at 982.82, as of Monday's close. To date, there have been 171 dividend increases and initiations - a pace that has already surpassed last year's total of 112 and reverses a 20-year decline in the number of S&P 500 issues paying dividends. Among the S&P 500, 365 companies pay dividends. S&P estimates total dividend payments will rise by $13.9 billion this year, and that investors will save $32.8 billion in dividend taxes. As for the lagging performance of dividend-paying shares this year, most Wall Street pros are taking it with a grain of salt, considering that the recent stock rally has primarily boosted technology shares and other sectors that are least likely to pay dividends. Strategist Ned Riley, of State Street Global Advisors, said investors in dividend-paying stocks will likely reap big gains because of the new policy - but it may take several years. Small Dividend = Small Tax Benefit Jeff Brown, Philadelphia Inquirer 8-5 Dividend-paying stocks lag stocks that don't pay dividends so far this year. What's going on here? Part of the problem is that dividends are so small that the tax cut doesn't translate into a lot of money. The fact that a company pays a dividend, therefore, doesn't make its stock much more attractive than the stock of a non-dividend-payer. Among the 365 dividend payers, the average annual dividend comes to only 2.17% of the stock price. If the stock traded for $100 a share, the dividend would be $2.17 a year. Cutting the tax rate from 38.6% to 15% puts only 51 cents [per share] more in the shareholder's pocket. In other words, it increases the annual return by only 0.5%. For shareholders in lower tax brackets - which is most of us - the tax savings are even smaller.
Exemptions from this withholding are granted to pension funds. But any fund that is open to taxable investors will be subject to this withholding, which can amount to 15 percent of the dividends paid. The IRS softens the blow by issuing a tax credit equal to the amount of the withholding. While the tax credit helps an investor in a taxable account, it is of no value to investors in tax-deferred accounts. For them, the net dividend yield on foreign stocks is significantly below the gross yield. In 2002, for example, there was a difference of 0.35% in the gross and net dividend yields of the benchmark MSCI World ex USA Index. Compounded over 30 years, this difference would reduce an investment nearly 10%. A new study finds that mutual fund managers alter their behavior in several ways in response to dividend tax withholding. The study was conducted by four finance professors, Susan Christoffersen of McGill Universityl, Christopher Geczy and David Musto of the Wharton School of the University of Pennsylvania and Adam . Reed at the UNCl. One way in which managers respond to the taxes is to engage in a series of complicated transactions called dividend arbitrage. These moves let funds trade away the tax credit they would otherwise receive from the I.R.S. in return for a modest fee. The researchers found that the fee amounted to about one-quarter of the tax credit. Investors in tax-deferred accounts are likely to favor dividend arbitrage because the tax credit the fund trades away is worthless to them. But investors in taxable accounts recover only a fraction of what they have lost. Some funds have chosen to avoid foreign dividend-paying stocks. The researchers found that American institutional investors tended to avoid Canadian stocks with high dividend yields. As of the end of 2000, such investors owned an average of 24% of the outstanding shares of Canadian stocks listed in the United States whose yield was below 1%. This was nearly three times as high as the comparable percentage for stocks with yields above 4%. By avoiding stocks with a high yield, funds may be forfeiting more than they are saving by avoiding foreign tax withholding. From 1975 to 1995, according to two finance professors, Eugene Fama of the University of Chicago and Kenneth French of Dartmouth, the highest-yielding foreign stocks beat those with the lowest dividend yields by more than five percentage points a year on an annualized basis.
Bond experts urge investors to stick with their bonds. Investment experts in general also would agree, recommending that investors have a diverse portfolio including stocks and bonds. While stocks are the best bet for increasing the cash in your portfolio, bonds are used to preserve it. "There's always a place for bonds," said Sharon Stark, chief fixed-income strategist at Legg Mason. As far as returns on bond mutual funds go, it's not clear that the bond-buying binge should be over. While bond funds on average are down 1.3% so far in July, they still have a positive year-to-date return of 1%, according to fund tracker Lipper. And bond funds have provided decent returns over the long term. On average, bond funds have a cumulative three-year return of 7.1% and a cumulative five-year return of 5.8 percent, according to Lipper. More on Bonds Jennifer Ablan, Barrons 8-4 Rising yields has produced "compelling opportunities" in Treasuries as well as other fixed-income markets, says William Sullivan, senior economist at Morgan Stanley. Treasuries look reasonably attractive especially against a backdrop of low inflation for, at the very least, the next three to four quarters, he contends. "If one is to take a somewhat longer-term perspective over the next few quarters, I perceive current returns to be generous in Treasuries, especially referenced against a low inflation environment that is likely to persist," says Sullivan. "Maybe interest rates were too low in June, but perhaps they are too high here." [The Fed] is unlikely to tighten monetary policy for the next three-to-four quarters amid a labor market that continues to shed jobs, Sullivan adds. To maintain their portfolios' duration relative to the benchmark, MBS investors must buy non-callable Treasury bonds when rates fall, and sell them when rates rise. This forced buying and selling exacerbates volatility of the overall market. And because mortgages comprise the largest portion of the U.S. credit market it's "the tail that wags the dog," emphasize money managers and strategists. Overall, there has been more required selling of Treasuries for each and every basis point that interest rates rise, traders add. MBS & Treasury Bonds Steve Liesman, WSJ 8-08 According to John Lonski of Moody's Investors Service, the ratio of MBS to treasuries was 67% in 1993. Now its 175%. That means huge swings in treasuries when mortgage rates move because more MBS holders are buying and selling relatively less in treasuries. Akiva Dickstein, an MBS strategist at Merrill Lynch, offers that a half-percentage point increase in mortgage rates could force the sale of $300 billion in treasuries. That's a theoretical construct. But he allows that, even if he's only half right, that's a huge number. His conclusion: get used to volatility in the bond market for a long time to come. The reason is rooted in why refinancings exploded this time to begin with. You would think it's just because of the low rates, but there's more to it. One reason is a technology story: Computer programming and automated underwriting has made refinancing a lot cheaper. A lower cost reduces the interest-rate swing necessary to provide an incentive. Maybe more importantly, the average size of a loan has risen substantially. It now stands at $166,000 for an agency loan, one conforming to standards of Fannie Mae or Freddie Mac. Back in the early 1990s, the average value was $100,000. The larger the loan, the more sensitive the holder is to smaller changes in interest rates. Before a borrower might have required a full percentage point move to make refinancing worthwhile. Now a half percentage point move will do. Bonds: Ouch John Berry, Washington Post 8-3 The bond market's rout continued last week, with yields on all Treasury coupon securities except the 30-year bond rising between 23 and 29 basis points. Analysts said that much of the trading was driven by investors selling Treasurys to deal with their hedged positions in mortgage-backed securities. Still, it meant that yields on five- and 10-year notes are now at their highest levels in a year. Surprised traders continue to think the rout has about run its course. But they thought that two weeks ago as well. Most of the latest economic news has pointed to stronger economic growth ahead, one reason for the market's sell-off. Bonds Stats Aaron Lucchetti, WSJ 8-4 Since June 13, the date the bond market was at the height of its rally (and thus, yields at their low), Treasury yields have risen faster than at any point since 1987, according to Bianco Research, a Chicago research firm. The yield on the benchmark 10-year Treasury note, for example, has jumped to 4.42% from a 45-year low of 3.11%, while the 30-year Treasury bond yield has surged to 5.33% from 4.17%. That translates to a loss of nearly 10% for investors in the 10-year Treasury, and a 15% fall for holders of the 30-year bond. To get a sense of the scale of the decline, consider that the drop is greater than any three-month loss for bonds dating to 1927, the first year for which Bianco has data. Put another way: The Dow would have to drop nearly 1,400 points from its current level - by Halloween - to match it. 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 Just the Facts The Future Looks Good The bears are saying we aren't out of the woods yet, valuations are stretched, earnings growth has been the result of cost cutting not demand, and we are still losing jobs. The facts from our point of view are that the economy is picking up (2.4% GDP growth in April, May and June), and the cost cutting that has taken place will provide gigantic leverage on the way out. With a 4.4% 10-year [Treasury] note, we think fair value for the S&P 500 is 22 times '04 earnings, versus the current P/E of 17.6. Jobs are a lagging indicator, with the stock market being a leading indicator for consumer and business confidence. The second half of 2003 should be very good, 2004 should be better, and 2005 should be best. (Michael Moe, ThinkThoughts, ThinkEquity Partners via Washington Post 8-24) The Future Looks Bad With all these positive signs, what are the negatives for stocks? First would be all these positive signs. Good news is not a negative, but stock market surprises most often occur when all the signs point one way. All during the run-up following the March lows, skepticism and disbelief dogged the stock averages at every step. Now that individuals have become more comfortable with stock investments, and money managers are forced to invest in stocks to make up for their lagging performance, complacency is hitting the markets at just the wrong time. August and September can be cruel months, and I still expect a sell-off from these levels before October. (Roger Tweed, Tweed Report via Washington Post 8-24) Emerging-Market Update Stocks in the developing countries of Asia, Latin America and Eastern Europe have been among the world's best performers for the past three years, and this year the Morgan Stanley Capital International emerging-markets index has jumped about 22%. That's better than returns in the U.S., Europe or Japan. For the past three years through July 31, the MSCI emerging-markets index is down 16.5% when translated into U.S. dollars. That compares with a 45% decline in the Dow Jones Stoxx Index of 600 European companies, also in dollar terms, and a 33% fall by the S&P 500 index. (Craig Karmin, WSJ 8-17) SEC To Implement Style-Drifting Surveillance The SEC is developing a real-time, computerized surveillance technique that will alert it when funds stray from their stated investment strategies into higher risk investment instruments. When detected, funds will face examinations by the SEC's Office of Compliance Inspections and Examinations. "There will always be somebody who departs from the stated investment policy," said a source close to agency thinking. "But we want to catch this before investors lose a lot of money." He gave the example of a self-described bond fund "that is producing returns more indicative of an equity fund. That could suggest investment outside" what is permissible limits set under the fund's investment policy. At bottom, the new SEC effort will close the information gap between the publicly-known risk, which investors can learn about in a fund's disclosure documents, and additional risks contrary to fund policy. (Stan Wilson, Instituional Investor 8-07) Morgan Stanley Changes Allocations With the S&P now at our year-end target (1,000), we are nominally reducing exposure to equities. Our prior asset allocation called for 70% exposure to equities, 25% to bonds and 5% to cash. With the run-up in both the bond and stock markets, we are shifting 5 percent out of both bonds and stocks into cash, leaving our new asset allocation 65% stocks, 20% bonds and 15% cash. We fully appreciate that the appeal of increasing cash holdings in an environment of near-zero percent rates is hardly mouth-watering. Nonetheless, we do believe the recent powerful rallies have materially lowered expected returns in both stocks and bonds. (Market Outlook, Morgan Stanley via Wash Post 8-3) 10 Yr Bond Yield = GDP Growth Rate There is a very simple way to think about the relationship between 10-year bond yields and the economy. There is a very close correlation between the year-over-year change in nominal GDP growth and 10-year bond yields. In the 1960's and 1970's, bond yields tended to trail growth of nominal GDP, because inflation fears were not there. From 1980 to now, the yield has exceeded growth in nominal GDP by 1.90 percentage points. But more recently there has been a tendency for the two to be nearly identical. When I look at the 10-year now, I don't have a problem with a yield of 4-4.5%, because that is what I think the nominal growth rate in the economy is. (Edward Yardeni, chief investment strategist at the Prudential in interview by Kenneth Gilpin, NY Times 8-3) Quick Facts, Stats & Opinions On July 31, the cap-weighted Wilshire 5000 was down more than 30% from its high in March 2000. Wilshire Associates says the Wilshire 5000 would have been 24% higher on July 31 this year than it was on March 31, 2000, had it been an arithmetic [non-cap-weighted] average. (Mark Hulbert, NY Times 8-31) Overall, we think we will see a major top in stocks by no later than October, no higher than 9,500 on the DJIA. This is a speculative bear market rally, long in the tooth, with consumer confidence cracking. . . . It has been the Fed pumping, with M-3 up 6.8 percent (annualized rate) and money flowing into stock funds ($20 billion into stocks in June) that have buttressed stocks. Expect the stock market to be back to growling like a bear by October. (R.E. McMaster, The Reaper via Washington Post 8-31) The bottom line is that the short-term technical picture points to perhaps a further consolidation of recent gains as the market weighs the effects of the massive stimulus injections versus an overburdened consumer and an uncertain jobs picture. Our advice is to hold current positions and await a better buying opportunity for new money. At this juncture there is little urgency to sell or make new commitments. (Dan Sullivan, Chartist Mutual Fund Letter via Washington Post 8-31) Buying stocks with the S&P 500 Index at 1,000 is a different deal from six months ago, when it was around 800. Not necessarily a bad deal, but a different deal. ``Stocks have climbed close to fair value, so our return outlook has come down,'' says Ken Gregory in his No-Load Fund Analyst newsletter. (Bloomberg, Chet Currier 8-26) More than one in 10 working Americans were creating or growing new businesses last year, according to Global Entrepreneurship Monitor. That was off only slightly from 2001 but still 50% higher than in 1998, at the height of Internet fever. (Robert Weisman, Boston Globe 8-17) The most serious question confronting investors in the United States equity market these days is whether the economy will be strong enough in the second half to permit corporate earnings to continue on a double-digit growth path. I would feel more comfortable if there were more of a buzz that the orders [for retail and industrial sales and capital investment] are coming in. (Byron Wein, U.S. Strategy, Morgan Stanley via Wash Post 8-10) While stocks discount future better times, they can't run too far ahead without indications of genuine business improvements - otherwise, the recent respite from reckoning will evaporate, just like it has in the past few years. . . . I want to buy and own stocks that will make us money regardless of whether the rally is real. That means focusing on cash cows and dividends. (Neil George, Personal Finance, McLean via Wash Post 8-10) We have to bear in mind that the market valuation models don't take into account the tax advantage that dividends now have over interest income (15% compared with 35%). With the new law, stock dividends give you over 20% more money after taxes (0.85 vs. 0.65) relative to interest income, so a premium should be added to the valuation model. As a result, the stock market based on the S&P 500 is now over 60% undervalued relative to Treasury bonds. (Louis Navellier, Blue Chip Growth Letter via Wash Post 8-10) The Fed has happily admitted that it will turn a blind eye towards some inflation as an extra insurance against deflation. That means no interest rate hikes for quite some time, and the new bubble in equities could get bigger. But all bubbles pop, as some of us knew in 1999. At some juncture, there will be a sharp upward turn in interest rates, as the markets realize that inflation is a risk again. When that happens, there will be serious negative developments in the home real estate, construction and financial industries. (Jay Weinstein, Oak Forest Investment Management via Wash Post 8-10) An investor in the 35% tax bracket would get about the same after-tax yield from a bond yielding 4% and a diversified blend of stocks yielding 3%. Nearly a quarter of the nation's large-cap stocks are paying dividends greater than 3%. (Ian McDonald, WSJ 8-5) Some US mutual funds are still charging fees intended to cover marketing and advertising expenses - even though the portfolios are closed to new shareholders and there is little need to market them, a study by Standard & Poor's found. S&P said that as of last month, 139 funds charged an average 0.62% for so-called 12b-1 fees, which are designed to cover distribution expenses and shareholder service costs. S&P said 74 funds charge the maximum rate of 1%. (Reuters, 8-5) Dow Jones tracks more than 1,500 companies in its US Total Market Index. Of these, 1,251 companies had reported earnings for the second quarter as of Friday. Combined net income for those companies was $112.5 billion, up from $69.2 billion a year earlier. At present levels, net income is approaching historic highs and falls just short of the $122.9 billion recorded when the economy was still booming during the second quarter of 2000. Thomson Financial estimates that earnings per share excluding one-time items rose 9.1% in the second quarter from the year-earlier period. (Jon Hilsenrath, WSJ 8-5) During the past 15 years, the Dow and S&P 500 have had their worst monthly performance during August, with the Dow off an average 1.9% and the S&P 500 down an average 1.6%, according to Jeff Hirsch, publisher of the Stock Trader's Almanac. August has also been the second worst month, behind September, for the Nasdaq. On average, the Nasdaq has lost 0.6% during August. (Amy Baldwin, AP 8-3) Only 16.2% of investors are bearish with 60.2% bullish, according to Investor's Intelligence. [That is] the largest spread since 1987, while the S&P yields 1.68% and sells for 32 times earnings. This is the kind of overvaluation we expect at a top. The Nasdaq 100 trailing 12-month P/E is 227, based on reported earnings. Cash held by [mutual] funds is only 4.5%. But breadth has been strong, volume has been bullish, and buying power was the highest it has been this year. Expect a re-test of the June 17 high at least. Key September DJIA support: 8,400 to 8,600. (R.E. McMaster via Wash Post 8-3) While stock-index funds get all the attention, bond-index funds have proved equally stellar. Over the 10 years through June 2003, Vanguard Total Bond Market Index Fund outperformed 83% of all intermediate-term bond funds. (Jonathan Clements, WSJ 8-3) Home Page Previous Factoid Top Sites
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