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In every bear market, the pundits loudly proclaim, "Buy and hold is dead." It never has been, and it isn't now. Overpay and hold is dead. - Mark Sellers, Morningstar
Within the Standard & Poor's 500, notes Steve Galbraith of Morgan Stanley, companies that report the cost of options as an expense have underperformed. He reports that companies with "ludicrous pension assumptions," high leverage and low profitability have done quite well. Low-price stocks have doubled, while other shares trail behind.
From 1990 onwards, the old VIX ranged from a low of 9.04 to a high of 50.48. The new one's comparable range is from 9.31 to 45.74. The new VIX is, on average, 3.8% lower than the old VIX. The new VIX is less volatile than the old one - about 12% less, in fact, as measured by their standard deviations. I focused on the 5% of trade dates since 1990 with the highest readings. For the old VIX, this meant any reading at or above 35.29, while for the new one, this meant any reading at or above 32.24. On average over the week following these extreme readings, the Wilshire 5000 rose by 1.3%, in contrast to the average weekly Wilshire gain since 1990 of 0.2%. That's a significant difference. And I reached the same result regardless of whether I was using the new or the old VIX. How about excessive complacency on the part of investors? It turns out that, in these instances, the new VIX does a very poor job of providing early warnings of a market decline. The only consolation is that the old VIX did an equally poor job as well. My bottom line about the new VIX: Very high readings are bullish, while very low readings are neither bullish nor bearish.
In truth, stock funds are miserable performers. Over the 30 years through December 2002, diversified U.S. stock funds returned an average 9.5% a year, versus 10.7% for the S&P 500, according to calculations by Vanguard Group using Lipper data. But that doesn't mean stock funds always appear to be losers. Indeed, in 14 of the last 30 years, stock funds beat the S&P 500. Those 14 years all had one thing in common. In every year, small stocks outperformed the blue-chip shares in the S&P 500. When that occurs, it's relatively easy for funds to outpace the S&P 500, because many of these funds favor small and midsize companies. But this isn't a great victory. Rather, it's a stupid comparison. Diversified U.S. stock funds own companies with an average stock-market capitalization of $20 billion, calculates Chicago's Morningstar Inc. That's well below the $44 billion average for the S&P 500. To see what a fairer comparison looks like, consider a study by Standard & Poor's, a unit of McGraw-Hill Cos. S&P divided U.S. stock funds into nine categories, such as large-cap value funds and mid-cap growth funds, and then compared their performance to those of an appropriate benchmark index. For fans of actively managed funds, the results aren't encouraging. In eight of the nine categories, a majority of stock funds lagged behind their benchmark index over the past five years. benchmark index over the past five years
Looking to index? I would be inclined to skip S&P 500-index funds, with their focus on large stocks, and instead buy Wilshire 5000 "total market" index funds, because these funds give you exposure to the entire U.S. stock market. Over the past 30 years, the Wilshire 5000 has climbed 10.5% a year, slightly below the S&P 500's 10.7% but comfortably ahead of the 9.5% stock-fund average. Alternatively, if you already own an S&P 500 fund, you might complement that holding with a Wilshire 4500 "extended market" fund, which includes U.S. stocks not included in the S&P 500. To duplicate the broad market, put $1 in the Wilshire 4500 for every $4 you have in the S&P 500.
S&P500 [operating] earnings are expected to rise 17% this year. [Reported] earnings are also considered likely to surge 61% for 2003. And [core] earnings are forecast to gain 78%. Confused? S&P's forecast of a 17% increase this year is based on a measure known as operating earnings. Most companies and many Wall Street analysts use this figure because it allows companies to put their best foot forward. Operating earnings exclude so-called one-time write-offs and other special charges that can reduce earnings. Those who use them say operating earnings give a clearer - and smoother - picture of earnings over time. For this reason, operating earnings suffered the least after the market crash, the recession and the sluggish growth that has followed. Twelve-month operating earnings for the S&P 500 index fell 31.6% from Q3-00 through Q4-01. By contrast, the second S&P earnings measure, reported earnings, plunged 54% in the same period. S&P says that reported earnings are expected to rise 61% this year. Reported earnings follow generally accepted accounting practices, or GAAP, and therefore are more volatile because one-time events are not excluded. The newest S&P yardstick is called core earnings, which are forecast to rise 78% this year. This measure is designed to account for the cost of stock options, which became a popular form of compensation during the technology boom. Companies have excluded stock options from the group of expenses that would reduce earnings; the core earnings measure restores them. Core earnings also remove another accounting gimmick that inflates corporate earnings. When bond and stock market returns on a pension fund's investments exceed the expected return, a company can add the excess return to earnings. Core earnings exclude this add-on.
If you had simply left your investments to run, your $10,000 would have grown to $305,000 over the next 30 years, according to Baltimore's T. Rowe Price Associates. But if, instead, you had rebalanced back to your 25% targets at the end of each year, not only would your portfolio have been less volatile, but also you would have amassed $323,000, or $18,000 more. What if you had taken that portfolio, moved 10% into bonds and then rebalanced annually? Your bonds would have underperformed stocks, returning just 8.8% a year. But thanks to the gain from rebalancing, the 90%-stock-10%-bond mix would have generated 10.5% a year, the same as the all-stock portfolio.
An aggressive and well-placed warehouse store can sell up to 1 million gallons of gasoline in a month, dwarfing the typical station's flow of about 150,000 gallons a month, according to industry analysts. Unconventional gasoline vendors are expected to sell more than 11 billion gallons of gasoline this year, up from 4.4 billion gallons in 2000, according to EAI, a consulting outfit. Their market share, now nearly 7.5% of U.S. retail fuel sales, is expected to reach 13% by 2007, EAI said. France saw a similar trend begin in the 1980s, and the one-stop shops now account for more than half of that country's fuel sales, according to the National Assn. of Convenience Stores. For a variety of reasons, some experts think the new wave of gasoline sellers will top out with 20% to 30% of market share in the United States. For one thing, discounters and supermarkets can't build enough sites to meet the traveling public's needs, and they are especially ill-suited for many of the busy corners and remote freeway-adjacent parcels where smaller gas stations thrive.
Russ Koesterich, U.S. equity strategist at State Street, said given investors' high expectations, the earnings season will likely need to impress. "The market is pricey, but rallies don't come to an end simply because they're too pricey. It will if earnings disappoint," he said. [We maintain our] view that over-allocation in bonds and fixed-equity investments may hurt overall returns in the near and long term. [We are] particularly bullish on small- and mid-cap equities, and growth has been outperforming value as a style. Valuations remain a concern, as does continued weakness in the labor market, but the overall picture for stocks is encouraging over the near and long term. Pullbacks in the market can create excellent opportunities for savvy investors. (Jim Collins, OTC Insight via Washington Post 9-21) The result of the last six months has been a welcome change from the previous three years' bear market. The average equity fund has gained over 26% in this period, 21.8% year-to-date, and 19% in the last 12 months. We continue to believe we are in a cyclical bull market that will carry prices higher well into next year or later. (Sheldon Jacobs, No-Load Fund Investor via Washington Post 9-21) History shows me that the risk in this market remains on the long side and that the next move of any importance should be to the down side as we move into the coming seasonal cycle low later this year. Once we see signs of cyclical deterioration, . . . we will then have our cue to get in short. (Tim W. Wood, Cycles News & Views via Washington Post 9-14) Our sense . . . is that the easy money has been made in the stock market for the time being. Looking ahead, though, we are more bullish, as the prospects for solid and well-defined long-term economic and earnings growth seem quite good, suggesting that stocks should trend slightly higher on an average annual basis through the latter part of this decade. (Selection & Opinion, Value Line Investment Survey via Washington Post 9-14) In August, the Leuthold Group, a Minneapolis research firm, said the S&P 500 could reach 1,250 a year from now - a 23% gain from Friday's close - if it followed the pattern of past recoveries. The Nasdaq could gain 9% over that period, Leuthold said. The study, Examining 100 Years of Stock Market Recoveries, found the biggest surges almost always come in the first 12 months after a bear market hits bottom. Those gains averaged 47% for the S&P 500 and 57% for the Nasdaq. The first 12 months of the current market recovery will end early in October. Of the 22 bear markets studied from 1900 to the present, there were only three cases in which the market fell in the second 12 months after the recovery began. The last of those instances was in 1932. So, if this pattern continues, we can expect healthy stock market gains over the next 12 months. (Jeff Brown, Philadelphia Inquirer 9-14)
Says Edward Yardeni of Prudential Financial, "The market has been singing 'Let's get cyclical' for awhile, and that will continue into next year." Yardeni recently raised his S&P target to 1260 by June 2004, 140 from 1100, and is partial to retailers, consumer-related financials, media stocks, homebuilders and technology companies leveraged to capital spending. "This is very much a bet on a more normal cyclical recovery," he says. Yardeni thinks investors are "scared of missing the next leg up" in stock prices. "Barring a terrorist incident, rather than the traditional September/October crash, we could get some pretty intensive buying by investors who don't feel they've caught the rally" he says. Yardeni's S&P 500 Target: 1140 by year-end, 1260 by June '04. Yardeni's 10-Yr. Treasury Target: 4.5% to 5.0%. Abby Joseph Cohen, of Goldman Sachs, is recommending an unusually heavy commitment to stocks. She advocates a 75% equity allocation, at the uppermost end of the firm's typical 40% to 75% range. Cohen has been steering clients toward economically sensitive sectors all year. She is overweighting technology, retail, hotel and media shares. With the market in agreement, Cohen says the firm is recommending less of an outsized investment in these industries than it did several months ago. Nonetheless, Goldman continues to advocate a disproportionate investment in cyclical issues. "The benefit to stocks from lower rates is over, but stocks can do okay while rates rise if that's due to an improving economy." Cohen's S&P 500 Target: 1150 fair value. Cohen's 10-Yr. Treasury Target: 4.2% by year end. Cohen sees potential trouble arising from the sluggish economies of America's largest trading partners. "We are the world's largest exporter, something that people forget because of our large trade deficit," she says. "We sell high-value-added products to other developed countries. To the extent that economies do not improve in Europe and elsewhere, it could prove to be a risk." On these shores, Cohen is observing warily the straitened fiscal circumstances of many state and local governments. These, too, she calls "significant impediment to growth." Richard Bernstein, of Merrill Lynch, refuses to climb aboard the bandwagon at all. A long-time bear, he sees lingering hazards in a post-bubble economy, and reckless speculation among investors. Bernstein is the only forecaster calling for a market decline. Bernstein's S&P 500 Target: 860 in 12 months. Bernstein's 10-Yr. Treasury Target: 4.6% in 12 months. To Bernstein, even published earnings aren't all they're cracked up to be. Bernstein contends that second-quarter earnings from operations marked the peak, in terms of year-to-year growth, for the current cycle. Based on reported numbers, which include writeoffs and other nonoperating items, next quarter is likely to be the peak. In other words, even if Wall Street's forecasts are taken at face value, the best has just passed, or is about to do so. The danger now, as Bernstein sees it, is that irrational expectations again have been embedded in stock prices, and that excess liquidity is moving the market "far away from reality." Investors are paying "irrational" premiums to take on risk, he says, even as they continue to undervalue quality. If these trends continue, the result will be the same misallocation of capital that characterized the technology bubble.
The study, by GovernanceMetrics, quantifies what many investors intuitively have guessed - that companies with weak governance trail the market. For all of the U.S. and foreign businesses rated by the firm, companies with the worst governance ratings returned 5.4% for the 12 months ended Aug. 12, compared with 11% for all stocks rated. The Dow gained 9.7% in the 12 months ended Aug. 12. Over three years, the worst corporations lost an average of 13% a year compared with a loss of 1.8% for all companies. The Dow lost an average of 3.7% annually during that period. Highly rated firms beat those currently rated near the bottom over five and 10 years as well. GovernanceMetrics rates businesses on 600 criteria ranging from auditor independence to conflicts of interest among top executives to potential share dilution from stock options.
Employment is measured by a survey of households and a survey of establishments. The latter is considered more reliable because it has a larger survey sample (400,000 businesses vs about 60,000 households). The two series generally move together over time. Right now they're going their separate ways, and the gap is getting wider. According to the establishment survey, payrolls are still falling. In the last year, 560,000 jobs have been lost. The household survey (also for non-agricultural workers) shows job creation of 646,000 jobs in that same time frame. Today's employment report was greeted as good news for bonds and not good news for stocks. Joe Carson, director of global economic research at Alliance Capital Management challenges that assessment. `Assuming the payroll data are correct, wage and salary growth will be anemic in August,' he says. That follows a 0.1% decline in wage and salary income in July. Using a forecast of 6% for nominal GDP growth in Q3, which is in line with consensus, weak wage and salary growth implies stronger operating profits. `Today's jobs data does not alter our view on Q3 GDP,' Carson says. `What it does tell us is who is benefiting from the growth.' More Thoughts on Employment Report Leigh Strope, Associated Press 9-07 "This suggests that we may be further than we thought from a truly sustainable economic recovery," said Bill Cheney, chief economist at John Hancock Financial Services Inc. "I don't think the recent revival in the economy is sustainable unless we see some job growth soon," said Mark Zandi, chief economist at Economy.com. "We need to see those jobs to help pick up the slack when the benefits of tax cuts and interest rates begin to fade early next year." In short, a flood of jobs is going overseas and will not be replaced, said Sung Won Sohn, chief economist at Wells Fargo. "We have simply seen the tip of the iceberg," Sohn said. "I think it will get worse, not better." Slippery Data on the Job Market Alan Krueger, NY Times 9-18 The [employment] picture is not nearly as cloudy as some have made it out to be. First, the household survey shows an artificial jump of more than half a million jobs in January 2003 because of a technical adjustment that ratcheted up the size of the population that month. Second, the two surveys count jobs differently. The household survey counts people who hold two jobs only once, while the establishment survey excludes self-employed, private household and agricultural workers, for example. If adjustments are made to the household survey to make it count jobs in a manner comparable to the establishment survey, then instead of an increase of 842,000 jobs since August 2002, the household survey indicates a loss of 425,000 jobs Ù almost as large as the 560,000 jobs lost according to the establishment survey. These adjustments do not account for the entire divergence between the surveys since the end of the recession, but both surveys point to a job-loss recovery. Manufacturing's Output is Stable Gene Epstein, Barrons 9-08 Soon after the August employment report was issued Friday morning, National Association of Manufacturers president Jerry Jasinowski called it "lousy." Jasinowski cited the figures on manufacturing as further evidence that this is "not just another cyclical downturn." Jasinowski beleives it is due to "structural changes in international trade" that are threatening the "economic strength of this country." The evidence does not support Jasinowski's view. The problem is not "relentless foreign competition," but the relentless increase in productivity. Manufacturing's share of private sector output has barely changed over the last decade. According to the best estimates, manufacturing output accounted for 19.4% of total private sector output in both '96 and 2000, the highest share since '89 (figures on a value-added basis). Through the '01 recession, the most recent year for which data are available, the share fell to 18.2%, nearly as high as 18.6% from '91 to '93. The survey indexes on manufacturing issued by the Institute for Supply Management (closely watched by Chairman Greenspan), jumped in August, after increasing in July. They are now signaling about an 8%-10% annual increase in manufacturing production, which makes sense, since the sector will have to produce enough to both satisfy rising production and rebuild the inventories that have been depleted. Even at the current rate of productivity growth, a double-digit rise in output should mean the sector must start adding jobs.
The International Monetary Fund, in a global survey of underground economic activity last year, found that this sector has been growing in the United States for 30 years. The authors of the I.M.F. report have estimated underground economic activity at 8.6% of GDP in the United States, up from 6.7% in 1990 and just 4 percent in 1970. Because most people who work off the books are in labor-intensive fields, it is a safe bet that 9% of GDP translates to more than 9% of the work force. One reason for this growth is the arrival of millions of immigrants, especially illegal ones. There were an estimated 8.7 million illegal immigrants in this country in 2000, according to the Census Bureau. And a large proportion are working off the books for employers who appreciate cheap, compliant labor free of employment regulations and payroll taxes. Another reason is the growing importance of the service economy: it is easier to keep this activity off the books. In the case of child care, for instance, parents do not want to wrestle with paperwork and payroll taxes, while the child care providers often prefer to avoid taxes. Women's participation in the labor force exceeded 60% in 2001, up from 34% in 1950. That change has created much more demand for child care, gardening and other domestic help.
Saying "no" to growth: Strong performance can unleash a flood of new money into a mutual fund. But particularly in the case of small-stock funds, growing portfolio size can threaten future performance. The growth forces the manager to either hold many more stocks - rather than just the most promising ones - or to move into larger issues. That is why, particularly when shopping for small-stock funds, many fund advisers favor companies that have shown a willingness to shut their funds to new investors before they get too big. Kunal Kapoor, associate director of fund analysis at research firm Morningstar, says the Wasatch, Bogle, Numeric Investors and Turner fund families are among those with a strong record in this area. Caution about new funds: Roy Weitz, publisher of Web site FundAlarm.com, complains that some fund firms introduce lots of new and sometimes gimmicky funds because "they can sell them" and not because those portfolios are really smart long-term holdings. He and others note, for instance, that investors are still smarting from the losses they suffered in the plethora of Internet-stock funds that management companies rolled out in the late-1990s bubble. One alternative is to seek out fund companies that have a more limited, time-tested menu of funds and that think carefully before adding new items to the list. Capital Research & Management, the manager of the American Funds, "is the classic example of a fund company that is very careful about rolling out new funds." Reasonable fees: Mutual funds carry annual fees to pay their portfolio managers and cover other expenses. But lower fees, all other things being equal, give one fund a head start in the performance race against others, because those expense charges are subtracted from the investment returns the portfolio manager achieves. Vanguard Group is the best known provider of low-cost funds. The $14-billion Dodge & Cox Stock Fund has an expense ratio of 0.54%, versus an average 1.40% for Morningstar's category of "large value" funds. Investing in their own funds: There is a simple reason to favor fund firms where the portfolio managers or company executives have big stakes in their own mutual funds.When fund insiders are willing to eat their own cooking - it sends a great message that management's interests are aligned with those of shareholders. Frank talk: Actions may speak louder than words. But besides looking for strong performance, many fund specialists say they really appreciate managers who provide detailed explanations of their investing strategies and who thoroughly review their stock-picking successes and their missteps. Bill Miller of Legg Mason Value Trust and Oakmark managers as some whose shareholder reports candidly discuss the stock picks that have worked and those that haven't.Vanguard has warned investors against getting carried away in the investing fad of the moment, even when that fad is a type of fund that Vanguard sells, such as index funds in the 1990s and government-bond funds more recently. Protection from Market Timers Jeff Brown, Philadelphia Inquirer 9-07 Small investors can help protect themselves by keeping in mind the benefits of diversification. The more investments you have, the less you'll be hurt if something goes wrong with any one of them. In this case, it means owning funds that contain lots of stocks. Late-breaking news can dramatically drive a stock's price up or down. But if it is just one among hundreds of stocks in the fund, the news will have little effect on the fund's share price. Such a fund is, therefore, not a good candidate for the kind of game Canary was allegedly playing. Volatile funds - those prone to wide up and down price swings - are more likely subjects for such schemes, since money can be made on short-term price changes. I'm not saying you shouldn't have a small portion of your portfolio in these more volatile funds. But if you want to buy them, you now have a new risk to consider.
First, the numbers, courtesy of Vickers Stock Research Corp. Vickers calculates what it calls an "8-week sell/buy ratio" for stocks listed on the NYSE and AMEX. This ratio is calculated by dividing the dollar value of all insider sales of listed stocks over the previous 8 weeks to the dollar value of all purchases. This 8-week sell/buy ratio currently stands at 4.29, which means that insiders from companies whose stocks are listed on the NYSE and AMEX are selling $4.29 worth of their companies' stock for each $1 they are purchasing. You have to go back 17 years - to mid-1986, in fact - to find a time when the ratio was significantly higher than today's level. How ominous is a ratio this high? To find out, I analyzed Vickers' insider data back to 1974, which is the first year for which they calculated this 8-week sell/buy ratio for listed stocks. I focused in particular on the 84 weeks over the past three decades in which this ratio was at least 4.0. On average, the stock market did not exhibit any particular weakness over the year following each of these occasions. Twelve months later, in fact, the Dow was 13.0% higher on average. That's somewhat better than its average gain in all other 12-month periods in the past. However, it turns out that the stock market performed much worse than average in the second year following these occasions on which the sell/buy ratio was above 4.0. On average after the 24th month, the Dow was 14.4% higher than where it stood at the beginning of the two-year period, or just 1.2% higher than where it stood after the 12th month. Which suggests that insider selling is a leading indicator with a long lead time. Independent confirmation of this long lead time comes from an academic study by Bin Ke and Stephen Huddart of Pennsylvania State University, and Kathy Petroni, of Michigan State University in their study, "What Insiders Know About Future Earnings and How They Use It: Evidence From Insider Trades." The researchers found that insiders anticipate downturns in their companies' earnings by as much as nine calendar quarters, or more than two years. [ From their report : Stock sales by insiders increase three to nine quarters prior to a break in a string of consecutive increases in quarterly earnings.] The researchers also found that, regardless of how far in advance of bad earnings that insiders begin selling, they tend to wrap up that selling at least three calendar quarters before the bad news becomes public. Summaries below are by Ke, Huddart and Petroni and are from their study mentioned above. M. Barth, J. Elliott, and M. Finn ("Market rewards associated with patterns of increasing earnings." 1999) and H. DeAngelo, L. DeAngelo, and D. Skinner ("Reversal of fortune: Dividend signaling and the disappearance of sustained earnings growth." 1996) show that breaks [in year-over-year quarterly increases in profits] are associated with economically - and statistically - significant stock price drops. Insiders therefore have an incentive to sell stock in advance of breaks. Prior research suggests that the stock price drop associated with a break is greater for growth firms, when the break follows a longer string, and when the earnings decline at the break is greater. The market-adjusted returns following quarters where insiders sell are significantly lower than the abnormal returns following firm-quarters where insiders buy. The finding that insider purchases are more informative than insider sales (example: N. Seyhun, "Investment intelligence from insider trading." 1998) may be related to our finding that insider sales prompted by earnings breaks precede the break by nine months to two years. If insider purchases occur closer to the time good news is disclosed, the difference in the informativeness of purchases and sales may be related to the window over which trades are examined. J. Elliott, D. Morse, and G. Richardson ("The association between insider trading and information announcements." 1984) analyze trading behavior in the twelve months before large unexpected changes in annual earnings. They find less selling by insiders before both good news and bad news earnings disclosures. As a result, they do not draw conclusions on whether insiders use their knowledge of future earnings in their trading decisions. D. Givoly and D. Palmon ("Insider trading and the exploitation of inside information: Some empirical evidence." 1985) analyze trading behavior around 1,427 corporate events reported by the Wall Street Journal. Earnings announcements make up approximately 60% of the total events in their sample. In the four to five months before the event announcement, they find no tendency for insiders to purchase stock prior to good news or to sell stock prior to bad news. K. Sivakumar and G. Waymire ("Insider trading following material news events: Evidence from earnings." 1994) consider trading activity in the quarter preceding an earnings announcement, although the focus of their study is on trading after quarterly earnings announcements. They find that trading by insiders within one quarter is not correlated with errors in analysts' forecasts of next quarter's earnings. C. Noe ("Voluntary disclosures and insider transactions." 1999) builds on previous research by S. Penman ("Insider trading and the dissemination of firms' forecast information." 1982) examining insider trading and management earnings forecasts. Noe finds that increases in insider trade in the twenty days prior to disclosure are not correlated with management earnings forecast errors. Noe also documents a significant positive association between net insider purchases made within twenty days after a management earnings forecast and a measure of growth in earnings over the next three to five years. This result suggests that insiders base their trading decisions on forecasts of earnings a year or more in the future, rather than earnings to be announced in the next quarter.
Many advisers and investors believe that this is a strong bearish signal. But H. Nejat Seyhun, a finance professor at the University of Michigan who has devoted much of his academic career to studying the behavior of corporate insiders, argues that the bears are overlooking two significant factors. The first is the huge number of options that have been granted to insiders in recent years. One result of that practice has been a significant increase in the ratio of insider sales to purchases in the open market. That occurs because buying shares to exercise an option is not an open-market purchase, while the subsequent sale of those shares is. Option exercises among insiders increased sharply after a change in insider trading rules in 1991. Until then, the SEC required an insider to hold a share of stock for at least six months after acquiring it through exercising an option. After the change, insiders could sell their shares immediately after buying them, as long as the sale occurred at least six months after the option was originally granted. Comparisons of current and pre-1991 insider selling can be misleading, according to Professor Seyhun. He says a high ratio of insider selling in earlier periods was more likely to reflect pessimism about prospects for the insiders' companies. Professor Seyhun also points to what he considers another mitigating factor: the new wave of insider selling has occurred while the stock market has been rallying. His research has found that such selling carries far less bearish significance than selling during a market decline. To document this difference, Professor Seyhun looked at each publicly traded company on the New York and American stock exchanges and the Nasdaq market from the beginning of 1975 to the end of 2000, identifying all months when the company's insiders were net sellers. Professor Seyhun found that when insiders sold during a decline, the stocks they sold lagged behind the overall market by an average of 5% over the next 12 months. To illustrate, he points to the beginning of the 2000-03 bear market. Over the six months after the Internet bubble burst in March 2000, Vickers's eight-week sell-buy ratio more than doubled, from 0.78 to 1.94. From September of that year to the following March, the Wilshire 5,000 fell by 21%. In contrast, Professor Seyhun found no discernible pattern in the subsequent performance of stocks sold by insiders while the market was rallying. As a result, he concludes, the current high level of insider selling provides no signal for the market's direction.
It is not only the poor and working poor who are not faring well in America. Many of those in the middle, especially two-income families, are having trouble making ends meet, despite the boom of the 1990's. The conservative analysts W. Michael Cox and Richard Alm, in their 1999 book "Myths of Rich and Poor," asserted that Americans were buying a lot more goods like Gap clothes, Nike sneakers and VCR's, and the standard of living was improving faster than the data suggested. But the costs of what it really takes to be middle class today - education, health care, housing, drugs - rose much faster than median family incomes. According to federal data, for example, my own calculations show that nominal family incomes rose by about 5.5% a year from 1973 to 2000, but the cost of health care rose nearly 8% a year, and the cost of higher education 6.5%. Warren and Tyagi find that despite the popular notions about overconsumption, a typical family spends less on clothing today, discounted for inflation, than in the early 1970's. Similarly, it spends less on large appliances and on food, including going out to restaurants. As for vacation homes, the data suggest that 3.2% of families had them in 1973, and that 4% do now. Is this affluenza? What families spend a lot more on, the authors calculate, is a house in a safe neighborhood with a good school - about 70% more a year, discounted for inflation, for the typical family of four. And these families are not buying huge new homes. The average home size has been skewed upward by the wealthy. The typical family's house is only a half room or so larger than it was 30 years ago. The cost of health insurance is often up, even when spouses work, because corporate benefit plans are demanding higher employee contributions. For the typical family of four, it is up by 60%. And two incomes often mean a substantial increase in taxes because the family moves into a higher tax bracket. The upshot is that two-income families often have even less income left over today than did an equivalent single-income family 30 years ago, even when they make almost twice as much. And they go deeper in debt. The authors find that it is not the free-spending young or the incapacitated elderly who are declaring bankruptcy so much as families with children. Related article: Downwardly Mobility - Linda Stern, Reuters
This theory can't explain what we're seeing now, however. Consider the current yields on two of the Vanguard mutual funds that focus on intermediate term bonds. The Vanguard Intermediate Term Treasury Fund (VFITX) has a yield of 3.28%, while the Vanguard Intermediate Term Tax Exempt Bond Fund (VWITX) is yielding 3.31%. How did this anomalous situation come about? Band believes "the hoopla over President Bush's dividend tax cut lured wealthy investors (the main constituency for munis) into high-yielding common stocks. As a result, the yield gap between tax-free municipal bonds and Treasuries of the same maturity has narrowed to the vanishing point." Of course, it's always dangerous to assume that we know more than the market does. So it's important to at least ask the question: Might the market be acting rationally? It would be if income tax rates were going to be dramatically lower over the next decade than they are today. In that event, tax-exempt bonds on a pre-tax basis would need to yield almost as much as taxable ones in order to be competitive on an after-tax basis. Richard Band, editor of Richard Band's Profitable Investing, doesn't put much stock in that possibility. "In fact," he says, "muni yields could even drop as Treasury yields tick up - if, for example, the Democrats gain traction in the presidential rate and threaten to repeal the GOP tax cuts." Band suggests buying individual tax-free bonds instead of a tax-free bond mutual fund [with the exception of when closed-end funds are selling at a discount], for several reasons. "With individual bonds, you pay only one commission... There are no ongoing fees after the purchase, like you incur with a fund. You also get to choose your maturities and call dates."
Trying to put a single number on the riskiness a fund poses "the danger that investors - neither understanding the limitations of such a measure nor accurately assessing its relevance - nonetheless will rely upon it to their detriment." But while the trade group put up a fight at the international level, it remained silent this time about the NASD's second extended lease of life to the volatility pilot. Two years ago when the original 18-month volatility pilot was given its first extension on Aug. 31, 2001, the ICI had sent a letter urging that it be killed. This time, with Capitol Hill generating a lot of headlines troublesome to the industry, ICI has remained silent. Said one source favoring the ratings, "If any good has come out of Sarbanes-Oxley it is that it has made ICI realize there are worse things than volatility ratings, and the world won't come to an end if we do them." Which fund groups now use them is kept confidential by NASD, which said only three are doing so. Standard & Poor's, which sells volatility ratings, lists many more than three as subscribing to its service.
But before you dive head-first into bonds or shove your money under your mattress, know that seasonal trends also can work in favor of the market, and a lousy fall could set the stage for a strong finish toward the end of the year as money managers pick up newly discounted stocks. Peter Cardillo, chief strategist and director of research at Global Partners Securities, expects a shallow pullback in coming weeks, followed by a year-end rally. He predicts the Dow will approach 10000 toward the year's end, the S&P 500 will near 1100 and the Nasdaq will close the year out around 1900. Right now, the Dow is approaching 9400, the S&P is around 1000 and the Nasdaq is near 1800. Meanwhile, analysts say the fall pullback will be less violent this year than it has been in the past. Last year, the Dow tanked 12% in September. "The pullback will be mild and will be over by October," predicts Andrew Burkly, technical analyst at Brown Brothers Harriman. He sees "maybe a 5% sell-off from current levels" and believes "people will be quick to buy on dips," as they have done throughout the summer, which helps to cushion falling prices. Cyclical sectors are picking up steam as investors rotate their money out of more-defensive positions. Cyclical stocks perform better when the economy is moving at a steady clip. Since stocks hit their lows in March, the Morgan Stanley Cyclical Index is up nearly 48%, while the Morgan Stanley Consumer Index, which tracks stocks that tend to have steadier performances, climbed a more-modest 18%. One big test for the market will be the approaching preannouncement season. Mr. Streed, for one, thinks it will be less painful than in years past, when analyst revisions and company announcements that earnings would miss targets weighed on major indexes. Analysts, too, are upbeat. They currently expect earnings growth of 14.1% from a year earlier for S&P 500 companies in the third quarter, according to earnings tracker First Call. Indeed, not only are estimates not going down, they are actually collectively moving up. Back in July, analysts expected slower third-quarter earnings growth of 12.7%. But in an environment where hopes are high, money managers warn that disappointing results could cripple individual companies that fall short of hopes. "If it's just a few companies [missing estimates], those companies are going to get murdered," Mr. Streed says. "If everything is OK but you stand out as a problem child, they'll dump your stock and roll the money into things that are working." More Forecasts E.S. Browning, WSJ 9-2 Thomas McManus, who forecasts the stock market for Banc of America Securities, is feeling upbeat going into the last stretch of the year. He says stocks could rise another 5% or 10% before the year ends, to their highest levels in more than a year. Even the bullish Mr. McManus of Banc of America warns that the sharp gains are "now behind us." With stocks closer to fair value, they are likely to rise in line with the pace of earnings gains -- at 7% to 9% a year, he says. Richard Bernstein of Merrill Lynch sees a chilly autumn, saying stocks are so overpriced that they could fall as much as 14% during the next year. The Nasdaq composite "has already jumped over 61% while profits are up just 7% to 15%," notes Ned Davis of market-research firm Ned Davis Research in Venice, Fla. "Much of the good news is already in prices, and we could see a short-term market correction in September." " 'Tech' may still be a four-letter word for many investors," wrote Smith Barney economist Steven Wieting in a recent report. But the Nasdaq composite still is only back to one-third the record level of 5048.62 hit early in 2000. "We can't avoid the conclusion that the information-technology sector will likely provide the strongest rate of earnings recovery in the S&P 500." David Briggs, head of stock trading at Pittsburgh mutual-fund group Federated Investors, was a skeptic until spring. He has been impressed with the market's resilience, and thinks the rally will continue. "We have cash coming into stock funds," Mr. Briggs says.
Banks are likely to lag behind the market for the rest of the year. "I think we've seen the best we're going to see from that sector," says Jim Floyd, an analyst at Leuthold Group who studies industry sectors. One area that might do well is securities brokers, which benefit from market rallies because trading volume and investment banking pick up. Technology: Typically, tech stocks rise in the middle of the economic cycle. But the Nasdaq has soared nearly 63% since its October low, while valuations and growth expectations are far higher than any other sector. The issue for tech stocks is not how much higher can they go, it is whether business will improve enough to justify the prices. "What has to happen is earnings have to come through in Q3 and Q4 - and there's a reasonable chance they will," says Barry Randall, who manages the First American Technology Fund. On the positive side, tech stocks have rallied in November and December in six of the past eight years. Consumer Cyclicals: These include car companies and appliance makers that typically soar when the economy turns and consumers gain confidence. The problem is that consumers, helped by low rates, never really stopped spending. The consensus is that these stocks too could stall, especially if the recovery continues to be a jobless one. "Even though the economic cycle argues for them as well, you would be better off in other areas because they've already had their run," says Jim Paulsen, chief investment officer for Wells Capital Management. The contrarian view is that consumer spending has picked up recently and that this Christmas could be a happy one for retailers, especially compared with last year's bleak season. Health Care: Shares of drug companies, hospitals and medical-supply companies will likely remain weak if the economy stays strong. But if the recovery stumbles, investors could flock to these stocks. Richard Bernstein, Merrill Lynch's skeptical strategist, believes the recovery could be sluggish and thinks health-care stocks will do well. Consumer, Noncyclical: People buy toothpaste even during the deepest recessions, so these stocks tend to do well when the economy is down. Like health-care stocks, these are unlikely to do well if things are good. Energy: In a world where the ability to raise prices and pay dividends is rare and valued, energy companies are doing both, but getting little credit for it. On a market-cap weighted basis, the energy stocks in the S&P 500 raised their earnings by 53.5% in the second quarter, more than double that of financials, the next best performing sector, according to International Strategy & Investment, a research firm. Yet energy stocks are up just over 10% on the year, making them the sixth-best performer among the 10 Dow Jones industry sectors for the year, as well as for the past three months. "The reason energy is not working well in the short-term is investors do not believe that the price is sustainable," says Merrill's Mr. Bernstein. "Our story has been the price of energy stays high for longer than people think and that slowly but surely will attract capital." Ultimately, energy bulls argue, that will boost energy stocks. Indeed, if the economy booms, energy should do well because demand will rise, as it does during a normal economic cycle. If the economy falters, investors could also flock to energy stocks because they are the ones with the strongest earnings. Telecommunications: Phone companies, the market's weakest sector for the year, and maybe forever, will only do better when the industry itself turns things around. Utilities: Despite a slight post-blackout bounce, utilities stocks had a lousy summer after soaring earlier in the year as investors flocked to big dividend payers. Utilities could do well if the blackout produces rate increases, but more likely investors will shun them unless the economy slows. Basic Materials: After falling behind for much of the year, shares of mining companies, paper makers and chemical companies beat all but tech stocks during the summer, rising 10.7% over the past three months. These stocks tend to track energy stocks, rising late in an economic cycle when demand peaks. Just the Facts A Country on the Move In the last five years of the 20th century, 45.9% the population packed up and moved to different homes. The five-year moving rate has hovered at about 46% since 1970. Nearly one-quarter of the country's 262.4 million people five years and older moved to a new address in the same county, according to a Census Bureau report. The South attracted the most transplants - 1.8 million more than moved out of the region - while the West stayed about even, and the Northeast and Midwest saw declines. Long-distance moves are most common among people from their late teens to early 30s, primarily for college or a better job. Only 21% of Nevada residents were born there. Louisiana had the highest percentage of residents who are natives, with nearly 80%, followed by Pennsylvania and Michigan. (Associated Press 9-24) Fund Flow Update Investors poured a net $26 billion last month into stock mutual funds [the third-largest amount in more than three years], even as they withdrew $15.3 billion from bond funds according to estimates by Lipper. August marked the sixth-consecutive month of new money going into stock funds - the longest streak since the eight months ended in May 2002, soon after the peak of the bull market. Bond fund withdrawals surpassed the previous monthly record of nearly $11 billion, which came as the result of a sharp selloff in November 1994. (Yuka Hayashi, WSJ 9-19) U.S. Workers Top World's Productivity U.S. workers topped the world's productivity for 2002, with annual output having risen much faster than in Europe and Japan in recent years, according to a United Nations study. Americans were at the top because they worked relatively long weeks and took few holidays, the report says. Output per hour was higher in Norway, France and Belgium. Americans worked 1,825 hours on average in 2002, or 280 to 480 hours more than people in Norway, France and Belgium. But their output of $32 per hour was below the $38, $35 and $34 respectively in the three European nations. (Reuters 9-1) Mail Order Rule There is a little-known federal rule all consumers should be aware of called the Mail Order Rule. It says a merchant must alert customers if a shipment will be delayed and tell them when shipment can be expected. If a merchant's ad doesn't give a date for shipment, the rule assumes shipment within 30 days. A crucial part of the rule states that if a merchant can't ship in time, he has to give a delay option notice. The notice can be by phone, snail mail or e-mail, but it has to be clear. Here's the kicker: The notice has to include an option allowing you to cancel the order and get your money back, at no cost to you. (Paul Wenske, Kansas City Star 8-31) Quick Facts, Stats & Opinions According to an annual survey by Dalbar, a financial services consultancy, the average investor holds a mutual fund for 2.5 years. Dalbar estimates that the average investor earned 2.57% a year between 1984 and 2002, or roughly one-fifth of the 12.22% annual gain of the S&P 500. (Todd Mason, Philadelphia Inquirer 9-16) In 1998, the median net worth for families headed by people in their 40s in the top 10% was $531,600. The 2001 figure is $677,900, an increase of 27.5%. That, believe it or not, is a relatively modest increase. The median net worth of families headed by people in their 50s who are in the top 1% of wealth increased from $5.79 million to $9.05 million, a 56.3% surge. (Scott Burns, Dallas Morning News 9-07) Auto rates are expected to rise 6% next year, on top of the 8.5% rise seen this year, according to the Insurance Information Institute, an industry trade group which pegs next year's annual average cost per car at $898, up $51 from this year's average rate. After declining or staying flat through the late 1990s, premiums have jumped 32 percent on average since 2000, according to J.D. Power. (Andrea Coombes, CBS.MarketWatch 9-5) Universal Music Group, which accounts for about 30% of all music sales worldwide, said that beginning in the next few weeks it will put a sticker on almost all newly pressed CDs suggesting a $12.98 retail price - about $6 less than the current sticker. The company will also drop its wholesale cost to retailers from $12.02 to $9.09 per CD, except on releases from top-selling artists, which will drop to $10.10 wholesale for the first few months of their release and then drop to $9.09. It costs 75 cents to $1.10 to create each CD. (Frank Ahrens, Washington Post 9-4) Home Page Previous Factoid Top Sites
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