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How did investors react to this sea change in tax policy this year? By snapping up stocks that don't pay dividends. Companies in the S&P 500 that pay dividends have returned a healthy 31% in 2003, but shares of non-dividend-payers have soared nearly 57%. (Those numbers top the S&P 500's 25% rise because the index is market-cap weighted.) "People's attitudes toward dividends aren't magically going to change overnight," says Jason Trennert, a strategist with research firm International Strategy & Investment. "I think the main thing is time." Time may pass quickly next year when people begin to realize just how good a deal dividends have become. According to Standard & Poor's, companies in the S&P 500-stock index are expected to pay a record $160.6 billion in dividends to shareholders in 2003, up from $147.8 billion last year, the previous record. According to S&P's dividend-obsessed quantitative analyst Howard Silverblatt, investors in the S&P 500 will reap $136.5 billion in dividends after taxes this year. Last year's payout when taxed at the old maximum rate would have been $90.9 billion. Individual investors own about 36% of the shares of the stocks in the S&P 500, putting their after-tax dividend payout at $49.1 billion compared with $32.7 billion last year. That difference - $16.4 billion - tops the $14 billion that went to taxpayers in the summer as part of the boost in the child tax credit. There is plenty of room for growth in dividends by historic standards. Only 370 companies in the S&P 500 pay dividends, down from 435 just 10 years ago, though up from the low of 351 in 2002. The dividend yield is just 1.67%, well below the 3.87% level it was at as recently as 1990. While the impact of the dividend-tax cut on investors remains unclear, there is already evidence it is affecting corporate behavior. By making dividend-tax rates equal to capital-gains rates, companies are under less pressure to boost their earnings per share, which drives stock prices. Instead, it is easier for companies in slow-growth industries to satisfy shareholders by sharing their prodigious cash flow with investors. "I think the biggest thing is, for a number of companies the dividend-tax relief gives them a break from having to be a growth company at all costs," says Mr. Trennert of International Strategy & Investment. It will also ease the pressure for companies to buy back shares, which is one way slow-growing companies kept their earnings-per-share growth high.
Eighty college students were given simulated portfolios to manage over 25 "years." They could allocate assets between a stable, slow-growth bond fund and a volatile but higher-growth stock fund. Some students could reallocate assets monthly, others yearly, and still others only once every five years; each time, a computer showed them how they were doing. At the end of the experiment, the students made one final allocation that would be binding for 50 "years"; they were paid based on how much their faux portfolios earned over the entire experiment. The results: The students who reallocated monthly put more than half of their money in the bond fund, even at the last stage when they were forced to leave it there for decades. The students who reallocated once a year or less frequently, by contrast, put two-thirds or more of their money into stocks. Not surprisingly, the "monthly" students earned the least money. The researchers suggest that the "monthly" students were so unnerved by the stock fund's volatility (39% of the simulated "months" showed losses) that they fled to the safety of bonds, even though returns were much less. The other groups, who got feedback on their performance less frequently and, hence, saw far fewer losses stayed in stocks and came out ahead. The lesson is that obsessively checking your brokerage-account balance can make you even more sensitive to short-term losses than you were to begin with - possibly explaining why so many people invest their 401(k) accounts too conservatively. More information and more freedom to shift assets around, the researchers concluded, isn't always better: "Providing (myopic, loss-averse) investors with frequent feedback about their outcomes is likely to encourage their worst tendencies."
Behaviorists have puzzled over this for years. Some argue that investors overreact to information, especially when it seems to confirm the way they already feel about a stock. So each positive earnings report makes a strong stock look stronger, while each shortfall further burdens an out-of-favor stock. Eventually, the theory goes, "winners" become overpriced and "losers" become underpriced; when they revert to their norms, the winners stall out and the losers start looking good.
Many graduate students have returned to school after five or six years absorbing the culture of the working world, he explained. Those coming from accounting, he said, tend to see themselves as hired guns for corporate management. Their goal is to use the rules to achieve management's goal of the moment, such as reporting larger profits or revenue, or making debt look smaller than it is. But the real purpose of accounting is simple: to find out how much money the company made. There's more to it, of course, but that's the bottom line. At public companies, the accountants and auditors should be working for shareholders who want to know how the company is doing - not for managers who want to look more successful than they are. So regulators should resolve to simplify the rules and close loopholes. The hope: to get to a point where a roomful of accountants, given the same data, would all come up with the same result without talking to each other. That's the standard in math and science, and accounting is, after all, just math.
The risks facing equities and equity investors are deep and serious. Let's look at four. First, the quality of [reported corporate] earnings is still wretched. It's appalling how many games are still played to pretend earnings are stronger than they really are. The investment community is slowly waking up to the problem, but only slowly. Pension income [booked by companies as part of their earnings] is a big part of it. If companies would treat pension expectations and income properly, the earnings of S&P 500 companies would fall 15%. If those companies expensed management stock options, there goes another 10%. I think earnings are only about two-thirds of what they're reported to be. Equity valuations are another major risk. If you smooth out corporate earnings over the past 10 years, stocks today are trading at more than 25 times those earnings. That's not healthy [since it's much higher than U.S. stocks' historical average price-to-earnings multiple of about 16]. That's not a starting point for a bull market. A third risk is simple demographics. Waves of Baby Boomers will have to start cashing out to pay for goods and services in retirement in five years or so. That means more people than ever before will be selling stocks and bonds to buy goods and services from a proportionally smaller work force than ever seen in this country. That will put a lot of downward pressure on the prices of financial assets. It could also trigger inflation, given all that demand from Boomers. Last, the premium that stocks offer over inflation-indexed government bonds or TIPS is pretty skinny. Historically, companies have posted earnings and dividend growth 1% faster than inflation. Today stocks yield about 1% less than TIPS. They're yielding about 1.6%, compared to 2.4% for TIPS. So, there really is not much of an advantage to owning stocks over far less risky assets. If stocks were yielding 4% and TIPS were yielding 3%, then stocks would be a no-brainer. But that's not the case today.
If history tells us that hard assets are good for portfolios, recent market action may be telling us that hard assets will be needed even more in the future. Why? Simple. Long term, virtually the entire return on fixed-income investments is yield. Today, bond yields are very low. Similarly, nearly half of the long-term return on common stocks came from dividends. Today, dividend yields are near their historic low. As a consequence, the relative returns of competing assets such as real estate, energy, timber and precious metals may compare favorably in the future. Will it happen that way? No one knows.
Hedge funds have also been pouring money into commodities this year, adding to demand, helping to drive prices higher and increasing volatility. New hedge funds such as Ospraie Management and Catequil Asset Management have raised over $1 billion each to focus on commodity trading and are already closed to new investors. Other established funds, including those led by Paul Tudor Jones and George Soros, are allocating sizable portions of their assets to commodities after having ignored them for years. Some of the money is even coming from usually conservative pension funds and college endowments, managers of the funds say. This speculative buying, aided by low interest rates that make borrowing cheap, is adding another variable to the supply/demand equation. The Dow Jones-AIG Index of 20 commodities is up 21.4% for the year. The Reuters-CRB Futures Index, which comprises 17 commodities, is up 9.5% for the year. The Dow index's sharper rise is largely because it gives more weight to more actively traded commodities. While many investors believe the major run-ups in commodity prices are over, they say money can still be made because the markets are likely to stay volatile.
In a rare alignment of market forces, demand for farm commodities is strengthening at a time of tight supplies. The lower exchange rate of the dollar and a buying spree by China for soybeans and cotton helped to lift U.S. agricultural exports in October to $6 billion, a record for any month. World grain supplies are the tightest since the 1970s. A count of the U.S. cattle population on July 1, meanwhile, found the fewest animals since the survey began in 1982. American consumers are willing to pay more for beef and eggs, thanks in part to the high-protein diet craze. And the ethanol-fuel industry is rapidly increasing its use of corn. The price of soybeans, used in everything from energy bars to margarine, is up 35% from a year ago. The price of cattle is up 38%. Cotton is up 49%. Egg prices are 46% higher. The USDA's food commodity index jumped 26% in November from the same month last year to the highest level since its creation in 1975. Although farmers themselves are a tiny part of the population, they have an outsize impact on the economy because farming is such an expensive enterprise. A full-time Midwest grain farmer often owns millions of dollars of equipment and land, and spends hundreds of thousands of dollars annually on supplies. The businesses that sell to farmers and use farm products account for about 12% of the nation's gross domestic product and about 17% of jobs, according to the USDA. For consumers, the farm boom shouldn't increase their food costs significantly. The prices farmers are paid are usually a tiny part of the cost of making food; processing, packaging and transportation are all becoming bigger expenses. John M. Urbanchuk, an economist at LECG LLC, Wayne, Pa., says he expects retail food prices to climb 3.2% in 2004, compared with a food price inflation rate of a little more than 2% this year. The big exception is beef. Some economists expect retail beef prices to jump 15% in 2004. How long will the farm boom last? The agriculture sector is characterized by long spells of depressed commodity prices broken by sharp rallies. Several economists think the farm economy will stay strong at least through next year. A lot depends on the continuation of the economic boom in China, where consumers are using their swelling buying power to buy more meat. China is importing U.S. soybeans mostly to fatten hogs and poultry. The USDA expects China to import $5.4 billion of agricultural goods from the U.S. in the fiscal year ending Sept. 30, 2004, compared with $3.5 billion in fiscal 2003. The length of the commodity price rally also depends on how quickly farmers here and abroad can increase their production, as they are wont to do.
One glance at these loans, and you will likely suffer severe sticker shock. Suppose you are age 75 and own a $280,000 home in central New Jersey. According to the calculator, you would be eligible to borrow $198,800 using a HECM loan. But after deducting $19,617 in closing costs and a set-aside for service fees, the cash available shrinks to $179,183. With a HECM loan, you can take this cash as a lump sum, a line of credit or monthly income, or some combination thereof. Currently, there are five varieties of reverse mortgage on offer. The two types of HECM loans, which differ in the way they calculate their interest rate, are both federally insured. This insurance protects the lender against loss, should the reverse-mortgage balance be greater than the home's value when the homeowner dies or permanently moves out. There are lower closing costs on the three other types of reverse mortgage, Fannie Mae's Home Keeper and Financial Freedom's two Cash Account products. The reason: There's no insurance involved. But because these other loans aren't federally insured, you probably won't be able to borrow as much of your home's value. Financial Freedom's new Zero Point Cash Account is especially intriguing, because it has no origination fee and limits most other closing costs to a maximum $3,500. The Cash Account is only available as a credit line.
The study, "All that Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors," was conducted by two finance professors - Brad M. Barber of the University of California at Davis and Terrance Odean of the University of California at Berkeley. Their working paper is on the Web at papers.ssrn.com/sol3/papers.cfm?abstract-id=460660. Professors Barber and Odean studied the accounts of more than 750,000 individual investors from three brokerage firms from February 1991 through June 1999. The professors used several criteria to identify stocks that grab the attention of individual investors on any given day. They focused on stocks mentioned in articles by the Dow Jones News Service and on stocks with large daily changes in price or jumps in volume, assuming that even when there were no wire service reports about such stocks, individuals still paid particular attention to them. Fundamentally, the researchers found that it didn't matter whether the articles were positive or negative, or whether the stocks' prices went up or down. As long as there were attention-grabbing events of any kind, investors were much more likely to buy these stocks than to sell. This does not mean that stocks in the news always rise. Stocks that attract attention because of bad news still tend to decline, in large part because of selling by professionals who manage large portfolios. But the net purchases by individual investors tend to mitigate the price decline of stocks that have had negative news and to exaggerate the increases of those with positive news. Attention-grabbing news is a much bigger factor in individual investors' decisions to buy stocks than in their decisions to sell, the study found. That is because of the different challenges these investors face when buying and selling, the professors said. When buying, individuals gravitate toward stocks in the news because they find it overwhelming to give serious and equal consideration to each of the thousands of stocks on the market. In contrast, when selling, individuals need to focus only on the relatively small number of stocks that they already own. In winnowing stocks, they therefore have less need for shortcuts. This implies that attention-grabbing stocks tend to be overvalued as a simple matter of supply and demand, the professors said. Depending on the criterion used, the performance of attention-grabbing stocks bought by individual investors lagged behind the stocks they sold by as much as 0.7%, on average, over the next month. That is equivalent to 8% on an annual basis. The study, however, did not address long-term effects on prices. From: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors Brad Barber & Terrance Odean - October 2003 From the Introduction Which attention-grabbing stocks investors buy will depend upon their personal preferences. Contrarian investors, for example, will tend to buy out-of-favor stocks that catch their eye, while momentum investors will chase recent performers. In theory, investors face the same search problem when selling as when buying. In practice, two factors mitigate the search problem for individual investors when they want to sell. First, most individual investors hold relatively few common stocks in their portfolio. [On average during our sample period, the mean household in our large discount brokerage dataset held 4.3 stocks worth $47,334; the median household held 2.61 stocks worth $16,210.] Second, most individual investors only sell stocks that they already own, that is, they don't sell short. Thus, investors can, one by one, consider the merits - both economic and emotional - of selling each stock they own. Rational investors are likely to sell their past losers, thereby postponing taxes; behaviorally motivated investors are likely to sell past winners, thereby postponing the regret associated with realizing a loss (see Hersh Shefrin, & Meir Statman, 'The disposition to sell winners too early and ride losers too long: Theory and evidence' - 1985). Thus, to a large extent, individual investors are concerned about the future returns of the stocks they buy but the past returns of the stocks they sell. Our argument that attention is a major factor determining the stocks individual investors buy, but not those they sell, does not apply with equal force to institutional investors. There are two reasons for this: 1) Unlike individual investors, institutions do often face a significant search problem when selling. Institutions also face many choices when purchasing, but, unlike individuals, they also face many choices when selling. Institutional investors, such as hedge funds, routinely sell short. For these investors, the search set for purchases and sales is identical. Even institutions that do not sell short face far more choices when selling than do most individuals, simply because they own much larger portfolios than do most individuals. 2) Attention is not as scarce a resource for institutional investors as it is for individuals. Institutional investors devote more time to searching for stocks to buy and sell than do most individuals. Prior Research It is well-documented that volume increases on days with information releases or large price moves (Bamber, Barron, and Stober (1997); Karpoff (1987)). For example, when Maria Bartiromo mentions a stock during the Midday Call on CNBC, volume in the stock increases nearly fivefold (on average) in the minutes following the mention [Jeff Busse & Clifton Green 'Market Efficiency in Real Time' 2002]. Yet, for every buyer there is a seller. In general, these studies to not investigate who is buying and who is selling - the focus of our analysis. One exception is Lee [Charles Lee 'Earnings news and small traders' 1992] He examines trading activity around earnings announcements for 230 stocks over a one-year period. He finds that individual investors - those who place market orders of less than $10,000 - are net buyers subsequent to both positive and negative earnings surprises. Hirshleifer, Myers, Myers, and Teoh [David Hirshleifer, James Myers, Linda Myers, & Siew Hong Teoh 'Do Individual investors drive post-earnings announcement drift? 2002'] also document that individual investors are net buyers following both positive and negative earnings surprises. Lee (1992) conjectures that news may attract investors' attention or, alternatively, that retail brokers - who tend to make more buy than sell recommendations - may routinely contact their clients around the time of earnings announcements. Odean ['Do investors trade too much?' 1999] observes that investors buy stocks that have experienced greater absolute price changes over the previous two years than the stocks they sell. Merton [Robert Merton, 'A simple model of capital market equilibrium with incomplete information' 1987] notes that individual investors tend to hold only a few different common stocks in their portfolios. He points out that gathering information on stocks requires resources and suggests that investors conserve these resources by actively following only a few stocks. If investors behave this way, they will buy and sell only those stocks that they actively follow. They will not impulsively buy stocks that they do not follow simply because those stocks happen to catch their attention. Thus their purchases will not be biased toward attention-grabbing stocks. Odean ['Are investors reluctant to realize their losses?' 1999] reports that investors are more likely to purchase additional shares of stocks they already own if the share price is below, rather than above, their original purchase price. As predicted by Prospect Theory (Kahneman and Tversky, 1979), investors assume more risk when in the domain of losses than when in the domain of gains. The Data Investors at the large discount brokerage make nearly twice as many purchases as sales of stocks experiencing unusually high trading volume. A stock that soars or dives catches peoples' attention. Attention driven investors tend to be net buyers of both the previous day's big winners and big losers. Investors at the large discount brokerage firm are nearly twice as likely to buy as to sell a stock with an extremely poor performance (in the lowest 5%) the previous day. Attention driven investors tend to be net buyers of companies on days that those companies are in the news. This is true for both good news and bad news. Conclusions Consistent with our predictions, we find that individual investors display attention-based buying behavior. They are net buyers on high volume days, net buyers following both extremely negative and extremely positive one-day returns, and net buyers when stocks are in the news. Attention-based buying is similar for large capitalization stocks and for small stocks. The institutional investors in our sample - especially the value strategy investors - do not display attention-based buying. Institutional investors are more likely to be net buyers on days with low abnormal trading volume than on those with high abnormal trading volume. Our theoretical model predicts that when investors are most influenced by attention, the stocks they buy will subsequently underperform those they sell. We find strong empirical support for this prediction. Not only does attention-based buying not benefit investors, but it appears to also influence subsequent stock returns. Related: Are Small Investors Naive? Ulrike Malmendier & Devin Shanthikumar Sept 2003 From the Introduction Security analysts provide investors with information about investment opportunities by issuing buy and sell recommendations. The recommendations are likely to be biased upwards, in particular if an analyst is affiliated with an investment bank that is a recent underwriter of the recommended firm. [A rational investor should react less to recommendations from analysts who are affiliated and more to recommendations of unaffiliated analysts.] Using trading data from the New York Stock Exchange Trades and Quotations (TAQ) database (1993-2002), we find distinctly different trade reactions to recommendations among large and among small investors. Large investors react positively to buy and strong-buy recommendations of unaffiliated analysts, but do not display any abnormal trading behavior after positive recommendations issued by affiliated analysts. Small traders also react positively to buy and strong-buy recommendations of unaffiliated analysts - but they are equally, if not more, enthusiastic about stocks recommended by affiliated analysts. Since stocks recommended by affiliated analysts perform significantly worse than those recommended by unaffiliated analysts, small traders suffer losses due to their naivet‚. Increased competition among analysts does not remedy the informational distortion and adverse welfare effects. The only event that triggered a reduction in small investors' response to affiliated analysts during our sample period appears to be the analyst scandals of 2001 and 2002. After the intense media coverage of distorted recommendations and the various lawsuits, small investors appear to react less strongly to affiliated analysts. Prior Research This paper builds upon the evidence in Hsiou-wei Lin & and Maureen McNichols ['Underwriting Relationships, Analysts' Earnings Forecasts and Investment Recommendations - 1998] and Roni Michaely & Kent L. Womack ['Conflict of Interest and the Credibility of Underwriter Analyst Recommendations - 1999] that stock recommendations by affiliated analysts are more favorable but perform more poorly over short (3-day) and long (up to 2-year) horizons. Sergey Iskoz ['Relative Performance and Institutional Reaction to Underwriter Analyst Recommendations' 2002] confirms these results for strong buy recommendations and provides evidence that institutional investors may be accounting for the distortions of affiliated analysts, as far as one can deduce from the quarterly changes in institutional ownership. Related: Small and Large Trades Around Earnings Announcements: Does Trading Behavior Explain Post-Earnings-Announcement Drift? Devin Shanthikumar Oct 2002 From the Introduction Small traders exert buy pressure after an earnings announcement, whether that announcement is good or bad news, but they buy more strongly for a positive earnings surprise than for a negative one. Regarding the initial strength of their reaction to the type of surprise, results are mixed. When earnings surprises are based on a seasonal random walk model, small traders react slightly more weakly than large traders to the first surprise in a series of similar surprises but more strongly than large traders to the later surprises. When earnings surprises are based on analyst forecasts, small traders react more weakly to the surprises than large traders. When examining the relationship between trading and returns, results show that the strength of the small trade reaction is a weak negative predictor of post-earnings-announcement drift after the first month following the earnings announcement. Large trade reaction is generally a negative predictor of future drift, suggesting that while small traders may be underreacting relative to large traders, large traders themselves are underreacting. On the date of an earnings surprise, stock price moves dramatically. If an announcement is a positive surprise, price moves up and if it is a negative surprise price moves down. The post-earnings-announcement drift anomaly is the phenomenon where price continues to move in the same direction for the next three to six months. Prior Research There are many theories about the cause of post-earnings-announcement drift, and virtually all of the theories involve investors underreacting or overreacting to the announcement. Nicholas Barberis, Andrei Shleifer & Robert W. Vishny ['A Model of Investor Sentiment' 1998] model predicts initial investor underreaction and eventual overreaction. Kent Daniel, David Hirshleifer & Avanidhar Subrahmanyam ['Investor Psychology and Security Market Under- and Over-reactions' 1998] predict initial overreaction, which increases over time. Shanthikumar ['Small Trader Reactions to Consecutive Earnings Surprises' 2003] shows that small traders do display increasing reactions in their trading behavior. A key prediction of the Daniel, Hirshleifer and Subrahmanyam and Barberis, Shleifer and Vishny models is that investors will react differently to different surprises in a series. For example, investors will react differently to the third negative surprise in a row than they will to the first negative surprise. Shanthikumar (2003) provides evidence that small traders exhibit this behavior in the market. Because of this, we might see overreaction when we pool all earnings surprises together, when in fact investors underreact to the first surprise in a series and only overreact to the later ones. The Data We find that small traders buy after a negative surprise, but buy more after a positive surprise. They also buy more than large traders around all types of earnings surprises. This evidence suggests that investor reaction to the actual earnings surprise is being mixed with an attention effect [Barber & Odean 2002]. We find that large traders consistently react more strongly than small traders to the analyst-based measure of surprise. Related: Small Trader Reactions to Consecutive Earnings Surprises Devin Shanthikumar Oct 2002 From the Introduction We compiled measures of buying and selling behavior from NYSE Trades and Quotations data for over 2,700 firms for the ten years from 1993 through 2002, for several different trade-size categories. This dataset contains information from every classifiable trade that occurs on the NYSE during our sample period, encompassing over 640 million trades over the span of 10 years, and covering over 2,700 stocks. Results show that small traders exhibit an increasing reaction as a series of similar earnings surprises continues. Small traders react significantly more strongly to the second surprise than to the first, and significantly more strongly to the third than to the second. Furthermore, post-earnings-announcement drift appears to be weaker as the series [of earning surprises] continues, making the stronger reactions less profitable. Large traders have about the same reaction to each surprise. Additional analyses of several trade-size groups shows that there is no absolute cutoff between the two types of trading behavior, but rather there is a continuous gradation. Related: Do Individual Investors Drive Post-Earnings Announcement Drift? David Hirshleifer, James N. Myers, Linda A. Myers, Siew Hong Teoh March 2003 Prior Research Bernard and Thomas [V.L. Bernard and J.K. Thomas. 'Post-earnings-announcement drift: Delayed price response or risk premium?' 1989] suggest that Post-Earnings Announcement Drift [PEAD] is due to investors naively forecasting earnings. Furthermore, recent studies suggest that PEAD may result from the trading activity of individual investors. These studies are motivated by a literature that argues that individual investors are less sophisticated than institutional investors, and that the trading of individual investors is the sources of market inefficiencies (e.g., Hand [J.R. Hand, 'A test of the extended functional fixation hypothesis' 1990]; Lee et al. 1991; Grinblatt and Keloharju [M. Grinblatt & M. Keloharju. 'The investment behavior and performance of various investor types: A study of FinlandĚs unique data set' 2000]. One such study, Bartov et al. [E. Bartov, I. Krinsky, & S. Radhakrishnan, 'Investor sophistication and patterns in stock returns after earnings announcements' 2000], finds that PEAD is strongest in firms with low institutional shareholdings. Furthermore, Bhattacharya [N. Bhattacharya, 'Investors' trade size and trading responses around earnings announcements: An empirical investigation' 2001] provides evidence that the volume of small trades but not large trades is associated with the magnitude of random walk earnings surprises, suggesting that investors who make small trades may underlie the PEAD phenomenon. Lee assumes that it is individual investors who are making these small trades and he suggests that his findings are consistent with earnings announcements drawing the attention of individual investors to the stock. Our study differs from LeeĚs in that we (1) examine only extreme earnings surprises (which are the source of the drift), (2) directly identify individual traders rather than use the size of the trade as a proxy for whether the trader is an individual or an institution, and (3) directly identify the direction of the trade (i.e., whether the trade is a buy or sell) rather than use the price relative to the bid-ask spread as a proxy for whether the trade was initiated by a buyer or seller. If PEAD represents mispricing, then sophisticated investors can exploit this pattern. Specifically, when there is a positive earnings surprise, investors should buy shares a few days prior to each of the next three quarterly earnings announcements and partly unwind these positions in the days after these announcements. When there is a negative earnings surprise, they should do the reverse. The Data The data used in this study comes from a large discount broker. It includes trades made by 78,000 households, using that broker. The broker made 3,075,797 trades on behalf of these households between January 1991 and December 1996 inclusive. 1,969,747 of these trades involve common stock, while the remainder involves mutual fund shares, bonds, and other securities. We classify the households as actively-trading investors (6,000 households), high-capital investors (12,000 households), and general investors (60,000 households). Any investor that conducts more than 48 trades in a year is classified as actively-trading; investors that are not classified as actively-trading and that have more than $100,000 of invested wealth at any time are classified as high-capital investors; and all remaining investors are classified as general investors. Our final sample consists of 941,210 trades made in the 13 months following 65,703 earnings announcements. 54% of these trades are buys, with a mean number of shares purchased of 512 [and average dollar amount of $4,425 in 1991 and rising to $6,768 in 1996], and 46% of these trades are sells, with a mean number of shares sold of 594. 12 Although 76.9% of the investors are classified as general investors, these investors make only 40% of the trades, and the 15.4% of the sample that is classified as high-capital investors make only 11.4% of the trades. The remaining 48.6 percent of the trades are made by the 7.7% of the sample that is classified as actively-trading investors. While the median individual trades 4 times per year for a total of approximately $21,000, the median actively-trading investor trades 22 times a year for approximately $158,000. Actively-trading investors trade, on average, 6 times as often and 10 times as much (in dollar value) as general investors, and more than 4 times as often and more than 5 times as much (in dollar value) as high-capital investors. Even if individual investors as an aggregate do not drive drift, there could be important trading effects concentrated in particular classes of investors. The activities of na‹ve individual investors could be masked in the aggregate by arbitrage on the part of more sophisticated individual investors trading to profit from PEAD. Contrary to our expectations, we find no evidence that the general investors drive PEAD. While high-capital investors are net sellers following good news (an earnings-contrarian behavior), these results are insignificant. Finally, trading by actively-trading investors strongly supports an earning attention effect, but these investors do not appear either to cause or to take advantage of PEAD. Abnormal trading is stronger for negative earnings surprises than for positive earnings surprises. [ I show the raw data in a table below - and the 'net' trading is stronger for negative news - BUT the absolute trading level is significantly stronger - more than twice as strong - after positive news, if I am not misreading the data.] In the first 17 trading days after an extreme earnings surprise, net buying is fairly similar regardless of whether the surprise is good news or bad news, but starting on day +18, net buying after bad news significantly exceeds net buying after good news.
Our results indicate that individual investors do not cause post earnings announcement drift. We bring three kinds of evidence to bear on this issue. First, we test whether individuals trade in a contrarian fashion in response to extreme earnings surprises. If individual trading caused PEAD, investors would be net purchasers after good news and net sellers after bad news. This would reduce the amount by which prices react to earnings news, resulting in underreaction. In fact, in our sample individuals are significant net purchasers after both good and bad news, and this conclusion holds in different investor categories that differ in sophistication. Second, we test whether net purchases made by individual investors can subsume the ability of the extreme earnings surprise to predict subsequent abnormal stock returns. We examine the relation between ranked net purchases immediately following extreme earnings surprises and subsequent abnormal stock market returns and find that, on average, the stocks that individuals net sell following extreme earnings announcements outperform the stock that individuals net purchase following extreme earnings announcements. Although this effect is potentially consistent with individual trades pushing share prices away from fundamental values, it is statistically unrelated to PEAD. In fact, we find that controlling for RANK NET PURCHASES does not diminish at all the ability of extreme earnings surprise to predict subsequent returns. Third, we measure the extent to which, conditional on an earnings surprise at a given date, individual investors make abnormal trades in the days just prior to or after subsequent quarterly earnings announcements. Our findings are not consistent with the trading pattern predicted by the hypothesis that individual investor trading causes the concentration of PEAD at the three subsequent earnings announcement dates.
So what does he do with his own money? Much of it is sitting in humdrum mutual funds at Vanguard and American Funds. "The trick with investing is to stop dating and start marrying," Mr. Ellis contends. "Individual portfolio managers come and go. None of the stocks that they're interested in today will matter in the long term. The only thing that will endure is the values and the culture of the organization." On that score, Mr. Ellis reckons Capital Research [the manager of American Funds] and Vanguard are winners. "Many of us are driven emotionally to find the winner," Mr. Ellis says. "But most of the successes of investing are successes of not losing." What does he mean by that? To win on Wall Street, you need to avoid mistakes that could torpedo your long-run returns, like betting everything on a few stocks, saving too little, paying too much in investment costs and dumping your stock funds when the market goes down. "People changing their minds is what really ruins returns," Mr. Ellis says. "If you're not willing to hold on for 10 years, you shouldn't start."
Some economists cautioned that hiring by restaurants has not always been a precursor to a brighter job market. In several economic recoveries before the 1990s, the overall job market improved before restaurant hiring resumed. The current wave of restaurant hiring could also lose steam, economists said, if business activity does not continue to build. The restaurant business, which has about $420 billion in annual sales in the United States, accounts for just 6.6% of economic activity and has 11.7 million workers, according to the National Restaurant Association. These businesses not only want to attract workers but to stem the high turnover endemic in the industry. At restaurants where the average check is less than $25, there is about a 65% turnover rate among hourly employees, according to the National Restaurant Association.
What about the idea that the Santa Claus Rally happens just before and just after New Year's? The most specific definition in this regard that I have seen is from Jeffrey Hirsch, editor of the Stock Trader's Almanac Investor newsletter. In the December issue of this newsletter, he advises subscribers to "watch for the Santa Claus Rally the last five trading days of the year and the first two of the New Year." This period does indeed have a positive seasonal tendency, but be aware that it is part of a much broader seasonal tendency that often is referred to as the Seasonality Timing System. Introduced in the newsletter world in 1974 by Norman Fosback, this system is based in large part on the long-noted positive bias of the market around the turns of every month. The Seasonality Timing System is one of the best-performing market timing systems. Yet I didn't notice anyone referring to a "Thanksgiving Rally" at the end of November, or a "Halloween Rally" at the end of October. There is another way in which those pundits give meaning to the Santa Claus Rally: It supposedly would be a bearish omen if it were not to come to pass.This thought is often memorialized in the phrase, "If Santa Claus Should Fail to Call, Bears May Come to Broad & Wall." I took a look at how the stock market on average performed over the subsequent 11 months every time the Dow declined during December. I then compared this average to the market's performance following positive Decembers, as well as to similar statistics for every other month. It turns out that a declining December does not stand out as having particular significance. There are six other months that have better records than December at signaling a bearish market when they decline. Two of those other months are April and May. Which makes me wonder: Come next Spring, will we be hearing the phrase "If the Easter Bunny Should Fail to Call, Bears May Come to Broad & Wall?" I'm not holding my breath.
Small stocks deserve mention for an especially strong showing. The Morningstar numbers as of the end of last week: Small growth funds, up 41.3%; small blend funds, up 38.7%, and small value funds, up 37.3%. Emerging markets bond funds, the dark-horse surprise of the early 2000s, are up 27.8% this year to stretch their annualized three-year gain to 18.2%. Junk bond funds are up 22.5% this year and 8% a year over the past three years.
Oelschlager is, and has long been, far more optimistic than many of his money manager peers. What's different today from nine months ago is that more people may be willing to concede that an unabashedly bullish view no longer seems completely outrageous. Since the bursting of the "new economy" bubble in 2000, the conventional wisdom has been that America was in for an extended period of pain as the excesses of the late 1990s were wrung out of the system. That sentiment was deepened by the corporate scandals that began with Enron's demise in late 2001, and by the worst bear market in stocks since at least the mid-1970s. But since March, the performances of the economy and the equity market have demanded a rethinking of the idea that this entire decade is destined to be largely a bust. "They're all saying it can't be a secular bull market," says Robert Morris, chief investment officer at money management firm Lord Abbett, referring to many of his peers on Wall Street. "Well, I don't believe that. This market keeps confirming that it is a bull market." Jeremy Siegel, professor of finance at the University of Pennsylvania's Wharton School, says he believes the stock market is capable of producing average returns of 7% to 9% a year over this decade. Rising 7% a year, the S&P 500 wouldn't return to its 2000 record high for at least five years. But what does that matter, Siegel asks. Investors should be less concerned about what they lost than about earning decent returns going forward, he said. Edward Yardeni, chief investment strategist at Prudential, says the corporate earnings trend so far this decade "nearly matches the 1991 through 1994 profile." The Federal Reserve is holding interest rates near 50-year lows, which has slashed many companies' borrowing costs. The weak dollar also is helping the bottom line of U.S. firms as foreign sales translate into more dollars. And business earnings have primarily benefited from the sharp staff cutbacks many companies made in recent years and by their continued caution about hiring more workers. The tremendous recent gains in productivity are flowing directly to the bottom line. For those who are downbeat on the economy, one of the main arguments is that consumer spending eventually will peter out because of subdued job growth. And because consumer spending accounts for two-thirds of the economy, growth overall will be disappointing longer term, some say. For optimists like Jim Oelschlager, however, that view underestimates the American economy's demonstrated ability to reinvent itself, overcome obstacles and prosper. Investors who underestimated the economy at the start of the last two decades may have paid dearly, he notes.
Increased factory output - the ISM production index rose 5.7 points to 68.3 - wasn't enough to satisfy increased demand, resulting in a rise in the order backlog index to a 20-month high of 59. When asked if customers have sufficient inventories at this time, purchasing managers answered with a resounding 'no' and an index reading of 39.5. The ISM Index reaches the rarified atmosphere north of 60 only infrequently. When it does, `it usually coincides with multiple quarters of growth in the 7, 8 or 9 percent range,' said Henry Willmore, chief U.S. economist at Barclays Capital Group. That was true in 1961-1962, in 1964-1965, in 1972, and in 1983-1984. An ISM above 60 coincides with hefty payroll gains as well, according to Bob Barbera, chief economist at ITG/Hoenig in Rye Brook, New York. In the 12 instances the ISM index has been above 60 in the past 23 years, the average gain in non-farm payrolls that month was 375,000, Barbera said. The smallest increase was 231,000, excluding an August 1983 decline that was strike-related. The strength in manufacturing isn't confined to the U.S. The Global Manufacturing PMI, a composite index produced by JPMorgan and NTC Research in association with ISM and the International Federation of Purchasing and Materials Management, rose 2.3 points to 56.8 last month, just shy of the five-year-old series' high in Q4-99. `November smashed survey records for output and new orders dating back to January 1998,' said David Hensley, director of global economics coordination at JPMorgan. `Booming growth in output and orders is spurring firms to boost hiring and replenish inventories.' While the U.S. strength eclipsed that of the other major economies, November saw 17 of the 19 countries tracked by the JPMorgan PMI register above-50 readings. The boom-like economic data have started to distract the bond market from Federal Reserve officials' frequent refrain that rates will remain low for a long time. Short-term rates and interest-rate futures contracts have begun to challenge the Fed's outlook. `I don't understand why we are debating a change in the Fed's language rather than a change in official rates,' said Joe Carson, head of global economic research at Alliance Capital Management. `The Fed's stance is no longer credible.' Service Sector Stats WSJ 12-02 The Institute for Supply Management reported its nonmanufacturing index slipped to 60.1 last month from 64.7 in October. The employment component of the ISM index, on the rise for a second straight month, hit its highest level since March 2000. Prices paid increased for a sixth straight month. And inventories rose for the first time in five months. The backlog of orders, as well as new orders, declined. Unit labor costs fell 5.8%, the biggest decline in 20 years. Adjusted for inflation, workers' average hourly compensation rose 0.7%, down from a 3% increase in the second quarter. And One More Statistical Inconsistency Gene Epstein, Barrons 12-08 The only dark spot [in the employment report] was the tepid increase in average hourly earnings, which have risen an annualized 1.4% over the past six months. But that earnings estimate is limited to nonsupervisory workers in the private sector, about two-thirds of the total. Real disposable income for all households, by contrast, showed a six-month annual increase of 4.1%, at least through October, the most recent month available. Related articles: November Manufacturing Update - Timothy Aeppel, WSJ, Boosting Worker Output - Jon Hilsenrath, WSJ, Productivity vs Job Growth - Alan Krueger, NY Times and to see how quickly things change - see: August Employment Report - Caroline Baum, Bloomberg
The first such move came in July 1983. The stock market had hit bottom the previous August in the midst of a severe recession. Nearly all stocks rose in the 1982-83 market, but the biggest move came in small technology stocks. That boom topped out in the summer of 1983. Many speculative favorites in small cap tech vanished within a few years. But even high-quality companies lost market favor. Seven years later, Intel was worth less than its 1983 peak. The next one came in September 1987, a year after the stock market had accelerated after an economic slowdown during which businesses sharply cut investment, although a recession was averted because consumers kept spending. In 1987, stocks hit their highs in August, fell a bit in September and then crashed in October. That crash proved to have little effect on the economy, and most share prices came back within a couple of years. But the trauma at the time was intense. There are similarities to those markets now, although the strongest ones are to the period leading up to the 1987 manufacturing spurt. In the mid-1980's, American manufacturing was badly hurt by a soaring dollar that reflected foreign capital flows to the United States. Much the same thing happened in 1999 and 2000, although the attraction for capital had changed from high interest rates in the 1980's to a soaring stock market in 2000. By the time manufacturing began to show strength, the dollar had been sliding for more than two years in each instance. There are differences, of course. The dollar had fallen farther from its high in 1987 than it has now. Share prices were at record highs in 1983 and 1987, while most large stocks now remain well below their bubblicious peaks. But the lesson of history remains. The best time to buy stocks [has been] before, not after, it becomes clear that the manufacturing sector is recovering.
The biggest of all the domestic stock indexes is the Wilshire 5,000, created by Wilshire Associates in 1980. When it was created, it captured the total market value of the 5,000 largest publicly traded domestic companies. Today, it contains more stocks and reflects total domestic market capitalization of about $10.1 trillion - but it's still called the Wilshire 5,000. The next broad index is the Russell 3,000. Created by the Russell Co. in 1978, the Russell 3,000 is a list of the 3,000 largest domestic stocks. Although the number of stocks in the index is about half the size of the Wilshire 5,000, it captures 98% of all domestic equity capitalization. The 3,000, in turn, are divided into the Russell 1,000 and Russell 2,000 indexes. The Russell 1,000 represents the 1,000 largest domestic stocks. It accounts for about 92% of all domestic market value. The Russell 2,000 index, which is generally used as a proxy for small-cap stocks, accounts for about 6% of all domestic stocks. The Russell indexes are subdivided into growth and value subsets. The S&P's 500 index accounts for about 79% of all domestic equity value. As with all these indexes, the S&P 500 is market-capitalization-weighted - the greater the total value of a stock, the greater its weight in the index. The most common criticism from investment professionals is that such indexes aren't true portfolios, because they are highly concentrated. The S&P's 100 index represent about 57% of all market capitalization in the United States. The best way to be an index investor is to find a broad, low-turnover index that faithfully represents the performance of the U.S. stock market. In the year ending March 31, for instance, the S&P 500 and the Russell 3,000 had portfolio turnover rates of 5% - but the Russell 2,000 Growth index had a turnover rate of 41%. Long term, turnover loses tax efficiency and raises costs.
Now, investment strategist Kenneth Safian says he has found evidence that small enterprises really are playing an important role in the recovery. The evidence is buried in the government's monthly personal-income report, which was released last week. Proprietors' income, which is the income earned by individuals from running their own businesses and from partnerships, is surging. The Commerce Department reported Wednesday that proprietor's income, excluding the farm sector, was up 8.6% from a year earlier. By contrast, the wages and salaries of individuals on corporate payrolls were up just 2.3%. Mr. Safian, who is president of Safian Investment Research., says the upshot of the latest trend is that more workers are striking out on their own and earning money doing it. The economy, he says, "is becoming more entrepreneurial." If that is the case, it would say a lot about the dynamism of an economy that has been through series of shocks in the past three years. It might also help explain why official payroll employment levels have been so depressed in recent months. If more people are striking out on their own, then their job status in some cases wouldn't show up in the government's measure of employment levels at established businesses, which is down 2.4 million since the recession started in March 2001. Unfortunately, there are no official statistics for business formations across the $10 trillion economy. And there are other explanations for the recent pop in proprietor's income. It might mean that existing small companies are simply enjoying an upturn in profits, just as larger corporations are. Nationwide, corporate profits were up 30% from a year earlier in Q3. It might also be related to corporate outsourcing - more workers losing their jobs on corporate payrolls and then being hired back as independent, self-employed consultants, responsible for their own health benefits. Such a trend would shift their income from wages and salaries to proprietorship. The personal-income report Wednesday showed that overall incomes were up 0.4% in October from the month before. Proprietor's income rose by 0.4% from September, while wages and salaries rose 0.2% from the month before. It was the 13th time in the past 14 months that proprietor's income has outpaced growth in wages and salaries. This type of trend has occurred in previous recoveries. In 1992, for instance, nonfarm proprietor's income grew by more than 12% from a year earlier, and in 1984 it leapt by more than 20%. Other glimmers of a pickup in new business formations lend some credence to Mr. Safian's suspicion. For example, the state of Delaware, a center for business incorporations, has seen a sharp pickup in business formations, notes Mark Zandi, chief economist with Economy.com. In the fiscal year ended June 30, the state experienced a 14% increase in the fees it collects from individuals applying to register limited-liability companies. That trend appears to have accelerated since then, Mr. Zandi adds. Delaware isn't the only state where this is occurring. Michael Bernick, the director of California's Employment Development Department, says. "Our data show that new businesses incorporations are running very high." The number of incorporations held up even during the tech downturn, which hit California especially hard, Mr. Bernick says. In 2003, he added, it accelerated. While business-formation data is spotty, it is clear that individual business owners are seeing strong growth in their own income. Today, proprietor's income is taking on a rising share of total national income. At $822 billion, at an annual rate, it now accounts for more national income than the entire manufacturing sector's wages and salaries. It is just shy of the wages and salaries earned by government workers. Another Explanation Clare Ansberry, WSJ 12-04 During the 20 months after the 1991 recession ended, the government said that the economy generated 303,000 jobs. The number was eventually bumped up to 663,000 because the initial surveys included only established companies. November's employment numbers - which showed a disappointingly small increase - [probably didn't] detect the degree of activity by small businesses. Monthly employment data aren't broken down by size. And job-creation data from smaller firms are available only annually. Self Employed Stats Floyd Norris, NY Times 12-06 The government reported that the number of self-employed workers rose by 156,000 last month, to 9.2 million. That gain was a primary reason that the unemployment rate dropped to 5.9%. [Another] measure of employment is the percentage of people 16 years and older who are working, a statistic based on the household survey. During the boom, that rose to a record 64.8% in April 2000. It fell to a low of 62% in September and has now edged back to 62.4%. The increase of 156,000 self-employed workers means they now account for 6.6 percent of the people in the household survey who say they are working, up from 6.1% when President Bush took office. Related articles: Disappearing Knowledge Workers - Gene Epstein, Barrons, August Employment Report - Caroline Baum, Bloomberg, Underground Economy Skews Unemployment Stats - Daniel Akst, NY Times
A little-used technique until a few years ago, adoptions have picked up speed dramatically in 2003. "This is clearly the most active year for adoptions we've seen, without question," said John Benvenuto, director of research at Financial Research Corp., which tracks industry trends. "We're seeing more and more now, and we should expect to see more in 2004." So far this year, fund firms have announced 24 mutual-fund adoptions, compared with two adoptions in 1999, three in 2000 and six in 2002, according to FRC. Among recent transactions, John Hancock Advisers in August adopted M.S.B. Fund, then a $46 million large-cap fund managed by Shay Assets Management. And last month, Charles Schwab said it had agreed to adopt all 11 U.S. mutual funds operated by money-management firm AXA Rosenberg LLC. Adoptions are one way that smaller players can line up with industry powerhouses. Generally, the adopter takes over distribution and back-office responsibilities in return for some percentage of a fund's investment-management fees. Adopted funds always have strong performance records, which is what makes them adoption candidates in the first place; many have less than $100 million in assets.
Magazine covers. Jurrien Timmer, a senior market analyst at Fidelity Investments in Boston, sees the tide shifting when finance stories appear on the covers of nonfinancial magazines. This, he says, means "a trend is probably about to end." He mentions that Time magazine named Amazon Chief Executive Jeff Bezos as Person of the Year at the end of 1999, just weeks before the Internet bubble burst. Similarly, stories about the bear market earlier this year signaled to him that the market was probably about to turn up. Economist surveys. Mr. Timmer also uses surveys of economists as a contrarian indicator, meaning that he believes the exact opposite of what the survey says. "The majority is always wrong," he explains, "especially when they're economists." Cocktail parties. A similar principle guides the "cocktail party index" used by Washington, D.C., money manager Michael Farr. He tells people at a party that he is a financial professional and watches their reactions. If he is shunned, he knows it's a bear market and probably time to buy more stocks; if people treat him like a celebrity and ask for stock picks, he senses that the market's reaching a peak. So how do people react these days when he tells strangers he works in financial services? "I'm not popular yet," he says, which according to his theory means that stocks still have more room to rise. Box-office receipts. For Jack Caffrey, equity strategist at J.P. Morgan's Private Bank, box-office receipts are an insight into the thinking of the people who really drive the U.S. economy: you and me. If we're feeling anxious, insecure or just strapped for cash, we'll stay home and rent a movie or watch TV. Going out to the movies shows a degree of confidence. Gift-wrap sales. Goldman Sachs analyst Peter Appert has been using gift-wrap sales as an early indicator of Q4 corporate performance for the past 17 years. If people are stocking up on gift wrap, his theory goes, then they will be buying a lot of gifts at the mall and giving retailers a lift. NFIB Convidence Survey. Kathleen Camilli, U.S. economist at Credit Suisse Asset Management, relies on a couple of obscure economic reports to give her an early view of employment and manufacturing trends. Small businesses, for example, play an important role in creating jobs, but are often overlooked by government statistics. So Ms. Camilli watches the often-ignored monthly confidence survey from the National Federation of Independent Business. Unlike the official unemployment figures, this index turned positive in April and has been rising strongly since then. For manufacturing data, she prefers the Philadelphia Federal Reserve survey to the more widely used Institute for Supply Management manufacturing index, because it covers much of the same ground but comes out a couple of weeks earlier. Restaurants and bars. Chris Burdick, a senior market analyst for the Schwab Center for Investment Research in Denver, has his doubts about the avalanche of consumer-confidence surveys. He wants to know what people are doing, not what they're saying. So he keeps an eye on "food services and drinking places" sales, a component buried deep in a monthly retail sales report from the Commerce Department (see last line of each table found at www.census.gov/svsd/www/fullpub.html). "If people are concerned about the future," he says, "they're not going to spend money at eating and drinking establishments." Shipping numbers. Similarly, gross domestic product numbers are widely watched, but these aren't: truck tonnage figures. Donald Broughton, transportation-industry analyst for A.G. Edwards, believes truck tonnage represents economic activity that's not on the GDP radar. He says goods moving around is a basic sign of a healthy economy, and has found truck tonnage to be an efficient predictor of GDP, often two or three quarters ahead. Presidential approval ratings. Don Cassidy, senior research analyst at fund tracker Lipper Inc. in Denver, believes the presidential approval ratings hold a key to the economic outlook. Cassidy believes that the top priorities for most people are economic growth and job security. "And when we don't see those things," he says, "we tend to blame the guy sitting in the chair."
Not surprisingly, new stock sales [supply] fell during the bear market. After peaking at $29 billion in February 2000, stock issues declined drastically. By April of this year, such stock sales totaled $3.62 billion, according to data from Thomson Financial. These totals include IPOs, follow-on issues by existing companies, and sales by big investors such as venture capitalists. In April, in other words, the supply-demand equation was excellent. Demand was rising and new supply was minimal. But new supply picked up almost immediately. In September, as investors returned from vacation, stock issues hit almost $12.8 billion. Perhaps not coincidentally, the stock market sagged in September. Stock issues fell a bit in October (and the stock market rebounded). In addition, notes Leuthold Group, a research group based in Minneapolis, this year has seen a rise in the issuance of convertible bonds [which increase supply]. Many of those will convert into common stock at some point, further increasing supply. In the late 1990s, corporate buybacks and merger activity [which reduce supply] were among the main reasons that overall stock supply remained tame compared with demand. But buyback levels peaked in 2000 and have declined steadily since then. Last year, as stock prices sank, monthly sales by insiders [which increases supply] fell below $1 billion during three separate months, something almost unheard of since 1998. But this year, the insider sales have rebounded with a vengeance. They surpassed $3 billion in three different months. Purchases by insiders, meanwhile, sank last month to their lowest level since 1995. Few analysts are forecasting a sustained stock pullback. They do point out, however, that the supply-demand equation is becoming less favorable, which can be a sign that the stock rally is getting long in the tooth. Just the Facts Using EDGER for Fun & Profit The first step of any investor interested in a company is to read through at least five years of annual financial reports and the quarterly reports from the past year. These forms are available for free online in the EDGAR database on the Security and Exchange Commission's Web site www.sec.gov/. To learn about EDGAR, go to the SEC's "How Do I Use EDGAR?" (www.sec.gov/edgar/quickedgar.htm). This page will get you started. (Marshall Loeb and Brendan January, CBS MarketWatch 12-14) Falling P/E Ratios - It's a Good Thing In the first half of the year, earnings for the companies in the S&P 500 rose at an annual rate of 29%. Since then, the gains accelerated to the point that, including estimates for the current quarter, earnings growth for all of 2003 looks likely to exceed 60%, Ned Davis Research calculates. The rapid earnings growth means P/Es actually have been falling this year. So far this year, the P/E ratio of the S&P 500 has fallen to 27 from 32. (E.S. Browning, WSJ 12-08) It's Game Time Every December, stock prices get yanked around by a couple of year-end rituals, and it's happening right now. Some stocks get buffeted by "tax selling" as investors shed their losers in order to harvest losses to cut next April's tax bill. Others get jolted by game-playing money managers who lock in this year's gains by selling stocks between Thanksgiving and Christmas, fervently hoping that no late-December rally arrives to make them look foolish. (Stacey Bradford, SmartMoney 12-07) The Next Big Thing While the Nasdaq has soared 45% this year, it's not the perennial leaders in these areas that are carrying the market. One stark example: Microsoft is actually down 6% in the past year. Instead, there is a group of hot stocks in newfangled areas, such as Internet phone calling [or VOIP - or 'voice over Internet protocol'] and satellite radio, that are surging. By 2006, more than 50% of all phones used by businesses will use VOIP, experts say. The early leaders in this area include Net2Phone, SpectraLink, Verso Technologies, VocalTec Communications, AudioCodes and Sonus Networks. SpectraLink has more than tripled since April. Sonus is up 600% in the past year. And in the field of satellite radio, shares of XM Satellite Radio Holdings surge to $23.20 from $2.15 in just the past year. Two other hot sectors to watch: mobile-phone sales and online sales of music. (Gregory Zuckerman, WSJ 12-07) Wealthy are Dropping Mutual Funds Wealthy investors were dropping mutual funds in favor of other assets well before a market-timing scandal was unveiled, according to a recent survey. Mutual funds dropped to about 6% of assets as of August, down from 11% in 2001, among investors with at least $5 million in net worth, according to a report from Spectrem Group, a consulting firm. At 6%, mutual funds fell to the second-least-popular asset class among high-net-worth people, beating only stock options and restricted stock, which totaled about 3% of wealthy people's assets in 2003. Asset classes that grew during the same time frame included managed accounts, which rose to 26% from 13%; alternative assets, which grew to 9% from 8%, individual stocks and bonds, which climbed to 31% from 26%, and cash, which jumped to 9% from 3%, according to the survey. (Dow Jones Newswires 12-02) Where to Read The Economic Tea Leaves On-line David Wessel, WSJ 12-04 Brad DeLong at http://econ161.berkeley.edu/movable_type/ a pro-Clinton economic historian at the University of California at Berkeley and an ex at the U.S. Treasury. Stephen Roach: at www.morganstanley.com/GEFdata/digests/latest-digest.html Morgan Stanley economist Tyler Cowen & Alex Tabarrok: at www.marginalrevolution.com conservative economics professors at Virginia's George Mason University John Makin at www.aei.org/publications/contentID.2003013109411113/default.asp conservative American Enterprise Institute economist Paul Kasriel at www.northerntrust.com/library/econ_research/weekly/us/ Chicago's Northern Trust economist George Magnus at www.ubs.com/e/about/research/ubs_ib.html UBS economist Quick Facts, Stats & Opinions The current bull market is justified. However, equity prices have come very far in a short span of time, and it is now our feeling that the stock market's current elevated level discounts most of the profit gains that we forecast in 2004. (Selection & Opinion - Value Line Investment Survey via Washington Post 12-28) We think U.S. and foreign equities will do well [in 2004] while high-grade bonds won't. We expect sector performance to shift piece-by-piece toward inflation beneficiaries, reversing the piece-by-piece deflation response of equities in 2000-2002. We think the Fed will be forced to raise the Fed funds rate to 2.5% or more in 2004 to stop dollar weakness and the increasing financial distortions from 1 percent interest rates. Rather than slowing the economy, the first 1% to 1.5% increase in the Fed funds rate will act as an accelerant - "get it while you can" - encouraging corporate borrowing and inventory rebuilding. Higher interest rates will be a net positive for the household sector since it is a net creditor (interest-bearing assets exceed total liabilities). (David Malpass, Global Commentary, Bear Stearns via Washington Post 12-28) As we move through the second stage of the recovery, we believe equities should remain the best-performing global asset class. Bond yields have to rise; yet history suggests that this should leave P/E ratios treading water rather than falling. This leaves equity upside in the hands of earnings growth, and with a global estimate of 10% to 15% for 2004 increasingly driven by non-U.S. markets, this also sets our return assumptions. (Matthew Merritt, Global Portfolio Strategist @ Smith Barney via Washington Post 12-28) India is emerging as a great economic power - at last. Which country has the world's second biggest middle class? India. Among its 1 billion consumers, anywhere from 150 million to 300 million are certifiably middle class and can afford a simple car or motorbike, electric appliances, perhaps a home. India, while still socialist, is moving closer to the middle of the road. It also has been building a famously first-class education system. Now Indian workers are taking more and more jobs from America. (Marshall Loeb, CBS.MarketWatch 12-26) Here is a reason to think next year could be another good one: Junk, or "high yield," bonds are on a tear, with returns of a whopping 27% so far this year, the best annual performance since 1991. Behind the gains are expectations that flimsy companies will be able to make their debt payments next year, and that corporate spending will keep rising. Bank of America predicts just 4% of these companies will default next year, down from 5% last month and double-digit rates in recent years. "The strength in high-yield is one more reason to think capital spending and employment will improve next year," says John Lonski of Moody's. (Gregory Zuckerman, WSJ 12-23) My early warning trend models for the DJIA, the NASDAQ Composite and the S&P 500 are weak. . . . A harsh correction (not a bear market!) should last several months. The bull market will extend well beyond the current correction. Market timing is critically important! (Robert S. Morrow, High Tech Growth Forecaster via Washington Post 12-21) With the S&P 500 Index of large stocks and the Wilshire 5000 Index of all stocks roughly 30 percent below the all-time highs reached in March 2000, you could argue there is ground to make up. The big problem with this reasoning is the capitalization-weighted nature of the S&P 500 and the Wilshire 5000, since the March 2000 highs reflected absurd valuations for large technology stocks. As the . . . Value Line Arithmetic Average shows, the typical stock is trading at all-time highs. (Dow Theory Forecasts via Washington Post 12-21) Right now there are two major camps of thought on the market. The first is that times are far more dire than we'd like to believe. The second is that the economy is getting better, and so are the markets. Put me in the second camp. That's why I continue to lay it on the line and encourage you to buy more, not fewer, stocks. In addition, while nearly every other newsletter . . . is cautioning doom and peddling gold and other proven long-haul losers, I'm here to tell you that those are the last things your nest egg needs to make it in the years to come. (Neil George, Personal Finance via Washington Post 12-21) Lighter December volume around the holidays can lead to abnormal market fluctuations. Pullbacks in the market can be an opportunity to increase equity allocations. (Jim Collins, OTC Insight via Washington Post 12-21) The change in the dollar against the euro is either a 47% gain in the euro or a 32% decline in the dollar since July 2001 when the rate was about 0.84 euro to the dollar. (Stephen Dunphy, Seattle Times 12-14) It does strike us . . . that playing some more aggressive offense makes sense. Market pundits have observed that 'lower-quality stocks' have been the leaders. The bottom 25% market performers of the S&P 500 and Russell 2000 in 2002 are up 66% and 121% this year, respectively. We see what's really going on is that small- and mid-cap stocks are in a bull market, and the combination of fundamentals, attractive valuation and increased attention will continue to lead to out-performance. It's the perfect environment for hitching our wagons to the stars of tomorrow, today. (Michael T. Moe, ThinkThoughts via Washington Post 12-14) Our conclusion . . . is that at current prices our particular insurance investments [Berkshire Hathaway (BRK), Odyssey Re (ORH) and White Mountains Insurance Group (WTM)] offer better return prospects than the S&P 500 and are less risky. The main drawback we see is that since the best insurance companies are the ones that are most opportunistic both in the insurance markets and in the securities markets, returns will be lumpy in the short term (a couple of years). Higher lumpy returns are better than lower smooth ones any day. (Samuel A. Mitchell and partners via Washington Post 12-14) Money manager William Miller, whose Legg Mason Value Trust stock mutual fund is set to outpace the S&P 500 for a 13th straight year, said 2004 returns on U.S. stocks may approach this year's levels. Corporate profits will continue to rise next year, lifting the market higher, Miller said. The rally will, in turn, lure more money into stocks. (Bloomberg 12-11) The Lipper Management Company Index of publicly traded money managers averaged a 13.3% gain over the past five years, compared with 3.2% for the average U.S. stock fund. (Ian McDonald, WSJ 12-09) The way we see it, commodities are in a long-term secular cycle that started almost two years ago and should last at least a decade. Furthermore, since the global economy is still trying to get its bearings in a post-bubble era, real assets should perform extremely well. Short-term profit-taking and volatility notwithstanding, commodities should reward the patient investors handily. . . . In China, for example, car sales rose by 56 percent last year and are expected to grow by a million vehicles per year. It's not hard to project the implications this intensity of demand will have on oil prices. (Elliott Gue and Yiannis Mostrous, Personal Finance via Washing Post 12-07) The long-term unemployed [those seeking jobs for six months or more] grew to 23.7% of all the unemployed in Novemeber, the highest level since July 1983, when the jobless rate was a much more drastic 9.4%. (Louis Uchitelle, NY Times 12-6) It was no coincidence that the dollar dropped noticeably against the euro after the administration announced import quotas on Chinese knitted fabrics, dressing gowns, robes and bras. Analysts say investors fear the move could be the start of a protectionist slide that would lead to higher prices and slower growth. "The market realizes the net positive effect of trade with China,'' said Lara Rhame, a senior economist at Brown Brothers Harriman. "There is a concern that a trade disruption will turn into a financial market disruption.'' (Edmund Andrews, NY Times 12-07) While people pour over a variety of reports and advertisements to select a house, car or TV or even to pick out a restaurant, they often buy stocks on a whim. They heard about it in a chat room or from their neighbor, or it went up a lot yesterday. A columnist, analyst, newsletter editor or TV talking head says it "can't miss." Or it has a low P/E ratio or meets some other criteria that make it seem cheap. (Kevin Kennedy, Coolcat Explosive Small Cap Growth Stock Report via CBS MarketWatch 12-03) But none of US would ever be guilty of that. Nonfarm business productivity grew at a seasonally adjusted annual rate of 9.4% from July through September, the Labor Department said Wednesday. That was the strongest showing since Q2-83 - following the 1981-82 recession - when productivity grew 9.7%. It also topped the government's initial estimate of 8.1%, and Q2-03's productivity rate of 7%. Workers' hours also expanded at the fastest pace in three years. (WSJ 12-03) Home Page Previous Factoid Top Sites
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