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For each 1% rise in the stock market, an investor's estimate of his own IQ goes up 1 point. - Mark Sellers, Morningstar And for each percentage point that one's portfolio beats the S&P, the estimate goes up 10. - Investment Factoids
We're not necessarily headed to slaughter. A formula the Federal Reserve is said to use to measure the market's value suggests the S&P 500 could rise 10 percent by year-end and still be undervalued, even if the 10-year Treasury yield jumps to 4.75% by Dec. 31. Typically, stocks don't go into a bear market until they're well overvalued compared to fixed income," says Richard Geist, head of the Institute of Psychology and Investing. Still, there are abundant signs that many investors are throwing caution to the wind. Here are six gathered from members of CBS MarketWatch's editorial staff: 1) We are ignoring the Mutual fund scandal. [See fund flows.] 2) We're going online, many of us daily, to check the rising value of our assets, as soaring traffic on portfolio-trackers attests. During the bear market, most investors would sooner smack themselves in the head than open their quarterly account statements. 3) The expected stock offering has many investors foaming at the mouth. 4) Traffic on online message boards focused on under-$5 stocks is exploding. 5) There is a suddenly ravenous appetite for risk, as measured by their growing lack of concern for market volatility. Even global mutual-fund managers are nervier than they've been in three years, as a Merrill Lynch survey shows. 6) NetFlix, the online DVD-rental company, announced a big Q4 earnings gain and 2-for-1 stock split. It's now trading at a P/E ratio of 370, and is up 700% in a year, with a total stock value of nearly $2 billion. This for a firm whose business model could easily be usurped by Wal-Mart or Blockbuster, or supplanted by the next generation of video delivery.
The Bearish Forecast A key to job creation is adding capacity, and at this point that doesn't seem to be in the cards. Indeed, more than half of the 50 large manufacturers in a December survey by the Manufacturers Alliance, a research group, don't expect to add any capacity to their U.S. operations during the next three years. Beyond that, 36% actually plan to cut capacity. Meanwhile, the survey shows that only 13% expect that U.S.-based capacity will increase over the next three years. Although U.S. manufacturing activity picked up significantly in the last half of 2003, capacity utilization is about 74%, well below the average 80% for the period of 1972 to 2002. Daniel Meckstroth, chief economist with the Manufacturers Alliance, expects manufacturing to lose 15,000 jobs this year, as continued hemorrhaging in some industries offsets gains in others. Businesses involved in moving freight -- rail, shipping and trucking companies -- will grow because of higher exports. Machinery, benefiting from higher business investment, could add 57,000 workers, but import-vulnerable industries such as textiles, apparel and leather, could lose more than 45,000. Plastics and rubber won't likely grow fast enough to warrant the need for additional workers because of huge gains in productivity and instead could lose about 20,000 jobs. The Bullish Forecast The National Association of Manufacturers sees U.S. manufacturing production increasing by 6.1%, well above last year's snail pace of 1.4%, and outpacing overall GDP of 4%. GDP measures a country's output of goods and services. The bullish forecast is based, in part, on a projected 9% rise in exports. Manufacturers account for two-thirds of the country's exports of goods and services and have benefited from the weak dollar, which makes U.S. products relatively cheaper overseas. Another big factor: long-delayed business spending on machines and computers. NAM expects a 13% increase in business equipment and software spending in 2004. To accommodate the added output, NAM economist David Huether sees payrolls expanding, with the sector picking up 250,000 jobs this year. Much of them would be in areas, such as fabricated metals, electronics and industrial equipment that benefit from exports and capital investment. That gain is modest compared with other recoveries but still hugely significant given the 2.8 million jobs lost in the sector. While manufacturing represents less than 17% of U.S. GDP and 12% of the work force, it spills over widely into other sectors of the economy, from transportation to energy.
The ratio is meant to show a fund's costs as a percentage of its investment holdings. But transaction costs are also borne by the fund's shareholders. "This study demonstrates conclusively what consumer groups have argued for years - that fund expense ratios are misleading," said Mercer Bullard, a University of Mississippi law professor and SEC critic. The study offered the PBHG Large Cap fund as an extreme case. Its reported expense ratio was 1.18% in 2001, but the study estimated that frenetic trading activity would have added 7.43 percentage points. Pilgrim Baxter & Associates declined comment. Two Vanguard Group index funds stood out for low overall costs. Trading outlays would have added little to the expense ratios of 0.18% for the Vanguard 500 Index and 0.2% for the Vanguard Total Stock Index. All told, the 30 largest funds spent $643 million in commission costs in 2001, the study said. The funds publish this data in an obscure annual document called a Statement of Additional Information. The advocates urged regulators to require more prominent disclosure of costs. "If you're going to use an expense ratio, it shouldn't be misleading," Bullard, the University of Mississippi law professor, said. My google search for the study failed to turn up any additional information. For a related story, see Fund Probe Focusing on Brokerage Deals - which offers data on how the 'brokerage deals' adds to mutual fund trading costs.
As part of their research, the professors checked a database of all publicly traded domestic companies for those whose earnings at any time from 1951 to 1998 grew at more than the median annual rate for five consecutive years. That may seem a modest prerequisite, since that median over those 48 years was around 6%. But very few companies met that condition, and those that did were rarely those that investors had valued at the high end of the spectrum. The professors concluded that very high P/E ratios were hardly ever justified. In 2004, however, many investors evidently expect that some companies' earnings will grow much faster than 6% a year. To show that, it's necessary to do some math. Consider eBay, whose P/E ratio, based on earnings for the 2003 calendar year, is around 102. Assuming that eBay's stock price grows just 8% a year for the next five years, to $102 from its current $69.35, and that its P/E ratio in early 2009 is 40, then its earnings per share will have to grow 30%, annualized, for the next five years to justify its current valuation, according to Professor Lakonishok. He says these assumptions are conservative. An 8% return is below the stock market's annual average over the last century. And a company's P/E ratio almost always declines as its business grows and matures. Over the long term, the market's average ratio is below 20. To the extent that eBay's ratio five years from now is lower than 40, or that its stock price grows faster than 8%, annualized, its earnings will have to grow even more than 30% a year to support its current valuation. Two other examples of the required growth rates for high PE stocks immediately follow this posting. More information from "The Level and Persistence of Growth Rates" by Chan, Karceski & Lakonishok follows that posting. And there are two more related studies after those that get to the root of the high P/E problem - that earnings growth tends to revert to the mean over time. Professor Lakonishok has not studied eBay's business in particular, so he does not want to estimate its earnings growth over five years. But, he said, "based on the experience of U.S. companies over the last 50 years, the probability that a large company will achieve such a growth rate is probably not higher than winning the lottery." Of course, eBay is not the only company for which investors have huge growth expectations. According to Thomson First Call, consensus forecasts of analysts now project that more than 100 other companies will have earnings growth of at least 40%, annualized, over the next five years. One cautionary note - the study does not specifically say what percentage of stocks fail to be worthy of their high P/Es. The failure rate is fairly small for projections one year in the future for the averaged portfolio of stocks in the highest quintile of P/Es, but balloons in estimates over 3 and 5 year periods. Two more examples of the required growth rates to justify high PE stocks "The Level and Persistence of Growth Rates" Chan, Karceski & Lakonishok March 2001 Take a firm with a ratio of price to forecasted earnings of 100. Such cases are by no means minor irregularities: based on values at year-end 1999, they represent about 11.9% of total market capitalization. To see what growth expectations are implicit in such a price-earnings ratio, we adopt a number of conservative assumptions. In particular, suppose the high multiple reverts to a more representative value of 20 in ten years, during which time investors are content to accept a rate of return on the stock of zero (assume there are no dividends). A multiple of 20 is conservative, since Siegel ("The shrinking equity premium", Journal of Portfolio Management 1999) notes that the long-term average value of the price-earnings ratio is 14. Further, an adjustment period of ten years is not short, in light of the fact that many of the largest firms at year-end 1999 did not exist ten years ago. These assumptions imply that earnings have to grow by a factor of five, or at a rate of about 17.5% per year, for the next ten years. Alternatively suppose investors put up with a paltry ten percent rate of return. Ivo Welch ("Views of financial economists on the equity premium and on professional controversies", Journal of Business 2000) reports that financial economists' consensus expected return is considerably higher. Then earnings must grow at an even more stellar rate (29.2% per year) over ten years to justify the current multiple. "The Level & Persistence of Growth Rates" Chan, Karceski & Lakonishok March 01 At year-end 1999 the distribution of the ratio of stock price to analyst consensus forecasts of the following year's earnings, has a 90th percentile of 53.9 while the 10th percentile is 7.4, yielding a difference of 46.5. One measure of the market's expectations, security analysts' forecasts of long-term growth in earnings, also displays large differences across stocks. For example, the 90th percentile of the distribution of IBES five-year forecasts is 40% as of year-end 1999, compared to the 10th percentile of 8.9%. If analysts and investors do not believe that future earnings growth is forecastable, they would predict the same growth rate (the unconditional mean of the distribution) for all companies, and it is unlikely that the dispersion in forecasts or price-earnings ratios would be as large as it actually is. Evidently, then, market valuations and analysts' forecasts suggest that many market participants believe that future earnings growth is highly predictable. The belief that growth is persistent runs counter to the economic intuition that there should not be much consistency in a firmĖs profitability growth. Following superior growth in profits, competitive pressures should ultimately tend to dilute future growth; similarly exit from an unprofitable line of business should tend to raise the remaining firms' future growth rate. Some support for this logic comes from Fama and French (2000a). Their evidence for the aggregate market suggests that while there is some short-term forecastability, earnings growth is in general unpredictable. The above example highlights the two questions we tackle in this paper. How plausible are investors' and analysts' expectations that many stocks will be able to sustain high growth rates over prolonged periods? Are firms that can consistently achieve such high growth rates identifiable ex ante? Prior research has covered some of these issues. Among the earliest studies are Little (Higgledy piggledy growth, Bulletin of the Oxford University Institute of Economics and Statistics 4, 1962), Little and Rayner ("Higgledy piggledy growth in America", 1966), who examine the growth in earnings of a limited sample of U.K firms in the 1950s. Related, early evidence for U.S. firms are described by Lintner and Glauber (1967), and Brealey (1983). William Beaver ("The time series behavior of earnings", Journal of Accounting Research 8, 1970), Ray Ball and Ross Watts (Some time-series properties of accounting income, Journal of Finance 27, 1972) start a long line of papers that apply time-series models to earnings. However, few firms have sufficiently long earnings histories to allow precise estimation of model parameters, and the emphasis in this line of work has been on short-term forecasting. More recently, Fama and French (The equity premium, working paper, 2000) examine the time-series predictability of aggregate earnings for the market. Our work is closest in spirit to that of Fama and French ("Forecasting profitability and earnings", Journal of Business 73, 2000) who look at the cross-sectional predictability of firmsĖ earnings, but even they focus on one-year horizons. The Fama & French research is summarized in a posting below. The Data Our sample of firms comprises all domestic common stocks with data on the Compustat Active and Research files. Firms are selected at the end of each calendar year from 1951 to 1997. The number of eligible firms grows from 359 in the first sample selection year to about 6825 in the last year; on average the sample comprises about 2900 firms. On average over the sample period, the median growth rate over ten years for income before extraordinary items is about 10% for all firms. Growth in the other two indicators also exhibit comparable medians. Out of an average number of 2900 firms available for sample selection at each year-end, 2771 firms on average survive until the end of the following year. Over the following ten years there are on average 1265 surviving firms. Of these, 11 have sales growth rates that exceed the median in each of the ten years, representing 0.9% of the eligible firms. If sales growth is independent over time, we should expect to see 0.5 (about 0.1%) of the surviving firms achieve runs above the median over ten years. There is a great deal of persistence in sales growth. Over a five-year horizon, for example, on average 118 firms, or 6.3% of the 1878 firms who exist over the full five years, turn in runs above the median. The number expected under the hypothesis of independence over time is about 59 (3.1 percent of 1878). [The 3.125% being 50% times 50% times 50% times 50% times 50%. This is the same odds as flipping heads 5 times in a row. In this case, heads would represent 'growth above the mean'.] So roughly twice more than expected achieve runs over five years. The persistence in sales growth may reflect shifts in customer demand, which are probably fairly long-lasting. A firm can also sustain momentum in sales by expanding into new markets and opening new stores, by rolling out new or improved products, or by granting increasingly favorable credit terms. Persistence in sales may also arise from managers' "empire-building" efforts, such as expanding market share regardless of profitability. In all these cases, however, costs are also likely to rise at the same time, so profits may not show as much persistence as sales. On average 67 firms a year, or 3.6% of 1833 surviving firms, have above-median runs for five consecutive years. The expected frequency of runs is 3.1% or 57 firms. There are thus 10 firms more than expected out of 1833, so the difference is unremarkable. We [then adopted a] more relaxed criteria for defining consistency in growth. We check whether a firm beats the median for most years over the horizon, but allow it to fall short of the median for one or two years. For example, looking forward from a sample selection date, 269 firms on average have sales growth rates that exceed the median in five out of the following six years. These firms represent 15.6% of the surviving firms, more than the expected value of 9.4%. In the case of income before extraordinary items, the departures from what is expected under independence are quite slender, especially over longer horizons. For instance, an average of 171 firms (or 9.9% of the survivors) have income before extraordinary items growing at a rate above the median for 5 out of 6 years, which is close to the expectation of 9.4%. Similarly if we let a firm falter for two years, 4.8% of the surviving firms have growth in income before extraordinary items that exceeds the median in 8 out of 10 years, compared to an expected value of 4.4%. As another way to single out cases of sustained high growth while allowing for some slack, we require a firm to post an average annual growth rank over the subsequent five years that falls in the top quartile. On average 1.4% of the surviving firms (amounting to 27 firms) pass this criterion with respect to growth of income before extraordinary items. Under the null hypothesis of independence, the expected value is 2.5%. The Predictive Power of Investment Analysts IBES long-term estimates do not become available until 1982, so the sample period runs from 1982 to 1998. The dispersion in IBES consensus growth forecasts is large, so analysts are boldly distinguishing between firms with high and low growth prospects. The median estimate in quintile 1 [the lowest 20%] averages 6%, while the median estimate in quintile 5 is 22.4% on average. Notably, analysts' estimates are quite optimistic. Over the period 1982-98, the median of the distribution of IBES growth forecasts is about 14.5%, a far cry from the median realized five-year growth rate of about 9% for income before extraordinary items. The median realized growth rate of 9% (without dividends reinvested) is based on all firms, including smaller firms that tend to be associated with somewhat higher growth rates. IBES forecasts, on the other hand, predominantly cover larger firms. Near-term realized growth tends to line up closely with the IBES estimate. In the first post-ranking year, the median growth rate in income before extraordinary items is 18.3% on average for quintile 5, and 5.1% on average for quintile 1. The difference between the growth rates for the other quintile groups is much milder. Over the first post-ranking year, the difference between the dividend yields of quintiles 2 and 4 (3.4% and 1.5%, respectively) corresponds roughly to the difference in their growth rates. Once differences in the dividend yield are taken into account, then, IBES estimates have forecast power for realized growth over the first year only at the extremes. In every quintile median forecasts exceed median realized growth rates [of the 3 and 5 year forecasts], with the most pronounced bias in quintile 5. For five-year growth in income before extraordinary items, the median forecast in the top quintile is 22.4%, much higher than the median realized growth rate, which is only 9.5%. Furthermore, the realized growth rate for the firms in the top quintile [are tainted by survivor bias]. IBES long-term forecasts are essentially unrelated to realized growth in income before extraordinary items beyond one or two years out. For example, over the five post-formation years, the bottom and top quintile average experience growth rates of 8% and 11.3% per year, respectively. The spread of 3.3% in the [groups'] growth rates is smaller than the gap between their dividend yields (which is 5.6%). Given the average investors holding period of a stock, the finding that forecasts are accurate in periods one year out is good news. I do not know how long investors tend to hold stocks, but the average holding period for investors of mutual funds is only 30 months. I would suspect stocks would be held for shorter periods. To some extent, this research is a warning to 'buy and hold' investors in growth stocks and a comfort to 'buy and hold' investors in value stocks. Analysts' forecasts substantially overstate realized long-term growth in the top three quintile portfolios. In the top-ranked quintile, the median projected future growth rate is about 22.4%, but the portfolio's realized growth is only 11.4% over three years and 11.3% over five years. The spread in predicted growth between the top and bottom quintiles by IBES forecasts is 16.4%, but the dispersion in realized five-year growth rates is only 7.5%. These results suggest that in general caution should be exercised before relying too heavily on IBES long-term forecasts as estimates of expected growth in valuation studies. Conclusions Our median estimate of the growth rate of operating performance corresponds closely to the growth rate of GDP over the sample period. Although there are instances where firms achieve spectacular growth, they are fairly rare. For instance, only about 10% of firms grow at a rate in excess of 18% per year over ten years. While sales growth shows some persistence, there is essentially no persistence in growth of earnings across the entire sample of firms. Signs of persistent growth in earnings are slim even in cases that are popularly associated with dazzling growth (pharmaceutical and technology stocks, growth stocks and firms that have experienced persistently high past growth). While security analysts' long-term estimates point in the same direction as realized growth over short horizons, they are over-optimistic and do poorly in predicting realized growth over longer horizons. Our results suggest that investors should be wary of stocks that trade at very high multiples. Very few firms are able to live up to the high hopes for consistent growth that are built into such stellar valuations. "Forecasting Profitability & Earnings" Eugene Fama & Kenneth French, The Center for Research in Security Prices Working Paper No. 456 There is a strong presumption in economics that, in a competitive environment, profitability is mean reverting. [From Allen & Salim: The underlying assumption behind the concept of market efficiency in perfect capital markets is that owners of capital would divert their resources to industries that would generate a higher level of returns than their present investments. This assumption would result in equality of the rate of return on investments not only within, but also across industries as resources are allocated to more efficient uses.] We provide corroborating evidence. In a simple partial adjustment model, the estimated rate of mean reversion is about 40% per year - which is similar to the median of the estimates for individual firms by Branch Lev ["Industry averages as targets for financial ratios", Journal of Accounting Research 7, 1969]. [Allen & Salim find a lower rate of reverting in the UK. See study below] We confirm the early qualitative evidence of LeRoy Brooks & Dale Buckmaster ["Further evidence of the time series properties of accounting income", Journal of Finance 31, 1976] that changes in earnings tend to reverse from one year to the next, and large changes of either sign reverse faster than small changes. We also confirm the formal evidence of Peter Elgers & May Lo ["Reductions in analysts' annual earnings forecast errors using information in prior earnings and security returns", Journal of Accounting Research 32, 1994] that negative changes in earnings reverse faster than positive changes. We also show that the mean reversion in profitability produces predictable variation in earnings. It is also possible, however, that non-linear mean reversion, and mean reversion itself, trace in part to accounting decisions. For example, Sudipta Basu ["The conservatism principle and the asymmetric timeliness of earnings", Journal of Accounting and Economics 24, 1997] argues that bias toward conservative reporting leads firms to report losses quickly but to spread gains over longer periods. Such a tendency could help explain why profitability reverts more quickly when it is low. "Forecasting Profitability & Earnings: A Study of the UK Stock Market" D.E. Allen & H. M. Salim Allen & Salim used a sample of roughly 987 UK firms per year for a period from 1982-2000. They found convergence towards the mean at a rate of 23% - 25% per year. There was a second differnce from Fama and French: The change in profitability "appears to be more strongly influenced by dividends in the UK - but this may be a reflection of differences in dividend taxation in the two countries and the fact that the UK has an imputation, as opposed to a classical taxation system.." In my quick read of this study, I did not catch how dividends altered earnings growth. So I will go with the classic explanation - that higher dividends led to lower earnings growth. And the tax system in the US caused even lower earnings growth companies to have lower or no dividends. And that this was not the case in the UK. But this is just conjecture.
But the epic disparity of recent years may be unsustainable. Perhaps the most telling indicator in the small-versus-large debate is relative valuation. Steven DeSanctis, director of small-cap research at Prudential, says stocks with smaller capitalizations trade at a trailing price/earnings ratio of 20.7, just above large caps' P/E of 20.3. Historically, they've traded at equal levels. Just because small-cap stocks aren't the screaming bargain they used to be doesn't mean they'll falter immediately. Since 1926, Mr. DeSanctis says, the average small-cap cycle has lasted 5.7 years. The current run is five years old, and Mr. DeSanctis expects small stocks to dominate early in 2004 but not for the full year.
A year ago, this wasn't a problem. Any good earnings news was cause for joy. But after last year's 25% rise in the Dow and 50% gain in the Nasdaq, expectations are higher, stocks are expensive, and investors are getting harder to please. Intel, for example, more than doubled earnings in Q4-03, compared with Q4-02, on record quarterly revenue. But the whisper expectation was for more. Intel's forecast for the first quarter, typically a slow period for tech business, was deemed insufficiently dazzling, so the stock fell despite the strong earnings. The real problems could come later this year, as expectations get frothier, says Chuck Hill, director of research at Thomson First Call. "We have been worried about this for a while," Mr. Hill says. Many investors don't realize that current corporate-earnings gains are highly unusual. Typically, Mr. Hill notes, analysts begin a quarter with high expectations for earnings and then gradually trim their forecasts as the quarter develops. But in recent quarters, earnings have been so good that analysts have steadily boosted their forecasts as the quarter developed. During last year's third quarter, analysts raised earnings forecasts for companies in the S&P 500 by about three percentage points, and the companies, as a group, beat the increased forecasts. Analysts raised forecasts during the fourth quarter as well, and companies now look poised to beat those raised forecasts, too. As the first quarter begins, analysts are showing signs of continuing to raise forecasts for this quarter as well. But this sparkling performance isn't likely to continue forever. By the second quarter, Mr. Hill says, expectations will be higher and analysts are likely to be cutting estimates as the quarter wears on, back to their normal habits. As the year goes on, this could drive expectations lower - and that could put stock prices under pressure. Earnings Stats Josh Friedman, LA Times 1-20 Of the 66 members of the S&P 500 that reported earnings through Friday, 41 beat analysts' expectations, Thomson First Call said. When reporting season is over, Hill expects the companies whose stocks make up the index to post overall growth of 26% from a year earlier based on results from continuing operations. That would be the seventh increase in a row and the biggest percentage gain since the third quarter of 1993. For the first quarter, analysts expect profits for members of the S&P 500 to advance an average of 13.7%. For all of 2004, the early line calls for growth of 13.2%. Both targets have climbed modestly since the start of the year.
Truck drivers (3.4 million) are not required to have "daily face-to-face interaction" to earn their paychecks, and neither are many of the other workers in the U.S. involved with transportation and freight-handling (8.0 million). Construction workers (6.8 million), mechanics and repairers (4.9 million) don't have this in their job descriptions either. How many workers might really be affected? Out of about 45 million doing skilled service work for better-than-average pay, make it one in four. And that assumes nearly all engineering, architecture, computer, mathematic, design, accounting, bookkeeping, records-processing and call-center work eventually goes foreign. Then, for good measure, add 5% of managerial workers (out of 21 million), and 10% of health-care workers (out of 10.5 million). Now, take the final step. What would happen if one in four - about 12 million - skilled-service jobs really did drift abroad? As economist George Riesman points out (see www.mises.org), the real income (adjusted for changes in purchasing power) of the average worker could only increase. After all, the vast majority of us don't supply these services -- we purchase them! So if a service job costing $100,000 per year (the American salary) now costs $10,000 (what the foreigner will accept), our real - that is, inflation-adjusted - income goes up by the difference. That's because, in this era of fierce competition, nearly all of it gets passed on to the consumer in terms of lower prices. White-collar folks have always been best equipped to land on both feet, especially in a service economy. Must the average worker be expected to lift a finger for this wealthier group, by forgoing a rise in his own income? As Riesman explains, the white-collar person will get another job paying more than $10,000, because if that sum were acceptable, the foreign worker paid $10,000 couldn't have displaced him in the first place. That point is crucial to the net result. Let's say the displaced worker gets another job for $60,000. He's down $40,000, while all others have gained $90,000, for a net gain of $50,000. This outcome is actually no different from a job displacement due to rising productivity. From AP, 1-18: In a research report in mid-2003, Gartner Inc. predicted that at least one out of 10 technology jobs in the United States would move overseas by the end of 2004. Forrester Research predicts at least 3.3 million white-collar jobs and $136 billion in wages will shift from the United States to low-cost countries by 2015. Trade Creates More Jobs than it Kills Andrew Cassel, Philadelphia Inquirer 1-18 The United States has led the world in productivity growth for more than a century, which is exactly why American living standards also lead the world. But raising productivity is also a disruptive process. Jobs are destroyed. Companies fall to competition. Entire industries disappear. It's always painful if you're on the losing side of change. It's doubly difficult when this disruptive process coincides with the weak side of the business cycle. Then the job-creating aspect of productivity growth is eclipsed by the job-destroying side, and all the changes seem to be for the worse. That certainly was the case a dozen years ago, in the wake of the 1991 recession. Doomsayers said America was unraveling, with a shrinking middle class and foreign competitors in Japan and elsewhere who were eating our lunch. That's when the term "jobless recovery" was first coined, along with Ross Perot's notion of a "giant sucking sound" pulling jobs to Mexico. Manufacturing losses were going to leave us a nation of hamburger flippers - remember? Yet the following decade included some of the most prosperous years America has ever seen. More than 30 million jobs were created, unemployment fell and homeownership - a sure mark of national well-being - hit record levels. And all that happened at a time when international trade was rising, as barriers fell and more countries joined the global market. That surely wouldn't happen again, if the U.S. did what several readers advised: Raise tariffs or slap punitive taxes on companies for "off-shoring" jobs.
This may explain the sharp drop in unemployed U.S. managerial and professional specialty workers last month. Considered the most vulnerable to offshoring, managerial and professional specialty workers saw their share of the reported jobless fall to 17.4% in December, after spiking up to more than 20% in the previous month. Their current proportion of the unemployed is now about equal to the average for the past two years. It's been reported that Lehman Bros. has become dissatisfied with the results of its call-center service operations in India after a number of customer complaints. As a result, the investment bank has reportedly shifted some of these operations back to the United States. Similar complaints from customers apparently led to the decision by personal-computer giant Dell to bring back to the U.S. a number of its operators who were based in Bangalore, the city known for being India's information-technology center. Meanwhile, a number of state and local governments have begun to reconsider their relations with call centers and other functions overseas. Indiana, for one, recently canceled a contract with an Indian software company, preferring, instead, to give local firms a shot at it. Other companies feel that, where a call center is the main voice of the firm to its customers, they'd rather not risk dealing with a staff based thousands of miles away that may not know that firm's culture as well as individuals based at the company, itself. In short, there's a certain lack of control that comes with offshore operations. Finally, the improvement in the U.S. economy itself is encouraging companies to switch their strategic emphasis from cutting costs to increasing revenues. Combine this with big jumps in wages abroad as a result of the surge in demand for foreign workers and you can see why offshoring may be a trend whose time has past. Offshoring Protection Angers India Bob Davis, WSJ 1-26 A provision in the massive spending bill Congress passed last week, though little-noticed in the U.S. media, is stirring up a storm in India, where it is seen as evidence of a backlash that will slow outsourcing. The law says that when the federal government decides to allow private companies to do work now being done by government employees, the private companies can't do the work outside the U.S.
This selective reporting of incubator funds' returns can make the surviving funds appear to be better bets than they really are, according to Richard Evans, a Ph.D. candidate in finance at the Wharton School of the University of Pennsylvania. Mr. Evans' study is available at http://assets.wharton.upenn.edu/~evansr/do_mf_risk_adjust.pdf. There is another problem with incubation, according to Mr. Evans. A fund company may change the strategies of its incubated funds once they emerge into public view. If that happens, incubator funds' track records will not reflect the new approaches. When funds are out of view, fund companies have an incentive to take higher risks.Incentives change once a fund emerges from incubation. Because the company's reputation is now on the line, its incentive to take risks falls, and a fund's strategy may shift. To be considered an incubator fund under the S.E.C. definition, a fund must be held privately. But companies can get around this by filing the paperwork to make their funds nominally public, while making sure that very few investors know about them. For example, fund companies can choose not to mention their incubator funds in any prospectus. They can also withhold their performance from fund performance databases like those maintained by Lipper and Morningstar. Putman Example Mr. Evans uses the Putnam Research fund to illustrate some aspects of incubation. This fund, which Morningstar places in its large-cap blend category, was one of 11 that Putnam Investments was incubating in late 1995. It was capitalized initially with about $3 million of Putnam's own money. It remained more than 90 percent owned by Putnam until July 1998, when the company first mentioned the fund in a prospectus. Mr. Evans said that 5 of the 11 funds that Putnam was developing in late 1995 never emerged from incubation, and that the performance of the discontinued funds was generally poor. In contrast, as of mid-1998, when Putnam began publicizing Putnam Research and aggressively attracting outside investors, its historical return was nearly 30%, annualized. This was when Putnam began providing the fund's returns in performance databases. In addition to reporting the fund's performance from that point forward, Putnam also provided those databases with its historical performance back to its birth in 1995. The historical returns, of course, helped Putnam's efforts to publicize the fund. Morningstar does not include a fund in its star rating system until it has a track record of at least three years. But because Putnam Research's returns went back to late 1995, the fund received a star rating as early as late 1998, even though it had been offered to the public for only about six months. In early 1999, when the fund's performance was first reported in Morningstar's Principia database, it had a five-star rating, Morningstar's highest. After emerging from incubation, Putnam Research's overall performance since mid-1998 has been mediocre, according to Morningstar, especially when compared with funds with a similar investment objective. Morningstar currently gives the fund two stars. Steve Oristaglio, a senior managing director at Putnam Investments, said it was "very important" to incubate funds before bringing them to market. "We believe we have a fiduciary responsibility to prove an investment concept" before selling new funds based on it, he said. Mr. Evans says he doubts that fund companies' primary motivation when incubating funds is to come up with a few genuinely impressive strategies. If that were the case, he said, funds that emerged from incubation would perform well not only in incubation but also after being offered to the public. He said he had found little evidence of that. Mr. Evans found that during its incubation, the average surviving fund outperformed a control group of other funds with similar characteristics and investment objectives by an average of nearly 8% a year. After incubation, though, the performance of the average surviving fund was indistinguishable from its control group. For investors, the primary implication of Mr. Evans' research is to ignore the performance of a fund during incubation. But because there is no readily accessible database that shows when a given fund has emerged from incubation, the recommendation requires some legwork. But Mr. Kinnel of Morningstar points to a sign in public databases that may help: a quick, sharp jump in assets. Incubator funds typically have few assets; in its incubation, for example, Putnam Research never had more than $15 million. How Fund Categories Fared Barrons 1-07-2004
Some of the standouts were heavy industry stocks in businesses such as chemicals, mining, steel and machinery. A Merrill Lynch index of 25 of those shares, including Dow, Phelps Dodge and U.S. Steel, zoomed 32.6% for the year, beating the S&P 500 index's gain of 26.4%. By contrast, defensive stocks in such industries as drugs, packaged food and household products attracted relatively little buying. A Merrill index of 34 of those shares, including Merck, Campell Soup and Colgate-Palmolive, was up 10.2% for the year. [From Ken Brown, WSJ 1-05: One oddity of the current recovery is that the cycles appear to be compressed. Normally, basic-material stocks, which had their best year in more than a decade, are considered a late-cycle sector, meaning they don't get going until well after the recovery takes hold. That's because demand and pricing for their products takes a while to pick up. This time, due to a combination of the weak dollar, high demand from China and supply shortages, these sectors have done well ahead of schedule. That could mean the shift into defensive stocks will come sooner than it normally would - even possibly the first half of the year. The biggest potential winner from such a shift would be health-care stocks, which haven't led the market since 1995 when they returned 52%.] [From Ken Brown, WSJ 1-05: Sam Stovall, chief investment strategist at Standard & Poor's, says that the market typically returns 38% in the first year of a recovery, slightly above the market's return since Oct. 2002. "I was pleasantly surprised with how strong the market's advance was and how widespread the advance was and how close it was to history," Mr. Stovall says. Mr. Stovall says that since 1942, the market has averaged a 13% return in the second year of an economic recovery, with specific year's gains ranging from 2% to 28%. S&P predicts the market will rise just under 10% in 2004.] Can the cyclical sector stay in the lead in 2004? Richard Nash, chief market strategist at Victory Capital Management, argues that it makes sense to continue betting on industrial stocks. His reasoning rests in part on the assumption that the industrial economy will benefit from federal business tax incentives aimed at spurring capital spending. Those incentives, including the right to take big tax write-offs for capital equipment purchases, were passed by Congress in May and are set to expire at the end of 2004. The sunset provision "should keep capital spending and the economy strong in the second half" of this year, Nash said. Tobias Levkovich, equity strategist at Citigroup Global Markets, said he's still positive on cyclical stocks, but figures that more investors will begin to look to "rotate" to defensive issues by midyear. Why? If investors figure that cyclical companies' earnings could decline in 2005, the time-honored strategy would call for jettisoning the stocks well before a downturn begins. John Thompson, who helps manage the Thompson Plumb Growth stock fund, believes this year's market will favor "big, high-quality companies" that took a back seat to more speculative issues in 2003. The drug stocks, in particular, look good to him in part because he expects fewer big-name drugs to go off patent in 2004 and be subject to generic competition. Can smaller caps beat big caps again? Standard & Poor's index of 600 smaller names jumped 37.5% last year, compared with 26.4% for the blue-chip S&P 500 and 25.3% for the Dow Jones industrials. That made it four straight years that smaller stocks have beat big names. Some analysts believe smaller stocks are ready to fade after four years of besting bigger names. It began to look that way in December: Blue chips trounced smaller stocks last month. The S&P 500 jumped 5.1%, compared with 1.7% for the S&P 600 small-stock index. Tom McManus, chief investment strategist at Banc of America Securities, is telling clients that the shift in leadership should continue. "As the robust economic recovery trend matures into a more gradual expansion, we think the larger-capitalization, higher-quality companies are the ones that are better positioned to outperform in that environment," he said. Another potential plus for bigger stocks: Last year's cut in the top federal tax rate on dividend income could attract more investors over time to dividend-paying shares, which tend to be bigger stocks. But some market pros say investors, on balance, may still prefer to bet on riskier stocks, including smaller names, in 2004 rather than play it safer in bigger stocks. Bernie Schaeffer, a veteran investor who heads Schaeffer's Investment Research, said one clue is that many mutual fund investors for most of last year were favoring funds that buy big-name, "value"-oriented shares, even though small-stock funds have performed far better. Those investors may be primed to take on more risk in the new year, he said. The Bearish View of 2004 David Tice, head of investment firm David W. Tice & Associates and a pessimist on stocks since the mid-90s, insists that the market decline that began in 2000 has been interrupted but not ended. The economy, he said, is burdened by record debt loads and is only being propped up by the Federal Reserve's maintenance of short-term interest rates at 45-year lows. Tice believes that the stock market has again become a "bubble" - meaning that share prices have been grossly inflated - and that the implications for the economy are worse than in the late 1990s because residential housing prices have followed a similar path since 2000, in his view. Both stocks and housing are certain to deflate with dire consequences, he said. "The Fed is trying to perpetuate the bubble; they don't want it to go down," Tice said. "But I don't think they can keep it going another year. You can't continue to borrow your way to prosperity." The Bullish View of 2004 William Nygren, a partner at money manager Harris Associates in Chicago, said he believed that investors returned to stocks in 2003 because they saw that share prices, which had plunged 35% to 80% from their 2000 peaks based on major market indexes, didn't reflect the true long-term prospects of many companies. The optimists have been proved correct, he said, as corporate earnings rose to record levels in the second half of last year. It's also important to note that stock prices, relative to underlying earnings, for the most part aren't near the levels of 2000, Nygren said. A classic yardstick of stock valuation is the price-to-earnings ratio, the stock price divided by annual earnings per share. For the blue-chip S&P's 500 index, the P/E ratio in March 2000 was 29 based on so-called operating earnings per share, meaning corporate results excluding one-time gains or write-offs. By contrast, at its 2003 closing level the S&P index P/E is about 19 based on S&P's estimate of 2004 operating earnings for the index. A lower P/E, in theory at least, means there is less risk in stocks. The Ho-Hum View of 2004 Most say gains in key indexes such as the Dow and the S&P 500 might be in the high single digits at best this year as investors grow more cautious. A Dow gain of, say, 8%, would be a far cry from the heady returns of the late-1990s bull market. But it would be well above returns on competing investments, such as the 1% or lower yields on bank savings accounts and money market funds, and the 5% or lower yields on government bonds. The poor returns available on bank and money funds, in particular, are likely to help fuel the market as investors look for something better, analysts say. More than $5 trillion is sitting in those accounts. "You don't have to go far to find someone with a lot of cash earning 1%," said Milton Ezrati, senior economic strategist at investment firm Lord Abbett. Besides betting on continued economic growth, investors who are bullish on stocks for 2004 see history on their side. The S&P 500 index's average gain in election years has been about 9%.
Treasury bond yields snapped back last summer after investors concluded the Fed was done easing credit. The yield on the two-year Treasury note bottomed at 1.09% in mid-June, rose as high as 2.1% by early December and ended Friday at 1.94%. One risk for bond and stock markets is that some bond investors could overreact this year, driving yields sharply higher - at least temporarily - based on stronger economic data or any hint from Fed officials that a credit-tightening move is on the horizon. It wouldn't be the first time the bond market overreacted. Will Inflation Return? As with low interest rates, it might not take much of a change in inflation to seriously disturb investors. Because of the perceived risk, many market pros are advising clients to think about whether their portfolios include investments that might serve as inflation hedges. "Interest rates have been low for so long, the economic and market impact of what might otherwise seem an unimportant shift [in the outlook] might actually be magnified in markets," warns Tom McManus, chief investment strategist at Banc of America Securities. What's more, he said, "even if the Fed does remain on the sidelines in 2004, rising rate expectations for 2005 might cause the equivalent reaction in 2004 that a real tightening would." Through November, the annualized percentage change in the CPI was below 2%. If there's no inflation problem in 2004, the Fed may not feel compelled to tighten credit. That's the expectation of David Rosenberg, economist at Merrill Lynch, who sees the CPI rising just 1.1% in 2004. Bill Gross of Pimco mutual funds suggests that investors look at tangible assets, which would include gold and real estate; inflation-protected Treasury bonds, which automatically rise in value in tandem with inflation; and foreign stocks and bonds, on the assumption that higher U.S. inflation could further hurt the value of the dollar, making foreign securities more valuable to American investors. Could stocks fare well even if interest rates or inflation rise? A popular assumption is that the stock market would sink in the face of higher rates or inflation. But that wouldn't necessarily be true. The late 1970s, a period of soaring inflation, was a great time to own energy and other stocks in commodity businesses, for example. It also was a wonderful time to own many smaller growth companies whose businesses prospered despite, or because of, the inflation environment. The Nasdaq composite index rose 107% from the end of 1976 through the end of 1980, even as many blue chip stocks struggled. Could the falling dollar trigger a crisis? With the apparent blessings of the Bush administration, the dollar's value has been tumbling for two years. Because the U.S., with its deficits, is dependent on foreign capital, a falling dollar could become a crisis if it makes foreigners balk at buying our bonds because of the risk of further devaluation of those assets. But most Wall Street pros say the buck's decline isn't near a crisis point. "I think we're far from that," said C. Fred Bergsten, head of the Institute for International Economics in Washington. Measured against key currencies, including the Swiss franc, the dollar hasn't yet given back the gains it racked up in the late 1990s, Bergsten noted. A weaker dollar means foreign shares get an automatic boost in the currency translation. That's a big reason the average foreign stock mutual fund has risen 39.1% in the last 12 months, compared with a 28.2% gain for the average U.S. stock fund, according to Morningstar. If the dollar is headed lower, foreign funds could be poised for another strong year. (From Jonathan Weisman and John Berry, Washington Post 12-26: The dollar has fallen about one-third against the unified European currency over the past three years - 15% this year alone. In the past 23 months, the dollar has slid 11% against all the world's currencies, according to Stephen Roach, chief global economist at Morgan Stanley. The decline has on balance been a boon to the U.S. economy, pushing the price of American-made goods and services lower on the international market, stimulating exports while trimming imports. Indeed, the economic forecasting firm Global Insight has calculated that the dollar's decline has saved as many as 700,000 manufacturing jobs since the slide began in earnest two years ago. Foreign governments and investors now own $2.5 trillion more in U.S. assets than Americans own of foreign assets. Foreigners bought $27.6 billion more U.S. stocks, bonds and other assets than they sold to Americans in October. As long as foreigners keep buying, the day of reckoning will be postponed.) The 2004 Outlook - Macroeconomic Advisers John Berry, Washington Post 1-04 Wages With overall joblessness remaining relatively high, employers probably won't be handing out large pay increases. Average hourly earnings for production and non-supervisory workers on private payrolls rose only 2.3% in the 12 months ended in November. Most forecasters expect workers to do better this year, but with increases still limited to around 3% or slightly more. At the same time, the length of the average workweek is likely to increase, so that weekly pay will rise faster than hourly earnings. Prices Inflation is expected to remain so subdued that even those modest pay increases should leave workers with added buying power. The consumer price index increased 1.8% in the year ended in November, and many forecasts are calling for a rise of 1 to 1.5% this year. Essentially, the average price of goods, which rose a scant 0.2% in the year ended in November, is expected to fall this year. Some goods' prices will go up, but others will fall more. In that 12-month period, for example, new motor vehicle prices were down 2.1% and those for used cars fell a whopping 11.3%. Apparel prices were also down, 1.9 %. GDP Macroeconomic Advisers' predictions, among the most widely followed of all forecasts, call for an annual growth rate close to 5% in the first three months of this year, tapering gradually to a 4.3% rate in the fourth quarter. The 4.5% average for the four quarters of 2004 would be modestly better than 2003's estimated average of 4.2%, the firm said. Unemployment A new Labor Department survey showed that in the final three months of 2002, more than 7 million payroll jobs disappeared at firms that either cut their rosters or went out of business. But almost the same number of jobs were created at expanding firms or companies that opened their doors for the first time during those months. In other words, there are far more job opportunities appearing all the time than the small month-to-month changes in payrolls imply. With most companies continuing to find ways to use labor more efficiently, [job] growth is not expected to be strong enough to put a big dent in the nation's jobless rate, which stood at 5.9% in November. Late this year joblessness will be down only to about 5.5%, according to the forecast. The 2004 Outlook Kelly Spors, WSJ 12-28 Charles Hill, director of research at Thomson First Call, has a rather cautious outlook. While he believes the economy will keep improving, he frets that some people are investing on momentum rather than solid value. "It's troubling to see how investors have piled back into these tech stocks," Mr. Hill says. Some smaller technology companies are "selling at ridiculous valuations" right now, he says. His pick for 2004: companies exporting to China. Manufacturers of raw materials such as paper, metals and chemicals should do well because of China's growing needs and rapid construction. He also likes big machinery companies such as Caterpillar, a supplier of construction equipment to China. Market sectors such as biotechnology and pharmaceuticals - many of which posted modest or no gains while the overall market staged a recovery last year - may finally get their dose of healthy returns. Eric Bjorgen, senior analyst for Leuthold Weeden Capital Management, predicts big pharmaceuticals will outperform other sectors, boosted by the recent passage of the Medicare reform bill. "Bottom line is," he says, there will be "a lot more drugs being sold to seniors." Mr. Bjorgen has analyzed how stocks have pulled out of bear markets over the past 100 years. Since 2004 will be the second year of the current recovery, he points out that Year Two historically sees around a 10% gain for stocks, but the market crests by year end. Only three times since 1900 has the market fallen in the second year following a bear market - the last time being 70 years ago. After a tremendous three-year sprint, bond prices may have run their course, market experts say. A survey of economists by the Bond Market Association shows most think the yield on the 10-year Treasury note will rise from the current 4.15% to 4.56% by March and 5.10% by next December. The 2004 Outlook Eileen Ambrose, The Baltimore Sun 12-28 Al Goldman, chief market strategist with A.G. Edwards expects the three major indexes next year to end up 12% to 14%. "Strong first half, lackluster second half. That's our theme," said Richard Cripps, chief market strategist for Legg Mason Wood Walker. Cripps predicts the Nasdaq may end next year with no gain or possibly be down 20%, while the other two indexes might be flat. "Technology does look ugly for 2004. It's extremely overvalued right now," said Pat Dorsey, director of stock analysis for Morningstar. There are few sectors that experts agree will be clear winners next year. Energy, which includes oil and natural gas producers and companies providing related services, is one of them. As the worldwide economy continues to improve, demand for energy will only increase, particularly in China, they said. Manufacturers, including automakers and companies that make equipment or materials for other businesses, also are expected to do well. Factoids Outlook As the new year begins, I see it as a good year to buy index funds. I think it will be a big cap year. And a good year for big caps means a good year for indexing - and that is a MATH thing. I see it as a good time to sell bond funds. Yields are going to rise and thus hurt bond investors. And that is another MATH thing. I would not suggest selling bonds if they are already under-weighted in your age appropriate portfolio. I think it will be a good year for Energy and Pharmaceutical stocks, but I would not over-weight those sectors - I would only make adjustments so that they were equally weighted sectors in one's portfolio - because past due sectors have a way of procrastinating their arrival. I believe it will be a tough year for REITs who's FFOs do not meet expectations and for REITs which do not have a dividend increase on the horizon. The 2004 Outlook - The Boldest Predictions Constance Mitchell Ford, WSJ 1-05 The outlook for the 2004 economy calls for moderate growth, low inflation and an improving job market. But behind that rather humdrum forecast, there are numerous wild cards, cautions and caveats. Here's how some economists responded when we asked them to give us their boldest predictions. China's Economy Stumbles China's economy has grown rapidly for years and is expected to post growth of 8.6% for 2003. But Robert Shrouds, corporate economist at DuPont Co., says China's growth rate isn't sustainable. "The government is taking steps to avoid overexpansion," Mr. Shrouds wrote in his forecast for the year ahead. "However, credit and the money supply are simply growing out of control. China faces overinvestment in many sectors of the economy, and the easy-credit policies of the past have led to a massive buildup of nonperforming loans, reducing confidence in China's already shaky financial system." The consequences of a shakeout could be dire, he warns. "If the bubble pops, it could make the Asia crisis of 1997-98 look mild in comparison." The repercussions would be felt most strongly in Asia, and less so in the U.S. and Europe, he believes. Poor Prospects for the Poor Mark Zandi, chief economist at Economy.com, warns that households at the bottom half of the income ladder are a brewing problem, and will likely act as a drag on economic growth. "These households have tattered balance sheets," he wrote, citing such evidence as high debt and bankruptcy rates, along with high rates of auto repossessions, foreclosures, and related problems. "These households have borrowed aggressively," Mr. Zandi wrote, "to supplement their restrained incomes and maintain their spending." The tendency to borrow at high, and often adjustable, interest rates will catch up with low-income households as rates begin to rise, according to Mr. Zandi. "The economic implications are substantial," he concluded. "Although it will not short-circuit the current budding expansion, it will weigh on it." A Boom in Business Starts William Hummer, chief economist at Wayne Hummer Investments Inc., says the economy is poised for a new wave of entrepreneurship that should have a powerful impact. He lists several reasons 2004 will see such a surge: First, the economy is awash in unemployed executives, some of whom will inevitably start their own businesses. Second, corporate outsourcing will continue to rise, bringing opportunities for new companies. And finally, sweeping changes in tax laws in 2003 have made it more advantageous and less costly to own a business. "Opportunities for profitable and fulfilling self-employment seldom have been more promising," he concludes. Inflation Will Ease Further The consumer-price index, the most widely followed inflation measure in the U.S., was running at an annual rate of just 1.9% as 2003 closed. Many economists say that low inflation is too good to last and most predict a pickup in 2004. But not William Dudley, chief economist at Goldman, Sachs & Co. He figures there's room for inflation to fall further. Here's why: Energy prices - including oil - should decline, which will push headline inflation lower. On top of that, there is still too much output, meaning companies are producing more product than consumers can consume. This always puts downward pressure on prices. A third factor is that unit labor costs are falling faster than inflation right now. Usually, when you get that type of gap, inflation eases. Finally, profit margins are running at record highs. The high level suggests that further productivity gains are likely to show up in the form of lower prices rather than still further increases in profit margins. The bottom line, he says: Inflation will eventually rise - "after all, the Fed wants this to happen" -- but not in 2004. Renewed Energy Crisis Gail Fosler, chief economist at the Conference Board, warns of an energy shortage. She believes that the discovery that Enron Corp.'s shenanigans contributed to California's 2001 electricity crisis gave some a false sense of security. Contrary to this revised conventional wisdom, she wrote, the problems "were very real if somewhat less extreme. Brownouts continue in California through today." Last summer's blackout in the Northeast and a similar event in Italy "underscore the fragility of the electricity grid itself." Low natural-gas and electricity prices, she believes, have impeded investments in infrastructure. What is more, she notes, the Conference Board is forecasting economic growth of 6% in the coming year, "which will bring with a big drain on energy." As a result, she says, electricity will not be able to keep pace with economic growth. As to the effects of the predicted shortages: "The first-order effects will be on prices and secondly and only with a substantial lag, on output." War on Terrorism Ends Economist Robert McGee at U.S. Trust Co. believes the war on terrorism will succeed, which would have a major positive impact on the U.S. and global economy. "The Mideast has been the worst-performing region of the world economy over the past 25 years," he wrote. "The costs of this terrorism and wasted development to the global economy are arguably the biggest economic problem in the world."
Abby Joseph Cohen of Goldman Sachs argues that it is reasonable for P/E ratios to be higher in periods of low inflation. Her data show that the average ratio for the S.& P. 500 since 1950 has been 18.4 when inflation is 2.5% or lower. The average falls to 12.1 when inflation is 3.5% to 4.5%, and declines to 8.6 when inflation is more than 7.5%. Right now, Leuthold remains fundamentally bullish, with 60% of its portfolio in stocks, although that number has been reduced from 66%. Why? Leuthold is projecting that operating earnings for the S&P 500 will rise about 20% this year, well above Wall Street analysts' consensus projection of 12.8%, compiled by Thomson First Call. Mr. Engel projects that the S.& P. 500 will be just above 1,200 by the end of this year, even with a sell-off during the year. That is a gain of nearly 10%. Just the Facts Vanguard Dives Into ETF Market Vanguard will launch 14 new ETFs on the American Stock Exchange on Friday [1-30], and plans to roll out six more funds later this year. The new funds include: Vanguard Large-Cap VIPERs, Value VIPERs, Growth, Mid-Cap, Small-Cap, Small-Cap Value, Small-Cap Growth, Consumer Discretionary, Consumer Staples, Financials, Health Care, Information Technology, Materials and Utilities. The expense ratios for the new funds will range from 0.12% for Large-Cap VIPERs to 0.28% for the sector funds. Like the existing funds, the new ETFs are designed as a separate "VIPERs" share class of the company's existing index funds. Six other funds are still awaiting final regulatory approval, and the exact timing of their launch hasn't been set. These include three international funds investing in Europe, Asia-Pacific and emerging markets, respectively, and three sector funds in energy, industrials and telecommunication services. (Yuka Hayashi, WSJ 1-29) A Dark Side To Stock Buy-Backs Stock buybacks enrich company executives two ways. First, when executives sell shares, buybacks using shareholder funds relieve selling pressure on the stock. And buybacks may bolster an executive's compensation because some of their incentive pay could be based on earnings-per-share growth. "If insiders have been selling a lot of stock and the company has been buying a lot of stock, that presents the potential for conflict of interest," said Paul Hodgson, senior research associate at the Corporate Library, a governance research company. "I don't think it is a particularly good use of net cash flow." (Gretchen Morgenson, NY Times 1-18) Junk Bond Update On Tuesday, the average annualized yield on an index of 100 junk bonds tracked by KDP Investment Advisors dropped to 6.97%. This is the lowest yield for junk bonds since at least the 1970s. The yield on the index, created in 1990, had never been below 8% until late last year. Kingman Penniman, head of junk bond research at KDP, said many investors continue to gravitate toward junk securities because the yields, though low historically, still are well above what's available on Treasury bonds and other higher-quality securities. "I think the view is, 'If you're going to be in fixed income, you have to be in high yield,' ". But as junk yields fall, "it brings into question whether investors are being adequately compensated for the risk," said John Lonski, economist at Moody's. (Tom Petruno, LA Times 1-07) December Employment Report Despite the best holiday season for retailers since 1999, retail employment fell 38,000 last month. Manufacturing industries lost 26,000 workers, bringing the total decline last year to a half million. The average workweek fell. The manufacturing workweek fell. The index of hours worked, a proxy for output, fell. Manufacturing man-hours fell. The diffusion index of employment fell. The year-over-year increase in average hourly earnings fell to a 17-year low of 2%. Payroll growth for October and November was revised down. (Caroline Baum, Bloomberg 1-9) Dividend Update Fewer U.S. companies raised their dividend payments in December than a year earlier, but the number of extra, or one-time, dividends was the most for any December in more than a decade. That may indicate that more firms are balking at committing to a higher ongoing dividend rate, but are willing to make one-time payments to share profits with investors. A total of 136 companies raised dividends last month, down from 150 in the same month of 2002, data tracker Standard & Poor's said Monday. From May through November, 908 companies raised their dividends, a jump of 29% from the 702 that increased payouts in the same months of 2002. A total of 197 companies declared extra dividends in December, up from 100 a year earlier. The number of extras was the highest for any December since 1989, S&P said. (Tom Petruno, LA Times 1-06) High [Priced] Tech According to Sanford C. Bernstein's Vadim Zlotnikov, there is now a higher percentage of technology companies trading at more than twice the market multiple than at the peak of the bubble. Out of a universe of 600 tech companies, 55% are trading at more than twice the overall market multiple on 2004 estimates. (That figure includes profitless companies.) In March 2000, the figure was 49%. The central problem with the valuation of the Nasdaq is that tech earnings are no longer scraping along at the bottom, in which case a high multiple would be more justifiable. Profits have bounced back startlingly. While the bears were wrong at the beginning of this year in predicting they wouldn't, that doesn't make them wrong now in warning that tech stock prices are too high. (Jesse Eisinger, WSJ 12-31) Quick Facts, Stats & Opinions There are now Internet sites that, at no charge, will show the cost basis with just a bit of input from the investor. They include www.bigcharts.com and finance.yahoo.com (just type in "cost basis" in the search section), as well as the sites of many public companies. To get the basis, you must have the date when you bought the stock, and that still means keeping good records. (James Schembari, NY Times 1-25) Of the 175 companies in the S&P's 500-stock index reporting so far, 63% beat estimates, according to Zacks.com. S&P 500 profits in 2003 grew about 17%; this year, profits are expected to increase a more modest 13.2%, according to Thomson First Call. Richard Bernstein, chief U.S. strategist at Merrill Lynch, says the decelerating profits cycle is a key reason stocks will have a tougher hill to climb in 2004. (Erin Schulte, WSJ 1-25) Scandals in the mutual fund industry appear to be driving some investors to look for alternatives - in particular, exchange-traded funds, or ETFs. ETFs took in a record $14 billion in fresh cash in December, Lipper estimated Thursday. That was close to the estimated $15.5 billion net inflow into stock mutual funds last month. ETF assets totaled $156 billion as of Dec. 31, up from $106 billion a year earlier. Mutual funds have $7.2-trillion in assets. (Josh Friedman, LA Times 1-23) When you rebalance annually, you build discipline into your investment plan, adding money to laggards and shaving shares of leaders. "Rebalancing is one of the few free lunches out there," said Clifford Asness, managing principal of hedge fund AQR Capital. "You're generally selling things that have gone up the most and buying things that have gone down the most. Someone who doesn't rebalance is a tacit momentum investor." (Ian McDonald, WSJ 1-21) Boston fund-tracker Dalbar recently found that stock-fund investors earned a paltry 2.6% annualized gain from 1984 through 2002, compared with more than 12% for the S&P's 500-stock index. The reason: cash consistently flows to funds that have performed well over the past 12 to 18 months, not those that have trailed. (Ian McDonald, WSJ 1-21) According to the National Association for Variable Annuities in Reston, Va., these oddball investments pulled in a net $13.2 billion in 2003's third quarter, the latest period for which data are available. That was up from $8.1 billion a year earlier. Yet variable-annuity sales ought to be drying up. Why? The 2003 tax law dented their allure, by making taxable-account investing more attractive. (Jonathan Clement, WSJ 1-21) "All the experts on CNBC are saying we're overdue for a correction," says Steve Colton of the Phoenix-Oakhurst Growth & Income fund. "And when everybody says that, the market just keeps going up. It has a way of always surprising people." (Josh Friedman, LA Times 1-20) In 1981, about 9% of all the money consumers spent went to pay energy bills. The comparable number today is 5%. US consumers now spend a smaller share of their dollars on energy than they did 30 years ago, when oil sold for $3 a barrel. (Charles Stein, Boston Globe 1-18) Certain types of municipal securities generate interest that isn't subject to regular federal income taxes but is subject to the AMT. Among these are certain "private-activity" bonds. These are issued by states and localities, just like other municipal bonds, but they typically benefit private-sector borrowers, says Michael Decker, senior vice president of the Bond Market Association in Washington. (Tom Herman, WSJ 1-15) Over the 12 months ended June 30, the latest data available, foreigners bought $231.5 billion in U.S. Treasury debt, which was more than during any 12-month stretch in the past six years, according to Bianco Research. The purchases amounted to nearly two-thirds of all the borrowing the Treasury did in that period. Foreigners - including foreign central banks - now hold more than $1.3 trillion of U.S. Treasury debt, about 36% of all Treasury paper outstanding. Japanese investors held $502 billion in U.S. Treasurys. (Millman, Day, Singer, Sesit & Phillips, WSJ 1-15) Market capitalization as a percentage of GDP is one of the few reliable measures of over- or undervaluation. We saw gross overvaluations in 1929 at 87% and in 2000 at 172%. Today? We're looking at 106% - far higher than the 5% norm of the past 75 years and exceeded only by the absurd valuation of 2000. These data cannot be fudged to make the current bullish case. This market is not cheap. Momentum was the name of the game in 2003. Forget value. Unfortunately, this is the type of market which crucifies investors. Charles Allmon, Growth Stock Outlook via Washington Post 1-11) Eighty-six percent of the stocks on the NYSE are above their respective 200-day moving averages. (Dan Sullivan, The Chartist via Washington Post 1-11) Emerging markets beat the rest of the world in 1999, lagged in 2000 and have outperformed ever since, both in the bear and the bull market. On a five-year basis, emerging markets have significantly outperformed developed-country markets, including the United States. (W. George Greig, manager of the William Blair International Growth fund, NY Times 1-11) The Fidelity Nasdaq Composite Tracking Stock (ONEQ) has an expense ratio of 0.30% of assets, while it's competitor QQQ's 0.20% and delivers similar performance. Fidelity says the higher expense ratio is justified, considering the complexity of running an ETF that tracks the entire Nasdaq Composite. ONEQ offers investors more diversification and exposure to more mid- and small-capitalization stocks. ONEQ is the first ETF offered by the nation's largest mutual-fund firm. (John Shipman, WSJ 1-08) Since late March, 177 trading sessions have transpired. Over this period, there have been several brief pullbacks, [but] none exceeding 5%. This should bode well for the market's prospects in 2004. . . . A recent study by Professor John K. Harris, Tulsa University, . . . pinpointed 25 occasions in which 100 days went by without a 5% correction. He went back to 1942 and [found that], after the initial 5% pullback . . . the bull market which was in effect at the time was only 60% over. Since [in the current case] the initial 5 percent correction has yet to take place, this would suggest that the bull market could have many more months to run. (Dan Sullivan, The Chartist Mutual Fund Letter via Washington Post 1-04) A prevailing notion a year ago was that individual investors were disenchanted with the stock market and it would take years before their confidence would build to the point that they would return. . . . With that background, it hardly seemed likely that high-volatility and low-priced stocks would do so well this year. [Yet] the top 100 NASDAQ stocks were up 47% as of December 24, and the Russell 2000 was up 44%. With stocks rising, individual investors began buying mutual funds again. In the first 10 months of 2003, $123 billion flowed into equity funds, compared with an outflow of $26.3 billion in the same period of 2002. (Byron R. Wien, Morgan Stanley via Washington Post 1-04) Remember Freud's self-serving perspective on fees: he regarded them as therapeutic, because a paying patient had an incentive to take therapy seriously and to get better sooner. Believe it or not, mutual fund fees are therapeutic, too. That's because they encourage investors to put their savings into low-cost, passively managed index funds. (Daniel Akst, NY Times 1-04) When translated into dollars for American investors, stocks in some emerging markets more than doubled in 2003 - among them Thailand, up 134.3%, Turkey, 122.4% and Brazil, up 102.9%. Even some developed markets posted dollar gains that exceeded the American markets' 26.8% gain, as measured by Morgan Stanley Capital International's country stock indexes. Germany was up 60.1%; Canada, 52.1%; and Japan, 34.6%. Over all, the Morgan Stanley Capital International index of world stock markets, excluding the United States, rose 37.5% last year. Many large institutional investors expect more modest, single-digit increases this year. (Ken Belson, NY Times 1-02) While the drug industry's innovation pipeline looks clogged, the days of the blockbuster are not completely over. The consulting firm Datamonitor ranks 10 drugs with $1 billion in annual sales potential that are lined up for potential Food and Drug Administration approval in 2004. Leading the pack is Pfizer's pregabalin, a compound to treat neuropathic pain, epilepsy, and generalized anxiety disorder; Avastin, an anticancer drug developed by Genentech and Roche; Cymbalta, an antidepression drug from Eli Lilly; and the cancer-fighter Erbitux, marketed by Bristol-Myers Squibb and Merck. (Robert Gavin, Boston Globe 12-28) The technology that allows you to make phone calls over the Internet at cheap rates is poised to boom in 2004. AT&T, Time Warner Cable, SBC, and Verizon Communications, as well as start-ups like Vonage and Packet8, all plan big launches of the technology, know as "voice over Internet protocol" or VOIP. (Robert Gavin, Boston Globe 12-28) For 2003, European companies announced acquisitions of American companies worth $13 billion, compared with $44 billion in 2002, according to Thomson First Call. But nearly 40% of the year's total - or $5.1 billion - came in Q4, more than double the pace of Q3. (Daniel Gross, NY Times 12-28 ) Home Page Previous Factoid Top Sites
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