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What do you do when your plans go awry? First, don't panic. On Sept. 6, I detailed why having been too bullish doesn't necessarily mean that you should change course. Those principles apply now. The key is this: You should sell stocks only if you foresee trouble that other people don't foresee; don't sell in fear of trouble that everyone else is already anticipating. The only reason for a defensive posture, in other words, is perceiving risks that are little noticed. I can't find many. So what might be bothering you? Inflation? Rising rates? A weak dollar? Look closely and you will find that such worries are (a) widespread and already priced into the stock market and (b) exaggerated. Inflation is not as bad as you probably think it is. Over the past 12 months prices (excluding food and energy) are up 2.4%. As for rising rates: The rise is pretty much limited to the U.S. and to the short end of the maturity spectrum. Rates are not going up abroad (for the most part) and are not going up very much on long-term bonds. The 30-year U.S. Treasury yields 4.7%, down from 5.2% a year ago. Don't worry about interest rates unless you have an adjustable-rate mortgage. Rising short-term rates by themselves don't have a predictive history for global stock prices. Weak dollar? The dollar is actually up against all major currencies so far in 2005. Budget and trade deficits? They are for real, but they don't hurt the economy or the market, as I've pointed out in recent columns. Or, that stocks might fare badly for a decade as is currently fashionable to presume? Relax. There is no rational way to make such statements. Those who do are telling more about what they don't know than what they do. Stock levels a decade out result almost solely from shifts in the supply of securities six to ten years hence. No one knows how to estimate that. So don't let the gloomsters baloney you. If you want something to worry about, consider long-shot risks that other people are overlooking. One on my list is if George Bush appoints a disaster to replace Alan Greenspan. Another is if budding intracountry social tensions within the European Union cause an economic disintegration there. Others: a large terrorist attack; a new era of repression in China that depresses its economy. None of these is impossible, but I think the odds are sufficiently low that they do not justify an exit from equity investments.
You can't beat the feelings of watching your portfolio rise 20% or 30% in a year. It's great. You're the smartest guy in the room. You're witty, you're sexy, you're getting richer every day. You're at the top of your game. Then, wham! The market takes a dive. Suddenly, you're frozen and can do nothing. Maybe worse, you try to buy your way out of the selloff. But nothing you do makes a difference. Bear markets can come overnight and hang around for a long, long time. Who wants to live, or invest, that way? I sure didn't. I needed to break my up-down investing cycle, so I developed my own 12-step program that works for bull-market addicts just the way that other addicts have been aided by similar recovery plans. Practice these principles and you, too, could be enjoying a sense of peace you'll never find by obsessing over the market's daily roller-coaster ride. (You'll be richer, too.) 1: Admit you're powerless over the market, and your portfolio is unmanageable. Market cycles are totally unpredictable, and no one knows where the market is headed over the next few months or years. 2: Think in decades, not in quarters. Markets are fickle, volatile and irrational. And they go down. Forget market timing, you'll lose. Dalbar has followed mutual-fund investors for 19 years and found that market timers lost an average of 3.29% annually while dollar-cost averagers made 6.8% a year. Lesson: Always bet on the long term. 3: Turn to a "higher power," the market itself. The best way to make sure your investments go up over the long term is a well-diversified asset-allocation strategy that mimics the market itself: Buy index funds that automatically adjust their holdings for you. 4: Save 10%. If you aren't putting away 10 cents out of every dollar you make, you're spending too much and you are not saving enough for retirement. 5: Focus on your portfolio. Whether you're a retiree, boomer or college kid, most of your portfolio's long-term performance depends on your asset allocations, not the specific funds you pick. 6: Low turnovers lower your taxes and raise your returns. Actively managed domestic stock funds turn over their entire portfolios more than 100% every year. The manager's transaction costs reduce your returns and increase your taxes. Buy funds with turnover ratios under 30%. 7: Buy only no-load funds. Never pay a broker's commission. There are 1,057 no-loads among the 6,090 mutual funds in Morningstar's database. There's always a no-load that's as good or better than one with commissions. 8: Keep it simple. You need far fewer funds than you probably think. Studies suggest that 12 funds are enough for maximum risk protection, but when it comes to actual portfolio building, it varies. Some investment advisers recommend as few as six. 9: Stop playing with your portfolio. Rebalancing a well-diversified portfolio more than once a year is a waste of your time and money. Behavioral-finance professors Terry Odean and Brad Barber researched 66,400 Merrill Lynch accounts over a seven-year period and concluded that "the more you trade the less you earn." 10: Ignore the news. Buying or selling on breaking news is a loser's game. Markets react instantaneously to news, before an individual investor has booted up his computer or dialed his broker. 11: Don't believe people who "beat" the market. Just as an alcoholic shouldn't hang around the local saloon, a recovering bull-market addict shouldn't swap too many stories with investors who brag that they are way, way up. At best, they are deluding themselves; at worst they are lying. Don't let yourself go off the wagon and make more sucker investments. 12: There's life beyond the market. You may be powerless over the market, but you will have plenty of power over your own portfolio and your life.
For instance, 24% of men said they bought a hot stock without doing any research, versus 13% of women. Of that group, 63% of men said they did it again, whereas only 47% of women repeated the mistake. A majority of men cited holding a losing investment too long as their most painful mistake, yet 61% of men repeated the misstep, the survey found. By contrast, 48% of the women who waited too long to sell an investment did it again. And among men who ignored the tax consequence of an investment decision, 68% did it more than once, while only 47% of women did, the poll found. The survey, conducted by telephone last summer, examined the investment mistakes of 500 men and 500 women who had at least $75,000 in investable assets and an annual household income of at least $75,000. Merrill first released the overall findings in November, but didn't break it down by gender. The research comes as financial-services firms including Merrill are aggressively seeking to tap the women's market, traditionally an overlooked demographic. Merrill's Women's Business Development division focuses on women business owners, executives and philanthropists. PNC Advisors, the wealth-management arm of PNC Financial Services Group Inc., also targets high-net-worth female clients through its Women's Financial Services Network. Citigroup Inc.'s Women & Co. division, which charges $125 for membership, provides education and access to Smith Barney advisers who are particularly interested in working with women. Firms are reaching out to women because they are increasingly coming into wealth, either as small-business owners or as corporate executives. The female market also is attractive because women in general are more likely to rely on advice from professionals. In the Merrill study, about 70% of women said they had a primary financial adviser, compared with 50% of men. And 77% of women said they had a formal financial plan in place, versus 62% of men.
Don't Sweat Routine Market Correction When You Are Dollar Cost Averaging Lately, investors have been warned again and again that bonds could suffer nasty short-term losses if interest rates spike higher, because those rising rates would drive down the price of existing bonds. But in reality, unless you hold long-term bonds, the potential hit is pretty modest. Suppose you own a 10-year bond and yields rise from 4.5% to 5.5% over the next 12 months. After figuring in the interest you would collect over the course of that year, you would lose a mere 3.6%, calculates Vanguard Group. Moreover, this short-term pain would bring with it higher long-run gains. The reason: Thanks to the rise in yields, you would clock healthier gains when you sock away new dollars and reinvest your interest earnings. After the grueling 2000-2002 bear market, we are all well aware of how devastating stock-market losses can be. Nonetheless, even stock investors are sometimes overly fretful. I can understand being nervous if you have maybe $10,000 to invest. But I hear the same concern from folks who invest $100 or $300 every month. On occasion, readers have even told me they plan to quit their regular investment program, because they are convinced stocks will plunge. This doesn't make a whole lot of sense. If you invest $300 in a stock fund and the next day it tumbles 15%, you will lose just $45. True, if you had canceled your regular investment program, you would have avoided this loss. But you would also miss out on one of the big benefits of "dollar-cost averaging." Yes, this month's investment might purchase shares at a lofty price. But if you will continue investing through any market downturn, you will add to your holdings at lower and lower prices. Don't Sweat Fund Capital Gains Among stock-fund investors, I also hear way too much agonizing over year-end capital-gains distributions. If you buy a fund in a taxable account and the fund then makes a big distribution, you have to pay taxes on the distribution, even if you didn't enjoy any of the related gains. Once again, however, a little perspective is in order. If it's November or December and you are about to invest $10,000 in a stock fund, you should probably check that the fund isn't about to make a big distribution. But if you are salting away $100 or $300 every month, these distributions just aren't a big deal. Let's say you invest $300 in a fund and soon after the fund makes a long-term capital-gains distribution equal to 5% of its net asset value. You will have garnered an extra $15 in taxable income -- which will cost you a whopping $2.25 in taxes, based on a 15% capital-gains rate. So if you aren't going to fret about falling markets and fat fund distributions, what should you fret about? High on my list would be [1] investmenting in high cost mutual funds and [2] putting off the start of your retirement-savings.
The fact is, despite all the chatter about higher yields, a lower dollar and modest returns, these forecasts haven't been borne out by the market's recent behavior. What is going on? My hunch: Investors may indeed be right. But I'm not sure they will be right anytime soon. Prophecy: Rising Interest Rates For instance, in late 2003, economists were, on average, predicting that the 10-year Treasury note would yield 5.17% by year end 2004, according to a WSJ survey. Instead, the yield on the 10-year note finished at 4.24%. But economists are sticking to their guns, once again predicting that the 10-year note will be above 5% by year end. "When I look at the consensus forecast, my inclination is always to think that it will either go up less than that or more than that," says Kenneth Fisher, chief executive of Fisher Investments. "Will interest rates go up as much as people are forecasting? Unless you get abundant inflation, I think it's unlikely to happen." Mr. Fisher may sound like a knee-jerk contrarian. But his position makes a lot of sense. Market prices reflect the collective judgment of investors. If the vast majority of folks reckon rates are headed higher, presumably they have revamped their portfolios accordingly and thus this belief is already built into today's prices. "Markets are discounters of widely known information," Mr. Fisher says. "The things that move markets are the things that investors don't expect to happen. It's surprises that move markets." Prophecy: The Dollar's Decline Could a surprise drive interest rates higher? If foreign central banks pull their foreign-exchange reserves out of Treasury bonds and shift the money into other currencies, that could send the dollar reeling and cause U.S. interest rates to skyrocket. But at this point, "diversification" by foreign central banks has been so widely discussed that it would hardly constitute a surprise -- and the possibility may, in fact, be reflected in current currency values. Warren Buffett notes that "the fact that so many pundits now predict weakness for the dollar makes us uneasy." Sure enough, despite all the hand-wringing, so far this year the dollar has strengthened against the euro, yen and British pound. Prophecy: Lower Stock Returns That brings me to another piece of conventional wisdom: that stocks returns will be modest in the decade ahead. Everybody you talk to makes the same observation about long-run returns. But you don't see it in market prices. Indeed, despite forecasts of low long-run returns, investors appear to have a healthy appetite for stocks. The market had a gangbuster 2003 and a respectable 2004, and shares remain richly valued compared with dividends and corporate earnings. But earnings growth could prove surprisingly robust, leading to better stock returns than expected. Still, I believe the market consensus is at least partly correct. Over the next 10 years, the S&P500's performance will probably fall short of its eight-decade average of 10.4%, as calculated by Ibbotson Associates. Problem is, investors appear to be treating this long-run likelihood like it is a short-term market forecast. "It seems reasonable to say that stock returns in the decades ahead will be lower than in the decades before," says Meir Statman, a finance professor at Santa Clara University in California. "But translating that into what will happen in the next year or the next five years is really treacherous." You can make the same point about a whole heap of sensible investment assumptions. For instance, it seems likely that our huge trade deficit will eventually damage the dollar's foreign-exchange value, that the developing world's rapid growth will mean healthy gains for emerging-markets funds, that property prices won't continue climbing at today's heady clip and that -- after two decades of falling inflation and falling interest rates -- the next big move will be up. And those assumptions have some key investment implications: Favor shorter-term bonds, so you aren't so vulnerable to rising interest rates. Don't sink too much of your wealth into big homes and vacation properties. Save diligently to compensate for low stock returns. Dedicate 25% or 30% of your stock portfolio to foreign shares, including a decent stake in emerging markets. Keep in mind, however, that these are long-run assumptions and long-run strategies. What about the short term? In any given year, there's every chance these strategies will appear utterly foolish. One warning sign: You sound off about your investment views -- and nobody disagrees.
It might seem surprising that the stocks that Wall Street hates would do better than the ones it loves, but it makes a certain amount of sense. Contrarian investors actually look around for stocks with a lot of sell recommendations, and, if the company looks likely to survive, they buy. The reason is simple: Wall Street analysts hate to tell clients to sell. They avoid lowering their recommendation on a stock until after something bad has happened, when the stock already has fallen. Despite some analysts' awareness of the problem, they clearly have trouble with their ratings. The problem has gotten worse lately, even after the Wall Street stock-research scandals. Back in 2000, just as the stock bubble was bursting, 95% of the stocks in the S&P500 had no sells at all, according to Zacks. No stock had more than one sell rating. Today, only 38% are without sell recommendations. Of the 62% with at least one sell, 9% have five sells or more. Even after this groundswell of increased sell ratings, the stocks with the highest percentage of sell ratings still are doing better than those without any sells. In fact, the period when buy-rated stocks have recently performed best was during the stock mania of the late 1990s, when out-of-favor stocks were being abandoned and it was hard to find sell-rated stocks at all. From 1991 through 1996, the stocks with the most sell ratings outgained those without any sells, Zacks found. But from 1996 through 2000, those with no sells outpaced those with the most sells -- possibly in part because there were so few sell-rated stocks to measure. Since 2000, even though Wall Street supposedly has become more discriminating, the sells are leading again. In 2003-04, the sells rose 36% on average, while the buys rose just over 25%. David Dreman, chairman of Dreman Value Management, believes analysts are often wrong. A study he has done shows that analyst forecasts for corporate profits in a wide group of large and small companies have been off over the past 30 years by an average of 40%, either above or below the actual result.
Bernie Schaeffer, a veteran market player who heads Schaeffer's Investment Research in Cincinnati, suggests that many investors need to do a better job in this transition phase of assessing the risks they might face if the optimistic scenarios don't pan out. He worries that the relatively low level of volatility in the stock market over the last year has lulled investors into believing that a major decline is highly unlikely. Schaeffer fears the opposite - that a market pullback could be "rapid and scary", if one happens. The lesson of the 2000-02 bear stock market was that many people whose portfolios were overly exposed to risk found out that once their nest eggs were severely damaged, recovery was an extremely long road. A prudent investor today should be asking the questions that many didn't ask at the market peak in 2000: If things go bad, how bad could it be for me? The idea of prudence today ought to apply to other investments as well, including bonds and real estate. In this transition phase for the economy and markets, there simply is no good reason to be taking on a lot of risk, Schaeffer said. "It's like running in front of a steamroller to pick up nickels and dimes," he said.
Five mutual funds offered by J. P. Morgan and sold under the Intrepid brand are run according to principles of behavioral finance. All have outperformed the S&P500 index over the 12 months through March. The flagship Intrepid America gained 11.1% in the 12 months through March, compared with a 6.7% gain for the S&P500. Intrepid Contrarian gained 8.1% in that period. Contrarian, America and two other Intrepid funds, Value and Growth, were introduced two years ago. The fifth in the series, Intrepid European, is nearly five years old. What they may be onto are the systematic mistakes that even exceptionally knowledgeable people like Wall Street analysts are prone to make. For instance, there are studies showing that analysts tend to make far more earnings revisions of the companies they cover in the second half of a fiscal year than in the first, said Silvio Tarca, one of the managers of the Morgan funds. The reason, he said, is that analysts fall in love with their forecasts and resist changing them until the hard facts of corporate performance can no longer be ignored. A good buy candidate, he said, is a stock that has just had its first upward earnings revision and is still cheap, based on common valuation measures. Stocks to avoid include strong performers whose valuations leave little room for disappointment, Mr. Tarca said. "When companies have outperformed the market over three to five years, investors tend to extrapolate that performance out into the future," he said. "Investors become overconfident in their forecasting ability, they rush in to buy these glamour stocks, and they become overpriced." Managers of the Intrepid funds have incorporated a stock-picking process based on behavioral finance theory into a computer model. The model looks for two types of candidates: value stocks, whose prices have been knocked down more than is deserved, and momentum stocks, whose prices have yet to catch up with improved growth prospects. Often stocks can qualify on both criteria. This was the case with one of Intrepid America's five largest holdings, ChevronTexaco. Others in the top five are Johnson & Johnson, Bank of America, I.B.M. and the Altria Group. Johnson & Johnson is the only pure momentum play among the five, Tarca said. Bank of America and Altria are value holdings, as is I.B.M., which offers "good value, particularly relative to other I.T. stocks."
''We actually find no evidence that independence, by itself, matters," said David Weinbaum, of Cornell University's Johnson Graduate School of Management, who cowrote the paper with Martijn Cremers, of Yale University's School of Management, Joost Driessen, of the University of Amsterdam, and Pascal Maenhout, of INSEAD. The finding could rekindle controversy over a SEC rule adopted last year requiring that 75 percent of fund directors, including the chairman, be independent of the fund-management company. Two Republicans on the five-member SEC opposed the requirement, set to take effect next year, and it is being challenged in court by the US Chamber of Commerce. Academics looked at performance at the 25 largest US stock mutual fund families in recent years, considering fund directors' pay and investments in the fund and fund family, both for independent and non-independent directors. Independence in and of itself didn't affect fund performance, and non-independent directors, typically from the fund-management company, could have a very strong, positive effect on funds when their interests were aligned with those of ordinary investors through fund ownership. The best performance came when fund directors had substantial investments in the fund or fund family and relatively low pay of less than $75,000 a year, researchers found. By investing in funds where directors have high investments and low pay, they said, fund shareholders might realize additional risk-adjusted returns of 1.5 to more than 4 percentage points per year. Researchers aren't sure fund ownership by directors, known as having ''skin in the game," is what causes better performance, but think it may have an impact. Fund fees are a factor, but not a huge one. The researchers found fees tend to be lower at funds whose directors have a big ownership stake, but they determined that lower fees only account for about 20 percent of the difference in performance. They also found no evidence to suggest results are skewed because fund directors might somehow be picking the best funds in which to invest. Some fund companies require directors to own shares in funds they oversee, while others don't. On average, researchers found about 32% of independent directors and 40% of non-independent directors hold shares in the funds they oversee, but the vast majority, between 80% and 94%, do invest in other funds offered by the fund family.
A crisis is brewing in U.S.-China relations, owing to an apparently yawning U.S. trade deficit with China. Last year, the U.S. imported $162 billion more from its trading partner than China imported from the U.S. And this year, as Chinese apparel and textile exports flood world markets, the trade imbalance is on track to top $200 billion. In response, the Senate this month informally approved a measure that would slap 27.5% tariffs on all goods from China if that country doesn't revalue its currency, the yuan, in the next six months. The argument popular in Washington says China must unpeg the yuan and let its value rise so U.S. companies can again compete to get their goods into Wal-Mart and Target. But this is a fiction. The trade deficit is a misleading statistic. The merchandise trade figures do not take account of how products are made in today's global economy. Companies in "our industry here in Southern California do the designs, the patterns and colors and sizing and specs for all the garments made elsewhere," says Ilse Metchek, executive director of the California Fashion Assn. The patterns and instructions are sent over the Internet to factories in China, where the garments are made. They are then shipped back through the ports of Los Angeles and Long Beach and on to stores. Although the patterns that go out over the Internet don't count as "exports," the garments that come back in through the ports count as "imports." Thus, the trade "deficit" is said to widen. The pattern is the same in toys. Jordan Kort's Northridge-based What Kids Want Inc. designs toys under license from Walt Disney and Nickelodeon. Princess dolls and other toys are manufactured in China, but the lion's share of the proceeds from making and selling the toys go to Kort's firm, the retailers and Disney and Viacom. Indeed economists estimate that the Chinese manufacturers earn only 20% of the value of the goods they make for export. Meanwhile, major U.S. companies are thriving in China. Most world-class products in China are made by affiliates of U.S. and other foreign companies. Motorola makes a lot of the country's cellphones, GM makes cars, Caterpillar makes bulldozers. The numbers add up. Affiliates of U.S. companies enjoyed more than $75 billion in sales in China last year and recorded $3.5 billion in profits. None of those sales and earnings by affiliates figure in the export-import statistics. The real trouble is not the growth of the Chinese economy but the slowing of that growth. Infrastructure is failing in China. Factories are operating three to four days a week because they lack electricity to stay open full time. Electrical power is insufficient because railroads can't carry the coal to the power plants fast enough and there aren't enough power plants to begin with. That's ominous. The Chinese government wants to keep annual growth at 8% of the $1.3-trillion GDP so 20 million jobs a year can be created. The government fears unemployment because it can add to political unrest, already evident in frequent public demonstrations in the poorer, western regions of China. The dilemma for the Beijing government is that raising the value of the yuan would curb exports and reduce employment further. Yet the foreign reserves that China is taking in from trade and investment by international companies and from speculators betting on Shanghai real estate are distorting the economy in other ways. So China will take some action in the next year, most likely allowing the yuan to fluctuate moderately against the dollar, predicts Arthur Kroeber, editor of the Hong Kong-based China Economic Quarterly. But another expert, Morris Goldstein of Washington's Institute for International Economics, believes that moderation won't work. China will have to revalue its currency strongly — by at least 15% — said Goldstein, formerly an official of the IMF. "I don't say it will be easy," he said, "but it is necessary."
That figure seems sure to rise in coming years because developing economies, from Eastern Europe to China, are growing at about 8% a year, compared with 3% to 4% for the U.S. and scarcely any growth at all for Western Europe and Japan. Businesspeople look at such growth in formerly poor countries and see opportunity and long-term promise. "We are witnessing a revolution in the movement of capital," says economist John Rutledge, an advisor to President Reagan and the current Bush administration. Many Americans, however, look at the same emerging economies and see only a threat to U.S. jobs. Whether it's computer programming being performed in India or manufacturing of such diverse products as cars and clothing in China, the popular images of the global economy are creating anxiety at home. This is driving political moves in Congress and alarmist outcries on television and in a rash of new books that picture U.S. workers as a vanishing species. But the alarms get globalization all wrong. We've been here before. In the 1960s, the anxiety was over computers idling millions of workers. In the 1980s, the rise of Japanese industry was supposed to turn Americans into hamburger flippers. The nightmare visions didn't come true then, and they certainly won't come true today. Computers unleashed a huge new information industry, creating many thousands of jobs. And the competition from Japan pushed America into new frontiers such as technology and healthcare, where the U.S. now dominates. Likewise, globalization is creating wealth for American companies and new jobs at home as well as overseas. GE is a prime example of the way the world is turning. "Globalization is an asset for us," is how GE Chairman Jeffrey Immelt puts it. He sees the developing economies of Eastern Europe, Russia, the Middle East, India and China as GE's aces in the hole. Why? Because those countries are moving from village to city and farm to highway and therefore need GE's turbines for electric power plants, locomotives, jet airplane engines and water treatment and desalination plants. More to the point, the GE example also demonstrates that growth abroad can lead to benefits at home. The company employs 129,000 people in the U.S., a number relatively unchanged in the last five years, and 98,000 outside the U.S., up 6% since 2000. The non-U.S. employment seems sure to grow because foreign operations are now 49% of GE's $152 billion in annual revenue, up from 31% only three years ago. But work changes with technological advances, and the average job at domestic GE now pays double what it did 10 years ago, the company says. (In comparison, average weekly wages have risen only 30% over the same period, according to the BLS.) The truth is that modern work is increasingly shared across borders. GE, for example, makes jet engines in Evendale, Ohio, for new regional jets in China, with some parts made in China. Servicing of GE airplane engines is performed in Prestwick, Scotland. And lease financing on airplanes is done by its U.S.-based GE Capital Aviation Services. The company employs advanced materials and technology to make gas turbines in Greenville, S.C., for electrical plants around the world, with some parts made in other countries. "The intellectual capital components are made here," a spokesman says. Even intellectual capital development is becoming a cross-border operation. GE in recent years has opened technology research centers in Bangalore, India; Munich, Germany; and Shanghai. That means some discoveries will be coming from abroad because the U.S. certainly has no monopoly on brains. GE today has 1,800 researchers in Bangalore. The company also has invested $100 million to rebuild the venerable research lab at Niskayuna, N.Y., where GE's early geniuses Thomas Edison and Charles Steinmetz worked in the 19th century. Whether the work is done in Bangalore or Niskayuna, if it makes profit for a U.S. company it benefits Americans. As companies make more profits overseas, those earnings form the basis of higher stock prices in markets. And that expands the wealth of Americans through their pension or mutual fund or individual investment accounts. And not to be overlooked is the fact that growing profits finance expansion and new ventures everywhere for U.S. companies. GE has used its profit in recent years to expand into biotech, where it is teaming with Eli Lilly for research on Alzheimer's disease, and water desalination, where it is embarking on a major contact in Qatar. It has also acquired Universal Studios, combined it with NBC and is expanding both. To be sure, the domestic jobs picture is clouded. U.S. employment growth in this economic recovery has been weaker than in previous economic cycles. And wages are not growing. A study by the Economic Policy Institute finds that productivity and profits have risen far faster than wages in the current business cycle, a reversal of the historic pattern. Inevitably, some U.S. workers will be displaced. Management consulting firm McKinsey & Co. advocates special government and private industry insurance to finance retraining for employees. Yes, a lot of work in the future will be done outside the U.S.— but a lot of work will be created in this country as well. As the largest economy and the creator of most of the world's capital, the U.S. need not fear globalization. Instead, the American economy stands to benefit mightily from rising living standards for billions of formerly poor people.
But the focus on the globe's economic hotspots may be overshadowing some of the world's slower-growing, established economies that are the longtime trading partners of the United States. When macroeconomists talk about deficits in the context of today's global economy, they usually refer to America's twin deficits - the government budget deficit and the current account deficit. But economists say a third deficit, the so-called "growth deficit" in Europe and Japan, is having important effects on the United States economy. Earlier this month, the European Central Bank reduced its forecast of 2005 growth for the Euro area-the 12 nations using the Euro as their currency - from 2.0% to 1.6%. The IMF expects Japan's economy to grow by a mere 0.8% in 2005. The IMF expects the United States to grow 3.6%. Two-way trade between the United States and European Union members was $41.1 billion in February, second only to Canada. Trade with Japan was $15 billion, compared with $19 billion for China. Lakshman Achuthan, managing director at the New York-based Economic Cycle Research Institute, notes that the volume of United States trade with the G-6 countries (Japan, Germany, France, Italy, Britain and Canada) is four times as large as the trade with China and India combined. Consider the weakness of American exports. The level of imports tends to grab headlines - $161.5 billion in February, the Commerce Department reported last Tuesday. But exports matter, too, especially since they can stimulate domestic job creation. In February, exports totaled just $100.4 billion. The large developed economies of Japan and Europe have the resources - in theory - to buy the expensive goods and services the United States produces. And the story that U.S. exports have been stagnating for the last four years is really underplayed. Exports of goods and services fell from 11.2% of GDP in 2000 to 10.3% in 2004. Clearly, slow growth in large overseas economies harms exports. But the seemingly chronic weakness in Europe and Japan is a boon to the vast portion of the American economy that is sensitive to interest rates. Alan Greenspan has spoken of the conundrum of persistently low rates on United States government debt. But because growth in Europe and Japan remains muted, and because monetary policy remains accommodative in those areas, United States government bonds seem high-yielding compared with their Japanese and European counterparts. The growth deficit in Europe and Japan is also helping to tamp down inflation. If Japan and Europe were growing at a more rapid clip, oil prices would likely be far higher. And a small difference in growth in a slow-growing giant can help ignite the fear of inflation. In 1999, when Japan's economy moved from contraction to expansion, it helped cause a spike in oil and commodities. Perhaps the idling economic motors in Europe and Japan receive so little notice because we've become accustomed to them. After all, Japan's economy hasn't grown robustly for nearly a decade and a half. And some of the reasons for the lower growth are structural - low population growth and constrictive labor laws in Europe in particular. But in macroeconomics, as in investing, past performance is no guarantee of future results. In the early 1990's there was a perception that Europe and Japan were going to be growing more rapidly than the United States, thanks to their allegedly superior industrial policy. Just so, the differential in growth rates between the United States and Europe and Japan isn't going to go on forever. The United States may be growing somewhat faster than its long-term growth rate, and Japan and Europe may be growing somewhat more slowly than their potential growth. People who extrapolate are just not looking at history.
State Street Global Advisors, for instance, recently raised its ranking of the U.S. market a tad on the back of strong fourth-quarter earnings reports. But it still prefers stock markets in Singapore, Hong Kong and the 12 euro-zone nations. European and other international investors directly own about 11% of the U.S. stock market, according to Birinyi Associates, an equity research firm in Westport, Conn. That is small compared with foreign participation in most other major stock markets. Still the attitudes and actions of European, Japanese, Canadian and other non-U.S. investors are important. A bit like swing voters in an election, they can help determine whether the U.S. market overall, industrial sectors or specific stocks rise or fall. Europeans are having enough trouble getting enthusiastic about their own stock markets to want to take a gamble on a more expensive Wall Street, says Gareth Williams, an equity strategist at Lehman Brothers in London. On average, U.S. stocks are selling at 15.6 times analysts' average corporate earnings projections over the next 12 months, according to Mr. Williams. That compares with 12.8 for Europe excluding Britain and 11.9 for Asia excluding Japan. Among the world's major regions, only Japan's price-earnings ratio is higher than that of the U.S., albeit not by much, at 16.1.
American companies increasingly import many of the parts and components that go into the products they make in the United States. Gasoline engines purchased abroad for cars assembled in America were up 8% in January, to $960 million. Imported steering and suspension mechanisms also shot up 8% in January. Even when American companies make a product at home, their customers often prefer the imported version. The front-loading washing machine is a case in point. It has gained market share in the United States on a reputation for using less water and less energy than the traditional American machines. Front-loaders are made here, by Maytag and Whirlpool, among others, but they are not a high priority. By contrast, front-loaders are the most popular clothes washers in Germany, and appliance makers in that country, among them Siemens and Miele, are leading exporters of these machines. To satisfy American demand, shipments from Germany have risen sevenfold since 1999, to $419 million in 2004, including a 122% increase last year. While fashion and preference drive some imports, industrial integration on a global scale is the biggest single factor. American companies with operations abroad now account for nearly 48% of the nation's imports, the Commerce Department reports, up from an average of 45% in the 1990's. The Eaton Corporation makes truck transmissions in Brazil to be used in Navistar trucks. Ford makes gasoline engines in Mexico for cars assembled in the United States. Medtronic imports coronary stents and angioplasty balloons from its factory in Ireland. But the American-made content of a heart stent, a jet aircraft engine, or any imported item might be 50% of its value or more. But in the trade statistics, that distinction is not made; the entire value is listed as an import. General Electric has gradually shifted the manufacture of some refrigerators to its plants in Mexico and South Korea. That shift and the growing presence of Asian manufacturers like LG Electronics, a Korean company with a factory in Mexico, has contributed to a 154% rise in household refrigerator imports since 2000. How Fund Categories Fared Barrons 4-04-2005
There's now a risk that "the regulatory scrutiny either frightens off firms that are considering such fees or even forces firms already using fees to jettison them," Kunal Kapoor, director of fund analysis at researchers Morningstar. Indeed, Accessor Capital Management in January eliminated performance fees from its lineup of 15 funds. Regulators have not found fault with fee calculations at Fidelity and Vanguard, who continue to use performance fees on a combined 73 funds with $493 billion in assets. Pacific Life Insurance Co., meanwhile, got clearance from the SEC in December to try an unusual performance-fee formula. The management fee paid by investors in the $31 billion Pacific Select Fund will decrease, not increase, if the fund's average return over 10 years exceeds a target 8% a year. Under SEC rules, fund companies generally base performance fees on how returns stack up against a benchmark -- rather than whether investors make or lose money. One exception is the closed-end Royce Value Trust, which years ago got SEC clearance to waive its management fee if performance over a three-year period is negative. The rules also require a fund company that gets extra pay for doing well relative to a benchmark to suffer a similarly size reduction in pay if it does poorly. That isn't the case at hedge funds, where managers typically get their base pay even if returns fall into negative territory. The SEC's recent gripe with Bridgeway concerned the asset base on which performance fees were calculated. SEC rules require fees to be based on the average assets during the period used to measure performance. But Bridgeway calculated its fee based on the latest asset levels, which were higher than the five-year average, resulting in investors being overcharged. Other funds that allegedly overcharged investors, according to fund filings, include n/i numeric investors Small Cap Value Fund, Gartmore U.S. Growth Leaders Fund, closed-end Taiwan Fund and WWW Internet Fund, which was liquidated last fall.
Specifically, Pfizer was owned by 78% of blend funds, which invest in a mix of value and growth stocks, 68% of value funds and 68% of growth funds. Microsoft showed up in 74% of blend funds, 62% of value funds and 74% of growth funds. Citigroup was held by 62% of blend funds, 72% of value funds and 56% of growth funds. For the survey, Merrill looked at 150 funds, split into blend, value and growth categories, with a total of $1.1 trillion in assets. The average number of stocks held by a fund was 112. The report marked the first time Merrill reviewed investment styles as part of its quarterly analysis of fund-stock ownership. Sarah Franks, a strategy analyst at Merrill Lynch and co-author, said Merrill decided to include investment styles at the request of readers. According to the report, growth-fund managers see the biggest opportunities in stocks of financial firms and the consumer discretionary niche, which includes auto makers, retailers and media companies. Value funds are invested heavily in consumer staples such as grocery stores and food and tobacco companies, and generally avoid financial stocks.
Benvenuto estimates nearly 10% of retail accounts at large fund complexes consistently run far enough below minimum investments to become money losers warranting some form of intervention involving a warning or sanction. Putting a dollar amount on the problem is difficult because account minimums vary significantly from firm to firm. Expenses rise exponentially in inverse proportion to account size, Benvenuto said. For example, servicing costs in accounts funded with only $250 typically amount to 8%. Expenses fall to 0.66% when the account balance rises to $3,000. FRC's study, which also examined prospectuses from 20 large fund complexes, found most large investment providers' prospectuses include language spelling out sanctions and penalties for underfunded accounts. Each of the fund providers that participated in FRC's survey reported across-the-board amnesty for accounts falling 25% below minimum investments due to market fluctuations.
The change follows a fee cut by Fidelity Investments, which last year reduced fees on five of its index funds to 0.10% -- below those on Vanguard's Investor share-class funds, which most Vanguard investors own. Fidelity recently said the fee cuts would be permanent. Starting May 10, investors in 63 Vanguard funds will be able to qualify for Admiral shares if they have fund account balances totaling $100,000 or more. Previously, investors needed a $250,000 account balance or $150,000 in a Vanguard account established for at least three years to qualify. As a result of the change, the number of shareholder accounts eligible for Admiral shares will roughly double to more than 700,000. The amount of assets eligible will double to about $225 billion, accounting for more than a quarter of the $825 billion managed by the firm. Home Page Previous Factoid Top Sites
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