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Just as the previous research had shown for individual traders, the study found that male fund managers took more aggressive bets, were more likely to invest in stocks that had little in common with the other stocks they already owned, and were more likely over time to change the dominant investment style of their funds, a phenomenon called style drift. Previous studies found that, among individual traders, men were more likely than women to be overconfident in their abilities and thus trade too much. The researchers found a similar result among fund managers: the average fund managed by a man had a turnover rate that was 10% higher than that of the average fund managed by a woman. Given those differences, the researchers expected to find that the average female-managed fund had better overall performance. After all, previous research has generally shown that style consistency and lower turnover rates lead to better returns. But that is not what the researchers found. In fact, the raw returns of funds managed by women were slightly lower than those of funds managed by men, on average, evidently because women tended to manage their funds more conservatively. On a risk-adjusted basis, the two groups' performances were about equal. The researchers do not know the reason for this, but they do note that the behavioral differences between male and female fund managers are less pronounced than they are among individual traders. Although the researchers found no significant differences in returns once an allowance has been made for risk they say they believe that funds managed by women can lead to improved performance for investors who are constructing diversified portfolios. Often in such cases, an investor chooses a certain fund because it represents a specific investment style or asset class. If the fund is managed by a man, the researchers argue, there is a greater chance that he will not stay true to that style or class.
Why have small-caps out-performed for so long? "Forward earnings for small-company stocks rose faster than bigger-company ones last year, as they have for the past four years," says Edward Yardeni, chief investment strategist at mutual fund manager Oak Associates. Some analysts have been calling at least two years ago for a shift of market preferences back toward big stocks. The object lesson -- the timing of changes in relative performance among asset classes is no easier to predict than the ups and downs of the market as a whole. So the small-stock bandwagon may keep rolling. Given my argument that investors can't time these moves, what's a small-stock partisan to do now? There is one reasonable alternative. That is simply to rebalance, moving enough money out of small-stock funds into some big-stock vehicle to get the proportions back to whatever ratio was called for in your original asset-allocation plan. If you started out the 21st century with, say, $100,000 in each category, today you may have $186,000 in a hypothetical small-cap fund and $93,000 in a big-stock index fund.
Armed with enormous amounts of information about past market trends, analysts try to predict the future. Because they emphasize different sets of data, they often come up with very different conclusions. Steven C. Leuthold, chairman and chief investment officer of the Leuthold Group, relies on lots of numbers to make judgments about the market. His firm's mutual funds, in the aggregate, have outperformed their category peers in each of the last five years, according to Morningstar. The numbers tell Leuthold that small-cap stocks, as well as the overall domestic stock market, are likely to slow down. He says historical data suggests that the current string of small-cap of outperformance is "long in the tooth." Reviewing the numbers since 1926, Leuthold found that periods when small caps have done better than larger stocks have averaged 68 months, or almost six years. Only the rally of 1974 to 1982 was longer than the current one, which has lasted for nearly seven years. The current rally has made small caps less attractive from a fundamental valuation perspective. When small caps began to rise, they were 40% cheaper than large caps, according to measures like the price-to-earnings ratio. Today, they are about 10% more expensive. Worse yet, their earnings momentum has slowed. And this fundamental deterioration has begun to show up in trading patterns. For the first time in six years, fewer than 50% of small caps are outperforming the Standard & Poor's 500-stock index, he said. With all the numbers pointing in the same direction, Leuthold has no trouble forming an opinion: "Small-cap leadership is drawing to a close," he said, and no other group looks particularly strong. While Leuthold is cautious about prospects for the domestic market, Jeremy Grantham - chairman and chief strategist at Grantham, Mayo, Van Otterloo, which manages more than $100 billion - is downright pessimistic. Relying heavily on data that compares the current and past valuations of asset groups, Grantham each month issues a seven-year forecast. Although he is confident about getting the future trend of asset classes right, he is not so sure about the timing. "You'll never get that timing exactly right." But investors who don't mind being wrong for a year or two can do well over the long haul. Grantham said. "We live in a reliably mean-reverting world," explaining that every six and a quarter years, on average, assets return to their fair valuation, as measured by the replacement cost of corporate assets. From that point, they rise or fall in relation to that valuation, but eventually come back again. Predictable reversion to the mean leads him to conclude that small caps "will underperform larger stocks over the next seven years." He predicted an average annual decline of 1.7% for small caps, versus a decline of 1.2% for the largest 1,000 domestic stocks. By contrast, Grantham sees further appreciation potential in Japanese stocks. (So does Leuthold, who said, "We have the Japan market on our buying list.") Though Japanese equities have doubled in value since spring 2003, Grantham said, "I think Japan's about 15% cheaper than the average international developed country." Grantham favors investments in commodities generally, with one clear favorite. "I love timber," he said. Grantham expects timber investments to rise in price by 6% a year, on average, over the foreseeable future. He said wood prices had risen steadily for decades. Jim Rogers is ragingly bullish about the broad class of commodities. Rogers is a former hedge fund manager - he founded the Quantum hedge fund with George Soros in 1969 - and is the author of several books, including "Investment Biker: Around the World With Jim Rogers." He says commodities are in the early stages of a long bull march that should run for a decade or more. A sharp curtailment in mining exploration during the last bear market, along with the rapid industrialization of China, have left supply and demand "out of whack," Mr. Rogers said. Historically, bull markets in commodities have lasted 15 to 23 years, suggesting that the current surge should continue until at least 2014. Mr. Rogers sees great potential for gold, which has stormed to more than $550 an ounce. "Gold will undoubtedly make an all-time high," reaching more than $875 an ounce. Rogers holds Japanese stocks, which he considers a good long-term investment. "We will probably buy more if they keep selling off," he said. But he is hardly bullish about the American market, which he contends is richly valued. "I'm not optimistic about stocks over the next few years in the U.S. and in most Western countries." While he relies on historical data, instinct clearly plays a part in some of his judgments. He believes that financial stocks are especially vulnerable because people who work in the sector seem to be making too much money. "Even though the stock market's been bad for seven years, everybody's making a fortune," he said. "That's where the excesses are."
So how do stocks perform once bulls like this one enter their fourth year? The short answer is that they tend "to catch a second wind," said Sam Stovall, S.& P.'s chief investment strategist. Over the last 63 years, the S&P500 has soared 14%, on average, in the fourth year of a bull market. [See article below before you get too comfortable about 'year fours'.] There are a number of possible explanations for this late-stage surge. For example, investors who lack conviction may see the lackluster gains - or, in some cases, losses - generated in the third year of bull markets as a reason to head for the exits. In that way, Mr. Stovall said, third years tend to "shake off all the loose hands" just in time for the fourth, leaving the most persistent investors to give the market another boost. Investors may not know what to think this year. While the Dow is down nearly half a percent, the S&P500 is up more than 1%, the Nasdaq composite index is up 2% and the Russell 2000 index of small stocks is up nearly 5%. "That's the good news," said James Stack, editor of InvesTech Market Analyst, a newsletter. "But there's also bad news." In four of the last seven fourth years of bull markets, stocks disappointed: in one of those instances, they lost value, and three times they posted only modest single-digit gains. In the overall averages, however, such duds have been masked by three spectacular fourth years in which gains were about 30%. The most recent was the fourth year of the bull market that began in August 1982. What type of year is in store for the market now? Mr. Stovall, for one, predicts a somewhat below-average year, with single-digit gains. Note that the current bull market started on Oct. 10, 2002, the day after the S&P500 sank to 776.76. So the fourth year technically started on Oct. 10, 2005, not the beginning of 2006. Use the October starting point, and you find that the S&P has already surged more than 6%. How much farther can this bull run? Stack says that better-than-average fourth years of bull markets have tended to have something in common: "There was either a recession or a significant market correction in the prior three years. That helped ease some of the imbalances that develop in an aging bull market." As long as they don't set off new bear markets, such midcycle setbacks can help bulls recharge their batteries. But because the current bull market hasn't faced such a correction - despite geopolitical uncertainties, natural disasters and record energy prices - big risks remain. This is true of most bull markets: as they age, risks increase for investors. Jeffrey N. Kleintop, chief investment strategist at PNC Advisors, warned that market blowups "are common in the second half of a cycle." That would explain why many bulls don't survive through a fourth year. In the last 75 years, the average length of a bull market has been 3.7 years, according to InvesTech Research. The median is even shorter, at 3.2 years. How can stock investors reduce risk in the fourth year of this bull market? Here are some ideas: Focus on High-Quality, Dividend-Paying Stocks Typically, bull markets begin with investors betting on big gains in speculative stocks. But as bulls mature, attention shifts to shares of higher-quality companies. A study of bull markets going back to 1900 by Ned Davis Research, seems to bear this out. An index constructed for the study showed that in the first third of bull markets, stocks that pay dividends tend to trail those that don't pay them. In the middle third, the dividend payers lead slightly, but in the final third, dividend payers, on average, win handily. Alan F. Skrainka, chief market strategist at Edward Jones, says that "you should not own investments today that you would not want to own in a recession tomorrow." And while "quality bounces back," he said, "speculative investments fall and sometimes never recover." Don't Forget the Blue Chips It's true that small-capitalization stocks tend to beat large caps in all phases of bull markets. But Ned Davis Research found that the outperformance of small stocks tended to wane in the final stage of a bull market. For instance, small caps have historically beaten large caps by a significant margin in the first third of a rally; by the final stage, that lead shrinks by two-thirds. This time around, Kleintop says he thinks that large caps can wrestle away market leadership from smaller stocks. For starters, small caps have beaten large caps for more than five years. And large caps are cheaper than small caps on a price-to-earnings basis, even though blue-chip earnings grew faster than small-company profits last year. Play a Little Defense Two sectors that tend to excel during fourth years of bull markets, Stovall said, are health care and consumer staples. Neither depends on robust consumer spending in order to prosper. Since 1942, the consumer-staples sector has shot up 26%, on average, in fourth years, while health care has jumped 31%. A third sector that typically does well late in bull markets is technology. But strategists say investors may want to focus on tech stocks trading at lower P/E ratios, in case stocks pull back in the middle of the year. "The time to swing for the fences is in the first year of a bull market," Mr. Stack said. But "when you get to the fourth years, it's time to settle for singles."
Happily for the bulls, the pattern improved after that. Following consecutive gains in 1982-84, the S&P 500 climbed another 26.3% in 1985 -- and for good measure went on to put up plus signs for another four consecutive years. After advancing in 1991-93, the index sustained a relatively mild 1.5% setback in 1994 before surging ahead again. Following gains in 1995-97, it climbed 26.7% in 1998 and added a fifth year to the winning streak in 1999.
Morningstar recently completed a study, published in its Morningstar Mutual Funds newsletter, of how its rating system has worked. It found that the average domestic equity fund earning five stars on June 30, 2002 produced a 10.1% annualized return over the three years through June 2005, slightly beating the 10.0% of the Dow Jones Wilshire 5000 index. Progressively lower returns were produced by the other four rating categories, with the average one-star fund having an annualized return of 8.1%. In a separate study completed in December, this result was confirmed by two Pace University finance professors, Matthew R. Morey and Aron Gottesman. Investors have for years placed great weight on Morningstar's ratings. Researchers have found that a five-star rating, Morningstar's highest, typically leads to outsized inflows of new money, and that a one-star rating leads to a lopsided number of redemptions. Morningstar grades funds on a curve, giving its highest grades to the best performers. The 10% of funds at the top of a ranking of recent risk-adjusted performance, for example, are given five stars. The next 22.5% get four stars, the middle 35% get three, the 22.5% below that get two and the bottom 10% get one. The biggest change in 2002 was to alter the group of funds against which a given fund is compared. Before June 2002, a domestic equity fund essentially was compared with all other domestic equity funds. As a result, a fund whose manager had inferior stock-picking skills could nevertheless earn five stars if his investment style happened to be in fashion. Morningstar corrected this defect, dividing funds into 48 groups. A fund's rating is now based on how its return compares with that of just the other funds in its category. In deciding which investment styles should be emphasized in your portfolio, Morningstar's ratings are of no use. That's because its five-star list, as well as its one-star list, always contain funds from each of its style categories. In deciding whether to concentrate a portfolio in, say, small-cap value funds, you will need advice and analysis from other sources. There is another reason to view the ratings as just one piece of the fund selection puzzle: in some respects, the system is a work in progress. In October 2003, for example, Morningstar introduced additional changes in how it rates international funds. It is continuing to adjust the ratings system. On a more basic philosophical level, Morningstar's attitude toward its rating system reflects a belief that statistics play a limited role in investing. As Mr. Kinnel puts it, "investing is much too complex for any single measure to sum up the entire merit of a security."
[1] Historically, longer-term interest rates usually have been higher that short-term rates because investors required compensation for expected future inflation, which was likely to be volatile. [2] That calculus has changed because of the Federal Reserve's success in keeping core inflation both low and less volatile. `The bond risk premium on the 10-year Treasury note is unusually low -- around zero -- when the 10-year yield is compared to expected future short-term interest rates,' he said. `Many explanations have been offered to explain the conundrum --including central bank buying of Treasuries and pension fund duration extension. `But the collapse in the volatility of inflation relative to the volatility of real rates is a much more compelling explanation,' Dudley said. Over the past 15 years, volatility of the core personal consumption price index consistently has been much lower than that of inflation-adjusted short-term interest rates. According to Dudley's estimates, inflation volatility last year was less than a fourth of that of real rates. `This change makes investing in longer-dated fixed-income assets more attractive,' Dudley said. `Investors can lock in a stable real rate of return and are subject to little inflation risk.' On the other hand, buying a series of short-term securities isn't likely to provide a similarly stable real rate of return because the Fed, in an on-going effort to keep inflation low, will raise or lower its short-term rate target as needed. Pension plan administrators or households saving for retirement particularly can benefit from `locking in a steady real rate of return by investing in long-duration fixed-income assets,' Dudley said. Of course, such an investment decision requires investor confidence that the Fed will continue to control inflation more or less indefinitely. Dudley said he and his colleagues at Goldman Sachs believe that the Fed's success under Chairman Alan Greenspan will continue when his successor, Ben Bernanke, takes over next month. One consequence of the central bank's success is that it takes a higher Fed target for the overnight lending rate to offset the stimulus flowing from a lower bond risk premium. `If the bond risk premium falls by 75 basis points, then the average level of short-term interest rates will have to be about 50 basis points higher to offset this,' Dudley said. And that could mean that the current long string of rate increases - - 13 quarter-percentage point moves in the past 18 months with another expected on Jan. 31 -- ``could go somewhat further than anticipated.'' Since higher yields worked with a 12-18 month lag in terms of their economic impact, it seemed clear to me that 2006 would be a year of slower growth, perhaps 2%, and that the Fed and indeed the yield curve was about to reach a plateau around 4½%. This historical 12-18 month lag between a tightening cycle/flat yield curve is what fools many analysts into thinking that yields are still stimulative and that the Fed has more wood to chop. It takes that long for higher yields to affect the housing market, mortgage equitization, and corporate investment cycles, whereas many economists feel it should work more like an anesthetic in the operating room where the patient counts backwards from 10 to 1 and is out before he reaches 5. It doesnt work that fast.
The two researchers devised a fascinating test: If indeed it is the case that multiples of 100 or 1,000 represent psychological barriers, then the DJIA's behavior in the vicinity of those barriers should be different than its behavior when it is far above or below them. For example, it on average should take longer for the DJIA to move through a multiple of 100 or 1,000 than through any other level. And by the same token, once a barrier is broken, the pace of the DJIA's change should become faster than average. This is exactly what the researchers found. As a further test of their findings, the researchers examined the market's behavior whenever a less widely followed index approached levels that were multiples of 100. They chose the Dow Jones Wilshire 5000 index, on the theory that few investors are even aware of that index's level. (That seems an entirely safe assumption, by the way; how many of us know where the Dow Jones Wilshire 5000 is currently trading?) Unlike what they found in the case of the widely-followed DJIA, the researchers found no abnormal trading patterns in the market whenever the DJ Wilshire 5000 approached a multiple of 100 or 1,000. This finding reinforced the researchers' belief that it is the psychological perception of price barriers that is creating those barriers. The implication of the researchers study: The apparently excessive length of time it took for the DJIA to close above 11,000 may have no significance other than being a reflection of investors' psyches. Another implication: Now that the DJIA has closed above 11,000, it for a little while at least may rise at a faster pace than the other indices that in recent months have been outperforming it.
A recent study by Hewitt Associates, the employee benefit research firm, found that from 2000 to 2004, only 40% of 401(k) participants touched their accounts even once. In other words, three out of five of us didn't tweak our investment strategies at all; we didn't sell out of a single mutual fund or rebalance our mix of stocks and bonds during this five-year stretch. "On the one hand, it's good that workers aren't trying to time the market," said Lori Lucas, Hewitt's director of retirement plan participant research. "But on the other hand, it's not good that participants are failing to rebalance their accounts." It's important for all investors to rebalance - a fancy term for resetting your mix of stocks and bonds to ensure that it still conforms to your original plan - at least every year or two, financial planners say. Otherwise, your portfolio will rebalance your investments for you - and not necessarily in a good way. Say you started in 2000 with 60% of your money in the Vanguard Growth Index fund, which invests in large, growth-oriented domestic stocks, and with the remaining 40% in the Vanguard Small Cap Value Index fund, which holds shares of small companies. By the end of 2004, your portfolio would have become 66% small caps - which are more volatile than blue chips - and 34% large caps. "Too many people are ignoring rebalancing," says Mark Kenison, founder of Kenison Financial Services. "And too many people just ignore their 401(k)'s." It's time to become reacquainted with our 401(k)'s. And the start of a new year - when many people are already thinking about taxes and other employee benefit issues - is a fine time to start. Aside from rebalancing our portfolios, what else can we do? Here are some ideas: Keep Up on New Rules Thanks to recent tax law changes, the annual federal limit on 401(k) contributions has been creeping higher. Last year, the government permitted workers to contribute up to $14,000 a year to their 401(k)'s. And those 50 or older were allowed to save an additional $4,000 through so-called catch-up provisions. In 2006, both caps have been raised. The annual limit goes to $15,000, and the catch-up provision for older workers increases to $5,000 a year. Some plans have lower contribution limits than the federal maximum, so check with your benefits department. Save a Little More The beginning of the year is a great time to increase your contribution rate, especially if you received a raise or year-end bonus that allows you to sock away a greater percentage of your salary. "You can talk about rates of returns and selecting the right mutual fund, but the fact of the matter is, nothing will have as significant an impact on your 401(k) as the amount you're able to save," said Rande Spiegelman, vice president for financial planning at the Schwab Center for Investment Research. Say you put away $500 a month for the next 30 years, earning 8% a year. At the end of your working career, you'd have a bit more than $750,000. But if you could put away $1,000 a month for the same period, and earned just 6% annually, you would still do better. You would have slightly more than $1 million at retirement. How much should you be saving? In general, "you've got to be saving at least 15% of your current salary if you want to be able to meet your basic retirement goals," said Christine Fahlund, senior financial planner at T. Rowe Price. Yet a recent report by Fidelity Investments found that the average employee participating in a Fidelity-run 401(k) contributed 6.9% of his salary in 2004. This average hasn't really grown since the late 1990's. Increase Diversity While people are diversifying across basic asset classes, most 401(k) plan participants forget about important sub-classes of assets. For example, investors need a mix of large-, midcap and small-cap stocks, as each category tends to take turns leading the market. Hewitt's analysis shows that only around 5% of 401(k) balances are held in small-cap stocks and even less - 2.6% - in midcap equities. Another glaring area of neglect is international stocks and stock funds. While many planners suggest that investors keep around 20% of their equity allocation in foreign shares, 401(k) investors have less than 9% of their equity portfolios in overseas stocks and funds. Financial planners are also concerned about the high concentration of company stock held in many 401(k) accounts; the average is nearly 25%. Stay Sheltered If you changed jobs at the end of last year, don't cash out your 401(k). Instead, think about rolling the balance into an individual retirement account. A recent study by Hewitt found that 45% of workers who leave their jobs cash out their 401(k)'s when they depart - even though doing so incurs taxes and can lead to a 10 percent penalty for workers younger than 59.5 years. Because most 401(k) balances are still quite small, it's important that workers keep as much money in the accounts for as long as possible. Vanguard recently studied the 401(k) plans it manages and discovered that the average worker had a little more than $65,000 saved in 2004. But the median account balance was less than $24,000. Auto-Piloting Change If you know that you're not the type of person who will monitor a 401(k) account at least once a year, so-called lifestyle or asset-allocation funds may be for you. These funds invest in a mix of stocks and bonds but also rebalance that mix regularly. And some gradually dial down risk in your portfolio as you age. Last year, nearly two-thirds of 401(k) plans offered asset-allocation funds as investment options. Ted Benna, an employee benefits specialist regarded by many as the father of the 401(k), calls the rise of these funds, especially those that adjust as you age, "the most noteworthy development" in retirement plans in a number of years. And according to a new study by Hewitt, 401(k) participants who used asset allocation portfolios in 2002, 2003 and 2004 as their only investment earned greater average returns in their 401(k)'s in all three years than investors who invested entirely on their own. Related Don't Waste Your Money Rebalancing - Paul Farrell, MarketWatch
The study, "Is Stock Picking Declining Around the World?," has been circulating in academic circles as a working paper since late last year. Its authors are Utpal Bhattacharya, an associate professor of finance at Indiana University, and one of his graduate students, Neal Galpin. A version is at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=849627. Measuring the prevalence of stock picking would seem difficult, if not impossible. One would have to know each investor's intent when buying or selling a particular stock. Was the investor's transaction part of a passive indexing strategy, intended merely to recreate the market's portfolio and to match its performance, or was the objective to pick only a few stocks in the hope of outperforming the overall market? And investors themselves may change their minds along the way, further complicating the measuring. The report's authors sidestep these thorny problems by approaching the question from a much different angle. They calculated what stocks' trading volume would be in a hypothetical world in which all investors abstained from active stock picking. Armed with the answer, they could estimate the prevalence of stock picking by comparing each stock's actual volume with its hypothetical extreme. What trading would occur in a world where no one was a stock picker? According to the study, it would take place only when investors wanted to put more money into the entire stock market, or to take money out. All stocks would be bought or sold in tandem on such occasions, with no one stock bought or sold more than any others. Note that this does not mean that the same dollar amount of each stock would be traded. In a world of universal indexing, the authors note, there would be greater dollar trading volume of larger-capitalization stocks than smaller-cap ones. What should be the same for all stocks in this hypothetical world is the ratio of trading volume to a stock's total market capitalization. In the real world, the researchers say, these ratios vary widely from stock to stock. That's hardly surprising. But the study did find that they vary far less today than they did in earlier decades. In the 1960's, for example, the earliest decade in the study, the ratios differed so much that the authors estimate that stock picking accounted for as much as 80% of all trading volume. In the current decade, by contrast, they estimate that it accounts for just 24%. They repeated these calculations for 42 foreign stock markets, though back just to 1995, because there was less data for them than for the American market. They found that stock picking had declined in almost all those markets as well, accounting for less volume from 2000 through 2004 than it did from 1995 through 1999. The study's authors did find, however, that stock picking was more prevalent in emerging countries than in developed countries. For example, they say, it accounts for some 80 percent of the trading volume in the Chinese stock market. If stock picking has become so rare in the United States, shouldn't it be easier for stock pickers to find market-beating stocks? After all, the market becomes less efficient in setting stocks' prices as fewer investors are trying to beat it. In other words, is it possible that indexing has become too prevalent? The researchers say they think that the answer is no. According to a complex model that they developed, the stock market becomes remarkably efficient even when relatively few investors are trying to beat it - as few as 1 in 10, in fact. That means that even while stock picking has declined sharply in recent decades, enough investors are still engaged in the pursuit that the rest of us should avoid it ourselves.
Like the trend for most of this decade, however, earnings of smaller companies are expected to grow faster than blue-chip earnings in 2006. Sam Stovall, investment strategist at S&P, figures small-company earnings will rise 19%, on average, this year. But what if something goes very wrong the economy stumbles, housing crumbles, energy prices soar anew, or terrorists strike the U.S.? If you think the economic and market risks overall are rising, that's an argument for tilting more toward struggling big-name stocks. As Stovall puts it, "Investors usually will gravitate toward higher-quality investments when they become more worried about future prospects." Foreign stocks were the place to be in 2005, even amid a strengthening dollar that cut into returns overseas when translated into dollars. Japan's blue-chip Nikkei 225 index soared 40.2% in yen and 22.1% in dollars. The German market gained 27.1% in euros and 11.1% in dollars. Many emerging markets did even better. The Mexican market was up 44.5% in dollars. Michael Metz, investment strategist at money manager Oppenheimer Holdings, believes that the central message in the performance of most foreign markets is that investors are betting on continuing economic growth worldwide and improving prospects particularly in Japan and Europe. Stretched U.S. consumers, Metz says, may have a hard time boosting their spending in 2006, but that should be less of a problem for consumers in Germany, Japan and elsewhere, he says. "I think we're going to see a big pickup in consumption overseas," Metz said. Foreign markets, on balance, have beaten U.S. stocks all along in this decade. Could that argue for increasing your U.S. stock investments over foreign? Metz doesn't think so. "I think the next few years belong to foreign markets," he said.
Lower Stock Market Volatility It's not a coincidence that the bursting of the stock market bubble and the low dividend yield for this market cycle both came in March 2000. Historically, dividends have acted to put a floor under stock prices and provide investors with a decent return even when stock prices are headed south. So, for example, in the 10 years from the beginning of 1966 to end of 1975, a truly dismal period for stock investors, the S&P500 averaged a total return of just 3.3% a year, according to Ibbotson Associates' data. But how bad would it have been without dividends? The dividend yield for those years averaged 3.47%. Take away dividend payments (and the return investors got from reinvesting those dividends), and capital appreciation -- the increase or decrease in the price of stocks -- averaged just 1.42% a year. When stocks pay out 5.37% in dividends, as they did in 1974 after and because of the market plunge that year (large company stocks fell 29.72%, some investors will decide to hold on rather than sell. And that dampens the market's fall. This incentive wasn't in view in 2000. Capital appreciation was close to the only game in town. When stocks stopped going up, investors didn't see any reason to own them. Certainly, they weren't worth buying for their dividends. In fact, I suspect that the lack of significant dividend yields on the stocks that make up the Nasdaq Composite is one reason that it has taken so long to recover the ground it lost in the bursting of the bubble. Paltry dividends kept many value investors from buying these stocks -- and value investors play a critical role in the recovery of any heavily damaged stock price. (The Nasdaq 100 Index - QQQQ - lost 83% of its value from its peak in March 2000 to its bottom in October 2002. Today, the QQQQ index is at about 35% of its 2000 peak. The Nasdaq Composite's value is 44% of its 2000 high.) The Return of Patient Investors A decent dividend yield is the underappreciated foundation of long-term, buy-and-hold investing. You've all heard that no investor who has held onto stocks for 15 years has ever showed a loss for the period. And only two 10-year periods -- 1929 to 1938 and 1930 to 1939 (the years of the Great Depression) show a loss, according to Ibbotson data. Even then, the loss is relatively small: An annual 0.89% for 1929-1938 and an annual 0.05% for 1930-1939. But that rule is only true because of the historical dividend yield of 3.92% -- and the way dividend yields rise when stock prices decline. Take away the average dividend, and, suddenly, long-term investors in the 15-year periods that began in 1927, 1928, 1929, and 1930 lost money. And the 15-year period that began in 1960 comes close to showing a loss. Looking at 10-year returns, investors don't have to go back to the Great Depression to see that without the historical average dividend yield of 3.92%, it is possible to lose money with a 10-year holding period. It happened in 1965-1974, in 1966-1975 and in 1969-1978. That's not ancient history. A Shift Toward Large-Company Stocks Want a decent dividend these days? Pretty much forget about finding one among the common stocks of any sector besides utilities. And the pickings aren't that great among utility stocks anymore, either. Because utility stocks have run up so much -- the Dow Jones Utilities Index is up nearly 22% so far in 2005 after climbing 25.4% in 2004 and 24% in 2003 -- the dividend yield on the index had fallen to 3.15% as of Dec. 16. As large companies raise their dividends to something closer to the historical average, the gap with utility yields will close and large-company stocks will become more attractive. History suggests that large-company stocks rather than small-company stocks will benefit most from this dividend effect. I say "suggests" because it is difficult to construct a small-company index that accurately represents the characteristics of what most investors think of as small-cap stocks. But the data from the Russell indexes is a decent indicator of the difference in yield between big- and small-company stocks. The large-cap Russell 1000 Value Index shows a yield of 2.5% right now; the small-cap Russell 2000 Value Index shows a yield of 1.7%. And large companies are more likely to have free cash flow that they can use to more quickly raise future dividends than small companies, which are often in the capital-consuming early stages of their growth. This dividend differential is important. As Baby Boomers retire, they will be looking for yield and more willing to trade higher-but-uncertain capital appreciation for lower-but-more-certain dividend income. A Bad Omen for Growth Why dividend yields fell so low in the 1990s and why they're on a rebound now are open questions. The cuts in taxes on dividend income pushed through by the Bush administration have helped put the dividend back on the table as a shareholder-friendly corporate strategy. The 2003 Jobs and Growth Tax Reconciliation Act reduced the top rate on taxes on dividends to 15% from near 39%. The new rate is a 70-year low. But that doesn't seem to be all that's going on. In the 1990s, dividend increases failed to keep pace with rising stock prices, at least partly because companies thought they had better uses for their cash flow. When the potential return from reinvesting cash in the company seems high, companies are more reluctant to distribute cash to shareholders. It's logical: If the return on reinvested capital is high, it is actually to the long-term benefit of shareholders for the company to refuse to pay out dividends and instead keep that cash for its own reinvestment. From this perspective, the drop in the dividend payout ratio in the 1990s was a tribute to corporate optimism about the opportunities for growth that they saw in that economy. Something like the reverse of that thinking is playing a role in the recent growth of dividend payouts. Despite the strong economy, companies have been curiously reluctant to spend money on capital equipment and expansion. Corporate cash levels are climbing. The technology sector is a key example. Investors think of this sector as the home of go-go growth companies, always looking for ways to raise cash to exploit the endless opportunities ahead of them. But, right now, the 78 technology companies in the S&P 500 are sitting on roughly $140 billion in cash. Large institutional investors are starting to wonder if maybe there is a capital-spending problem. Back in September, 50% of global fund managers in a survey told Merrill Lynch that companies aren't investing enough in their own businesses. I can understand why. One effect of the new global markets where, overnight, a Chinese or Indian company can build a factory and undercut an established competitor's prices -- killing profit margins -- is that investing in production is riskier than ever. (It's also more essential than ever. If a company doesn't invest in constantly reinventing its factories and workforce, it becomes increasingly vulnerable to global competition. That, however, is another story.) In the 1990s, too many dollars reinvested by companies led to huge overcapacity and a stock market crash that decimated major sectors of the technology economy so badly that they're still struggling to recover. In the current decade, too few dollars reinvested by companies could lead to more jobs going to overseas competitors and to lower economic growth in the United States somewhere down the road. Somewhere in here there's a balance. Let's hope that the current dividend comeback finds it. And meanwhile, I think investors looking to outperform the market will pay more attention to stocks with decent and growing dividend yields in the years ahead.
The consensus forecast of 56 economists surveyed by The Wall Street Journal is that the nation's GDP will grow at an annual rate of 3.5% in the first half of 2006 and 3.1% in the second half. While those growth rates are considered respectable, they would fall short of the 4.1% average of the past 2.5 years. While concerns about housing dominated the survey, housing wasn't the only worry. Eight economists identified high energy prices as the biggest threat to the economy. They said they expect high prices to carry into 2006, leaving the price of oil between $50 and $60 a barrel. On the positive side, economists expect overall inflation to moderate this year. The consumer price index rose 3.5% in the 12 months ended in November. But the consensus forecast calls for the CPI to rise 3.1% in the 12 months through May 2006 and 2.3% in the 12 months through November 2006. Only four economists cited inflation as this year's biggest economic risk. The economy in 2006 "will start with a lot of momentum but will lose some steam as the year progresses," said Nariman Behravesh, chief economist at forecasting firm Global Insight. "It is running into some headwinds." Four More Years Few economists believe the economic expansion is in serious jeopardy. On average, those surveyed put the chance of a recession at just 15% and predicted that the expansion would last about four more years. Only one of the 56 economists, Ian Shepherdson at High Frequency Economics, expects the expansion to end anytime soon. Mr. Shepherdson told clients in December that "the housing market is set for a serious crunch" this year. He expects GDP growth to slow to zero by the fourth quarter of this year from an annualized rate of 4% in the first quarter. Most other economists believe that the housing market will slow, but not crash. And they think that strength in the business sector will at least partly offset the slowdown. Indeed, 37 economists said that business spending will be the most important engine of growth this year. In the past several years, "companies rebuilt profits, accumulated cash and streamlined their businesses," said Ethan Harris, an economist at Lehman Brothers. He added that they also have underinvested in capital and labor, "setting up the economy for strong growth in both employment and capital-equipment spending for an extended period." While business activity will cushion the impact of the slowing housing market, it may not completely offset it. Housing has bolstered the economy in many ways. In Q3, U.S. home prices were up an average 12% from a year earlier, according to the Office of Federal Housing Enterprise Oversight. Banks had real-estate assets totaling $2.9 trillion through the week ended Dec. 14, according to the Federal Reserve. The figure, which includes mortgage loans outstanding and property holdings, was up nearly 14% from a year earlier and up roughly 76% from five years ago. The boom has allowed millions of Americans to turn their homes into piggy banks, extracting cash for spending through home-equity loans, cash-out refinancing deals and capitals gains on home sales. Jan Hatzius, Goldman Sachs's chief U.S. economist, estimates that consumers withdrew $887 billion from residential real estate in 2005. He expects that to decline to $552 billion in 2006 and $363 billion in 2007. "At the moment housing is still a positive for the economy, and we aren't building in a crash. But there's downward pressure on housing even in a non-crash environment," he said.Of the 56 economists surveyed, 15 named the housing market as the biggest risk looming over the U.S. economy. That compares with just two economists a year ago. Worries about housing also emerged in other ways in the 24-question survey, which was conducted Dec. 7-16. When asked to assess household finances, 22 economists indicated they believed that consumers are stretched by low savings, high energy prices and overexposure to the housing market. When asked to name the biggest challenge on the horizon for Ben Bernanke, who is slated to become Federal Reserve chairman in February, 16 economists said it would be a housing slowdown. But the forecasts of moderating inflation are potentially good news for Mr. Bernanke. Fed officials have been worried that last year's surge in energy prices could fuel broader inflation. But with the price outlook looking potentially tame, the Fed is expected to stop raising interest rates in the next few months. Twenty-three economists predicted that the Fed would end rate increases in March. The consensus is that the federal-funds rate will be at 4.75% by the end of June, up from the current 4.25%, and stay there through the year. Long-term interest rates, meanwhile, are expected to rise a little, but not much. The consensus is that yields on 10-year Treasury notes will remain below 5% at year end. Second-Biggest Cloud The survey identified a potential monetary-policy mistake as the second-biggest cloud overhanging the economy. Eight economists said the biggest risk to the economy would be a possible overtightening of credit by the Fed. Higher interest rates would raise borrowing costs for businesses and consumers, potentially stifling spending and investment. Mr. Bernanke, who might feel under pressure to prove his inflation-fighting credentials, initially could find it hard to suspend rate increases -- or to cut rates -- if needed, the economists said. But some forecasters say that easing monetary policy could fuel fresh growth, although economists are slightly less bullish on stocks this year than last. Thirty-three economists said they expect the Dow Jones Industrial Average to finish 2006 somewhere between 11000 and 11999 -- or up 2.6% to 12% from the last trading day of 2005. That compares with 37 economists who said it would end 2005 within that range. Nine economists expect it to finish above 12000. The Dow industrials ended last year at 10717.50. In other survey findings: Forecasters said they expect the nation to add roughly 178,500 new jobs per month in 2006, enough to push the unemployment rate down to 4.9% by May from the current 5%. The corporate-profit boom is expected to continue. The consensus is that profits will rise 10.4% in 2006, but slow to 5% growth in 2007. Economists expect the dollar to slip a little this year. The U.S. currency is expected to buy 116 yen at the end of June and 112 yen at the end of 2006. The dollar ended 2005 trading at 118 yen. The euro is expected to buy $1.19 at the end of June and $1.20 at the end of 2006. At the end of 2005, the euro fetched $1.18.
Merrill Lynch global-equity strategist David Bowers has shown that the VIX tends to move inversely, and with an 18-month lag, to the spread between the 2-year and 10-year Treasury notes. That spread has narrowed down to almost zero, which suggests the VIX will be on the rise. Why the link between Treasury yields and the VIX? When short-term Treasurys -- some of the safest investments around -- offer the same sort of yields as long-term Treasurys, investors pour in. Then, cash-strapped firms have a harder time getting funding through stock and debt offerings, putting them in peril. That produces the sorts of stock moves that make options prices, and so the VIX, rise. Meantime, Merrill's U.S. strategist, Rich Bernstein, has shown that, when the VIX rises, risky stocks perform worse than their more staid peers. Thus, chasing rainbows might not be as good an idea in 2006 as it was in 2005. How Fund Categories Fared Barrons 1-06-2006
Monthly Employment Stats
The unemployment rate fell to 4.9% from 5.0% in November. There were 150.2 million workers in the U.S. labor force, with 7.4 million of those out of work. The average work week shrank six minutes to 33.7 hours. The average time the unemployed spent searching for work in December was 17.3 weeks, an improvement from the 17.6 weeks in November. For all of 2005, the economy added around two million jobs -- about the same as last year. The unemployment rate averaged 5.1% last year, an improvement from the 5.5% average registered in 2004. Average hourly earnings in December rose five cents to $16.34 -- a 3.1% increase in year-on-year terms and the fastest increase since February 2003. Economists have been watching wage data carefully in recent months for signs of increasing inflation. Peter Morici, a business professor at the University of Maryland, said Friday's data show "wages are advancing less rapidly that productivity, indicating that a tightening labor market poses little threat of igniting inflation." Job losses in construction, retail and transportation during December helped to blunt job gains in manufacturing, professional and business services, education and health services, government and elsewhere. December goods-producing hiring rose by 12,000 jobs. The manufacturing sector increased payrolls by 18,000 jobs, after an 8,000-job advance the month before. The construction sector cut 9,000 jobs last month. Service-providing employment went up by 96,000. Retail jobs fell by 16,000.
High-demand workers who switch jobs will see salary hikes as high as 30%, though the rest of the workforce can bank on modest wage gains, according to the Five O'Clock Club, a New York-based career counseling and outplacement service for managers and executives. "The average American has been in a job for four years," said Kate Wendleton, president of the Five O'Clock Club. "Based on how bad the market was four years ago, many of these workers are ready to make a move." Rather than sitting back and watching top employees jump ship, employers are finding ways to enhance worker satisfaction, Mr. Lebovits said. One way is through financial rewards companies will dole out larger raises to keep top talent in tough-to-fill slots. Average increases will be about 3.5%, but they could rise to 10% in industries that are desperately short of qualified personnel, said Jeff Cooper, head of the performance and compensation practice at Authoria Inc., a Waltham, Mass., human resources software company. Just the Facts Per/Share Profit Growth Boosted by Buybacks Alan Abelson, Barrons 1-02 One of the big arguing points of the bulls is the extraordinary strength in corporate earnings. And, no question, we've had a spectacular boom in profits. In Q3-05, operating profits of the S&P 500 were up a neat 11.5%, the 14th quarter in a row of double-digit gains. However, as David Rosenberg of Merrill Lynch points out, such a splendid performance reflects not so much any inordinate growth of revenues as the impact of an unprecedented mass of buybacks -- $456 billion worth of stock repurchases that TrimTabs Investment Research estimated took place last year. Operating earnings in dollar terms -- as against per-share net -- actually were up only 7.8% over the comparable year-earlier total. Which, David notes, was the narrowest gain in three years. The bottom line: there's a good deal less to the corporate bottom line than meets eye. Quick Facts, Stats & Opinions Madeline Schnapp, Director of Macroeconomic Research at TrimTabs Investment Research, told me that she and her fellow researchers at TrimTabs have explored the econometric relationships between the money supply data and the stock market "every which way from Sunday" -- and that they have found no straightforward correlation between it and the stock market. As a result, she believes that changes in M1, M2 and M3 are "next to useless" as market timing indicators. According to Schnapp, a much better indicator is changes in personal incomes. "After tax income derived from daily income tax withholdings is up a stunning 14.9% the last four weeks. We attribute this remarkable gain to a combination of healthy year-end bonuses and job growth but no matter how you slice it, cash available to invest is building on the sidelines." (Mark Hulbert, MarketWatch 1-20) Ibbotson Associates recently updated its benchmark-return studies to include 2005. Over the last 80 years, large-company stocks have returned an average of 10.4% per year. Small-company stocks, by comparison, have returned 12.6% in an average year, with bonds averaging 5.5% per year. Cash - as measured by the 30-day Treasury bill - returned an average of 3.7%, a bit higher than the average pace of inflation, which was 3.0%. (Charles Jaffe, Philadelphia Inquirer 1-15) Most Americans are hopelessly ill-prepared for retirement. For instance, according to AARP's analysis of the Federal Reserve's 2001 Survey of Consumer Finances, the typical baby-boomer household has total financial assets of just $50,700. (Jonathan Clements, WSJ 1-15) Just 14% of stock-fund assets are in U.S. and international index funds. Indexing is somewhat more common among big institutional investors, like endowments and pension plans. They have around 30% of their stock-market money indexed. Overall, maybe 20% of the U.S. stock market is indexed, figures John Bogle, founder of Vanguard Group and the fund industry's most vocal advocate of indexing. Yet, even though we have 20% of shares that are rarely traded, the New York Stock Exchange has had around 100% turnover in recent years, implying a typical stock-market holding period of just 12 months. as Mr. Bogle sees it, that is more than enough trading to ensure market efficiency. In the 1950s and 1960s, "the market went on perfectly satisfactorily with 15% or 20% turnover," he notes. (Jonathan Clements, WSJ 1-15) Since 1990, Intel has repurchased from shareholders"2.2 billion shares at a cost of approximately $42 billion. That's about a third of Intel's total shares outstanding. There's just one problem: Intel had as many shares, split-adjusted, at the end of 2004 as it did in 1990. Much of the cash went to sop up the hundreds of millions of shares Intel was simultaneously issuing for employee stock options. Joseph Osha, a semiconductor stock analyst at Merrill Lynch, says perhaps half the cash devoted to stock buybacks in general serves as little more than "backdoor compensation" for employees. Thomas M. Doerflinger, an equity strategist at UBS, found that the number of shares in the S&P 500 has continued to increase despite the bigger share-repurchase outlays by companies. In 2004, when companies reported spending some $197 billion on buybacks -- nearly 2% of the market value of the index -- the number of shares outstanding increased by 1.8%. In the 12 months through June 2005, shares increased 0.7%, and only a third of the companies actually shrank their share counts by at least 1%. (BusinessWeek 1-23) Private equity firms raised nearly $152 billion in 2005, a 65% jump from the year before and closing in fast on the record $178 billion raised in 2000, according to Private Equity Analyst. It was a year when five p.e. firms closed funds that were larger than the one-time record holder $6.5 billion J.P. Morgan Partners Global 2001 Fund. In fact, The Blackstone Group closed two funds with more than $12 billion. Venture capital fundraising also appears well on the road to recovery following the Internet bubble bust, as VC firms overall attracted $22.4 billion, an increase of 32%, with early-stage firms outraising later-stage counterparts. Later-stage VC firms, however, saw a nearly 150% increase from 2004 to $5.3 billion. (Hedge fund daily 1-12) It is a myth that Coke is identical everywhere. Coke from south of the border is made with from cane sugar. U.S. bottlers switched to high-fructose corn syrup in the 1980s to cut costs. In Europe, Coke is made using sugar from beets. (Chad Terhune, WSJ 1-11) "If history repeats itself, by 2020 more than 375 companies in the S&P 500 will consist of companies we don't know today." (Richard Foster as quoted in the Kirk Report 1-10) Hedge funds experienced the highest liquidation rate in a decade last year 5.7% more than twice 2004s 4.2%, according to Bloomberg News, citing Hedge Fund Research. In actual numbers, 484 of the total 7,436 hedge funds shut down as of Sept. 30, compared with 267 for all of 2004. (Hedge Fund Daily 1-10) E*Trade is expected to announce this morning that it has begun integrating into its IRAs cash-management features that allow retirees to access their nest egg with checks, electronic bill-paying options or the use of a debit card. Instead of having to draw down a set amount of money annually, quarterly or monthly, retirees can instead use their account for everything from paying the electric bill to buying an afternoon latte with the debit card. (Jeff Opdyke, WSJ 1-10) Despite the past year's deluge of Supreme Court news, 57% of Americans can't name a single sitting justice, according to a FindLaw.com survey of 1,000 adults. It shows that of the 43% who knew at least one, 27% named O'Connor; Thomas, 21%; Roberts, 16%; Scalia, 13%; Ginsburg, 12%; Kennedy, 7%; Souter, 5% and Justices Breyer and Stevens, 3% each. (Jeanne Cummings, WSJ 1-09) More than 60 stocks in the Standard & Poor's 500-stock index, including companies such as Citigroup, J.P. Morgan Chase, Wachovia, Dominion Resources, DuPont, American Electric Power, H.J. Heinz and Pfizer, have a higher after-tax dividend yield than the 10-year Treasury, according to Standard & Poor's. And with many big, dividend-paying companies sitting on mountains of cash and trading at moderate multiples of their per-share earnings, there is reason to expect that group of S&P 500 companies to grow in number. Investors who long focused on bonds may start eyeing and buying stocks that offer the same, or better, yield with the opportunity for capital appreciation as well. At the same time, it is reasonable to expect dividend checks to keep growing. Nearly 300 companies in the index increased their dividends, while only nine cut them. (Ian McDonald, WSJ 1-06) You want reasons to worry about the economy and the financial markets in 2006? I'll give you half a dozen. Bubbles in various real estate markets around the world, some of which may be popping at this very moment. Jumpy energy markets, accompanied by a chorus of voices asking, "Are we running out of oil?" Strains on the budget of the U.S. government and on the balance sheets of U.S. households, both bedeviled by what looks like chronic spending beyond their means. The threat of an avian flu pandemic, heightened by recent word from a United Nations official that the world is "losing the battle" against the virus in poultry. A tottering pension system, simultaneously suffering from symptoms of not enough savings. (Chet Currier, Bloomberg 1-01) "If a salesperson [broker] shows you a gee-whiz but complicated financial product, you can be sure of two things: You don't need it and it's overpriced," writes author and columnist Jane Bryant Quinn. "You can get the same result with something easier, wiser and lower-cost." (Michelle Singletary, Washington Post 1-01) U.S. consumers are on track to have spent about $39 billion more than they earned in 2005, according to government figures released near the peak of the pre-Christmas shopping frenzy. The last time spending outstripped earnings was in 1933. (Andrew Blackman, WSJ 1-01) Home Page Previous Factoid Top Sites
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