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Investment managers are more bullish on tech than they are on any other segment of the economy, according to a survey by the Russell Investment Group. That comes as somewhat of a surprise, given that tech stocks appreciated only 7.7% last year, on average, versus the 13.6% price gain for the broad S&P500. But with energy stocks and commodities possibly losing steam, investors are searching for the next investment group that may catch fire. And right now, the consensus seems to have settled on technology — the one sector that hasn’t experienced a sustained rally since the bear market of 2000. It’s noteworthy that investors aren’t simply betting that tech stock prices will rise more than the broader market. Rather, they are counting on tech company earnings to swell. Wall Street analysts predict that tech profits will grow 17% in 2007, according to Thomson Financial. By contrast, earnings among all companies in the S&P500 are expected to jump by a much more modest 7.9%, on average. And if you strip out tech’s expected contributions to the broad market, overall corporate profits are expected to improve by 6.8% this year. That’s a far cry from the double-digit growth enjoyed by S&P500 companies for the past 13 quarters. “It’s really the first time since the bubble burst seven years ago that tech earnings are expected to be such a major contributor to the broad market’s earnings,” said Jeffrey Kleintop, chief investment strategist at PNC Wealth Management. But therein lies a potential problem. Although tech earnings are expected to improve, market strategists say that there is a distinct possibility that these companies won’t quite reach the high bar that Wall Street has set. There are plenty of reasons to be bullish on the sector: the introduction of Microsoft’s new Vista operating system, for instance, is expected to set off a new round of corporate and consumer technology spending later this year and in 2008. But total technology revenues are expected to increase by only about 14% in 2007, according to analysts at Morgan Stanley. That would be a slower rate of revenue growth than in 2005 and 2006. Moreover, Michael Sola, portfolio manager of the T. Rowe Price Science & Technology fund, points out that profit margins at many tech companies are already at or near their pre-bubble peaks. And if profit margins don’t continue to improve and if revenues don’t exceed expectations, it will be hard for many tech companies to meet and exceed their profit targets. Mr. Sola says he is concerned that earnings expectations are already making it difficult for tech to surprise on the upside. “Typically, you get significant runs in sectors when earnings estimates start off too low and sentiment is poor,” he said. Right now, however, the opposite is true. Mr. Kleintop predicts that earnings for the tech sector will grow at a much more modest pace — around 9% to 10% this year. As a result, he said, overall S&P500 earnings may grow by only around 3%.
Is it too late to send some dollars overseas? Most market watchers say no. But some also suggest a less direct route to bet on international stock markets -- plunking dollars into shares of U.S. companies that have expansive operations overseas. That's because at least some foreign markets have become more expensive. "Buying U.S. companies with big overseas operations makes sense because the companies will have significant exposure to some of the fastest-growing economies around the world," says Christopher Zook, chairman of CAZ Investments, a Houston investment adviser. "Additionally, it provides some currency diversification for a U.S. investor." Three reasons to think foreign markets will continue to excel in 2007 are earnings growth, stock valuations and a continuation of the fall in the dollar. Earnings growth is expected to be stronger in many other countries than in the U.S. "Accelerating economic growth in the Eurozone and continued expansion of Japan's economy lead us to expect earnings growth between 10% and 12% for these areas," says Reiner Triltsch, head of international investing for U.S. Trust. That compares with expected mid-single-digit growth in the U.S. And while foreign securities aren't as attractive as they were several years ago, looking at stock prices relative to company cash flow, international stocks are still about 20% less expensive than U.S. shares, according to a recent analysis by U.S. Trust. That compares with a discount of about 30% four years ago. But foreign stocks are not yet at the expensive levels they reached in previous periods, such as a decade ago and the late 1980's, suggesting that opportunity remains. And despite the dollar's strength against the Japanese yen and euro so far this year, some economists predict weakness in the future for the greenback. They cite the bulging U.S. budget and current-account deficits and a continued move by foreign governments to shift some of their currency reserves away from the U.S. dollar. When the dollar declines, that increases the value of foreign-denominated securities to U.S. investors. One country to be wary of, however: India. Although the country's growth has been robust, and it is expected to continue to outpace most global economies, prices for Indian stocks are at expensive levels.
"Eventually the impact of the news wins out and the stock's price trends up," says Thomas George, a finance professor at the University of Houston's Bauer College of Business. Dr. George and colleague Chuan-Yang Hwang pioneered research about the 52-week high as a predictor of future performance. Greg Forsythe, senior vice president of equity ratings at Charles Schwab, says his clients are just as reluctant as many professional traders to buy stocks near their recent peaks. His response, in some cases: The stock price may be higher than it was a few months ago, "but it's low relative to where it should be." Mr. Forsythe urged clients to consider selected stocks near their highs in a November 2005 newsletter. He picked eight stocks that had Schwab's highest rating for potential outperformance -- based on factors including earnings quality and valuation -- and that were close to their recent peaks. Over the following twelve months, the group of stocks gained 22%, compared with the Dow Jones Industrial Average's 13% advance for the same period. The case for buying stocks near their highs may seem counterintuitive, especially since investors are usually counseled not to chase performance. That adage often holds true when it comes to individual mutual funds and asset categories -- high-yield bonds, for example, or technology stocks. But the research shows individual stocks that are near their highs can sustain that momentum through the next 12 months. There are some "momentum" investors -- on the lookout for companies with recent outsized stock returns -- who do use 52-week highs to spot possible targets. And, to be sure, some stocks near their 52-week highs may be unattractive and overpriced relative to the companies' earnings and prospects. So proximity to the high is perhaps best used as a tiebreaker that helps investors choose among a handful of stocks with good potential. If you have three equally attractive stocks, the one closest to its high is likely to be a "better performer and to perform more quickly" than the others, says Schwab's Mr. Forsythe.
The issue is 1099 forms, those statements that banks, brokerage houses and mutual funds send out to account holders around the end of January. Since 2004, millions of taxpayers have received revised 1099 forms -- typically in late February, March and even April -- restating information, such as dividends, that was reported on their initial 1099s. This year, some financial executives worry that things may get even worse, thanks in part to a recent tax-law change. Seeking to minimize the problem, a few firms have asked the IRS for more time to mail out their 1099 forms to investors. Among the firms that have received extensions from the IRS are Wachovia and Morgan Stanley. Morgan Stanley recently wrote clients to say it had received a 30-day filing extension from the IRS. The company made the request "in anticipation that tax-law changes will significantly increase the number of mutual funds that will be late in supplying their tax information," says Ted Jahn, executive director of client reporting in Morgan Stanley's Global Wealth Management Group. Morgan Stanley will use only about one week of that 30-day extension, which will give it enough time to capture the majority of this late tax information. This move should substantially reduce the number of corrected 1099s we need to send" -- but it won't eliminate them entirely. Morgan Stanley cited a law enacted last year that included a change in how tax-exempt interest income is reported to customers for 2006. Two new boxes have been added to the IRS's Form 1099-INT, for reporting interest payments. (The 1099 form for dividends is called Form 1099-DIV.) One of them, box 8, includes tax-exempt bond interest, tax-exempt interest dividends from mutual funds, tax-free unit-investment-trust interest and accrued interest received on the sale of a municipal bond. The other new one, box 9, shows tax-exempt interest that is subject to the alternative minimum tax. Paradoxically, the origins of the 1099 tempest date to a 2003 tax law designed to help investors. Part of that law slashed the top tax rate on most - but not all - dividends to 15%, effective retroactively to the start of 2003. Previously, dividends had been subject to tax as ordinary income, which meant at federal rates as high as 38.6%. Early in 2004, investors began to notice a sharp increase in the number of revised 1099 forms. Before the 2003 law was enacted, the percentage of revised 1099 forms sent out typically was only about 5% to 8% a year, says Patricia McClanahan, vice president and director of tax policy at the Securities Industry and Financial Markets Association, or SIFMA. In 2004, that percentage jumped to 14.3%, Ms. McClanahan says. In 2005, it fell to 11.7% - but then bounced back up again last year to 13.2%. SIFMA, a trade group formed recently by the merger of the Securities Industry Association and Bond Market Association, represents about 650 securities firms, banks and asset managers. So what should you do if you file your return this year and later receive a revised 1099 form? In some cases, the answer is nothing. Many corrections are so small it probably isn't worthwhile to amend your original return. That is especially the case if it winds up that you are entitled only to a small additional refund -- and you have to pay a tax preparer an additional amount to figure out how much. If the correction is large enough, it may well be worth the time and effort to revise your return. Moreover, if the revised information means you owe more tax, you should consider fixing your return before the mid-April deadline. Otherwise, you could face interest charges and possible penalties as well.
When we have more income, we spend it. Households in the middle quintile spend $5,295 a year on food. Households in the top quintile spend twice as much, $10,051. Middle-quintile incomes range from $33,381 to $53,358 but average $42,622. Top-quintile incomes are at least $85,147 but average $147,737. The same pattern holds for housing ($13,234 for middle income, $28,006 for top quintile), transportation ($7,437 for middle income, $15,691 for top quintile), apparel ($1,509 for middle income, $3,704 for top quintile), and donations ($1,222 for middle income, $3,869 for top quintile). The proportions of how we spend our income don't change dramatically as income rises. Middle-income households spend 13.5% of their total consumption on food. Top-quintile households spend 11.1%. As a percentage, food away from home remains virtually level at 5.6%. Middle-income households spend 33.8% on housing. Top-quintile households spend 31%. This figure hides major increases in mortgage and real estate tax spending as income rises. Middle incomes spend 11.7% on mortgages and 6.6% on property taxes. Top quintile households spend 15.2% on mortgages and 8.9% on property taxes. The percentage of income we spend on common categories falls slightly as income rises. The most dramatic change is the decrease in health care spending. It falls from 6.6% for middle-income households to 4.4% for top-quintile households. Retirees spend less as they age. Two-person households ages 55 to 64 have average incomes of $68,953 [but there are only 1.3 workers per household at this age, so that averages to $53K per 'worker'] before taxes and spend $54,058. Two-person households ages 65 to 74 have incomes of $52,406 before taxes and spend $44,471. Households age 75 and older have $37,969 in income before taxes and spend $34,104. They cope with declining income by paying dramatically less in mortgage payments and property taxes. They also chop their new vehicle purchases in half. And they all but eliminate vehicle finance charges. Retirees almost double their health care spending, but they also increase their cash donations. I can't believe some of the numbers. The survey shows that spending on apparel and services is only $1,509 a year for middle-income households, rising to only $3,704 for top-quintile households. If that's what we spend, what's supporting all those Wal-Marts, Kmarts and Targets – not to mention a zillion other clothing retailers? What we see on television, in movies and in advertising is well beyond the top quintile. Membership in the top quintile – the $85,147-and-up group – doesn't buy an automatic entry to Luxury Land. Only $807 a year for alcoholic beverages doesn't leave much room for Dom Perignon. And $7,107/year for vehicle purchases won't go far at the local Aston Martin dealer. Nor will the $1,568 the top quintile spends on fees and admissions buy many tickets to see Celine Dion in Las Vegas ($444 each for orchestra, $143 for second mezzanine). Big-time debt isn't universal. One household in four owns its home mortgage-free. An impressive 61% of households age 65 and over have no mortgage. Middle-income households pay only $302 a year in vehicle finance charges. Top-quintile households pay $550. Either way, it's not a lot of debt – at 6%, $550 translates into $9,167 in debt, a fraction of the average cost of a new car.
"The sell decision is the most important decision you can make" in investing, says Barry James, president of James Advantage Funds. "Even if you buy randomly and have a good sell discipline, you can probably outperform the market over a period of time." Here's a look at a few selling strategies professionals rely on. Sell When Profits Deteriorate A sharp earnings disappointment can be a good signal to sell because it is often followed by more bad news, says David Kovacs, a senior portfolio manager at Turner Investment Partners. "It's easier to sell and move on to another idea, rather than holding on to the stock and seeing potentially significant further declines," he says. "When the first chunk of bad news comes out, don't just sit there," concurs Daniel Morgan, portfolio manager at Synovus Investment Advisors. This can be particularly applicable to smaller, fast-growing companies that trade largely on expectations of future growth. Still, Mr. Morgan cautions investors to sell only if the news reflects a fundamental shift in the business. Remarks from television pundits or analysts are usually bad reasons to sell a stock, he says.< Pick a Price Target Vince Gallagher, co-portfolio manager of Needham Growth Fund, says that when his fund buys a stock, the managers usually have a target sale price based on the earnings outlook and the potential for the company to grow its business. "You can get carried away with a stock when it does well," he notes. "The lesson we've learned is that you should have a target when you buy a stock, and you should stick to the target." Mr. Gallagher does suggest investors rethink their price target if there is a big change in earnings or sales. Monitor Reality vs. Rationale Investors need to be very clear on why they bought a stock; they should review their rationale periodically and should also rethink the position when the reason no longer holds, says Craig Hodges, co-portfolio manager of the Hodges Fund. In simple terms, he says: "If the story changes [for the worse], get out of the stock." Keep an Eye on Trends If the market appears to be trending lower, investors may want to pare their positions slightly, suggests Mr. Morgan of Synovus. But "you don't want to sell out completely," he says. "You want to take some money off the table to preserve capital and then re-examine the market at a later date." At such times, investors may want to first pull out of their smallest, riskiest and most volatile holdings, says Scott Billeadeau, director of small- and mid-cap growth strategies at Fifth Third Asset Management. That said, some professionals believe investors can generate solid returns by focusing solely on finding promising stocks -- and not trying to "time" the market. "A lot of times when things look the bleakest, is when the market does well," says Mr. Hodges. "We've given up on the market prediction business and just focus on individual companies." Compare P/E to the Past Investors should consider selling a stock if its price-to-earnings ratio rises well above its historical levels, says Mark Coffelt, chief investment officer for the Texas Capital Value Funds. But a slight overvaluation may not be a sure reason to sell, he has found.
Foreign large-blend funds attracted $43.8 billion of net new money during this stretch. By comparison, highflying diversified emerging-market stock funds attracted $6.6 billion and domestic large-blend funds drew $4 billion, according to Financial Research. But does investing in blue chips abroad achieve the same results for a portfolio as investing in big, high-quality domestic stocks? The answer is still no, given the currency risks that you inevitably take on when investing abroad. Yet a growing number of people argue that foreign and domestic stocks are becoming more alike, given the increased correlation among the world’s markets. Since 1970, the Morgan Stanley Capital International EAFE index, for European, Australian and Far Eastern stocks, has returned 11.6%, on average. That is nearly identical to the annualized gain of 11.2% for the S&P500 index of domestic blue chips. But those slightly higher gains came with slightly higher risk, as foreign stocks on their own are still more volatile than domestic equities. Sometimes, a modest dose of a risky asset can make an entire portfolio less volatile. From 1970 to 2005, a 100% stock portfolio invested in the S&P500 would have earned 11.1% annualized, according to S&P. And that is with a standard deviation of 16.8. But by moving 25% of that money from the S&P500 to the EAFE index, the portfolio would have earned 11.4%a year on average, with a slightly lower standard deviation of 16.4. Add too much, and more volatility enters the mix. In this case, had 75% of the equity stake been invested in the EAFE index and 25% in the S&P500, the portfolio would have earned the same 11.4% annualized from 1970 to 2005. But the portfolio’s volatility would have shot up to 19.1. This shows that while the global markets may be moving more in sync, “the world markets aren’t completely integrated yet,” said James Peterson, vice president of the Schwab Center for Investment Research. Consider the recent performance of foreign and domestic blue chips. Over the last five years, the average foreign large-blend fund returned 13.8% a year on average, according to Morningstar, as many foreign economies have grown faster than that of the United States and as the dollar has weakened of late. By comparison, domestic large-cap blend funds advanced only 6.3% a year on average during this stretch. And last year, foreign blue-chip funds soared 25.1%, beating the returns of domestic blue-chip funds by more than 10 percentage points. Arguably, much of the investor interest in foreign blue chips can be attributed to their outperformance, not to their similarities to their domestic counterparts. The correlation between the S&P500 and the EAFE index has been 0.8 over the last three years, according to Morningstar. That is fairly high. A correlation of 1.0 implies that two assets are moving in perfect tandem. But consider that over this same stretch, the correlation between the S&P500 and the Russell 2000 index of small domestic stocks was actually greater, 0.83, according to Morningstar. Yet investors take it on faith that large-cap and small-cap stocks are entirely different asset classes. There are several reasons for continuing to treat foreign and domestic blue-chip stocks separately. “A big reason is the issue of currency,” Schwab's Peterson said. Investors who put money to work in a foreign market should consider that market’s volatility, as well as that of the currency in which its stocks trade. In 2006, the EAFE index rose 13.8% when measured in local currencies, according to MSCI. In dollar terms, the EAFE index actually returned much more last year: 23.5%. That is because the dollar lost value against the euro. A weakening dollar is a tailwind for Americans investing abroad because each share of their foreign stock becomes worth that much more in dollars. So isn’t this good news for domestic investors? It certainly was last year. But what happens if the dollar turns around this year and appreciates, as it did in 2005? In that case, investors could see a big chunk of their foreign stock market gains evaporate — even if the global stock markets are highly correlated — simply because the dollar gained value.
Among all stock funds that invest in domestic equities, including single-sector portfolios, the average gain was 13.4%, according to Morningstar. The S&P500 index had its best year since 2003, gaining 15.8%. Many people on Wall Street say the market’s momentum could last well into this year. And in at least one respect, history is on the market’s side. Since 1945, the S&P500 has never declined in the third year of a presidential term, according to Sam Stovall, chief investment strategist at S&P. And the average gain for equities during these years has been 18%. The equity markets caught a much-needed second wind in Q4. According to Morningstar, the average domestic stock fund surged 6.9% in the quarter, marking the sixth consecutive year-end rally for stocks. What propelled stock prices higher this time? For starters, data released late in the year “put to rest all the extraneous worries about the economy,” said James Swanson, chief investment strategist at MFS Investment Management. In the spring, concerns that the Fed may have done too good of a job of slowing the economy threatened to tame the bull market. In fact, a growing number of economists began to worry about the possibility of a recession on the horizon. As a result, stocks ran into a proverbial wall of worry in the spring and early summer. From May 5 to June 13, the S&P500 slumped 7.7%, its worst slide since the bear market earlier this decade. For the entire second quarter, the average domestic stock fund lost 2.8%. But as it turned out, the economy — and consumers — proved stronger than expected. Moreover, oil prices stabilized and the Fed all but said that it was done raising short-term interest rates for now. “Once investors were no longer worried about recession, they were willing to jump back on the risk train,” said Thomas McDowell, CIO at Rice Hall James. In the fourth quarter, investors, whom many analysts thought would embrace relatively conservative assets like blue-chip domestic stocks, went back to their speculative ways and were rewarded handsomely for their risk taking. Within the fixed-income world, the average emerging-market bond fund rose 4.9% in Q4 and 11.1% for the year. High-yield bond funds posted quarterly gains of 4.2% and annual returns of 10.3%. By comparison, the average bond fund that invests in long-term debt issued by the United States government rose just 0.1% in Q4 and 0.6% for the year. The picture was much the same in the equity markets. The average diversified emerging-market stock fund soared 17.4% in Q4 and 32.6% for the year. The best-performing fund category was Latin American stock portfolios, which posted gains of 21.5% for the quarter and 45.2% for 2006. On the domestic front, many of the same sectors that have been leading the markets in recent years dominated again in 2006. Precious-metals funds rallied 32.2% for the year and are now up 33.7%, annualized, over the last five years. Real estate and utilities portfolios posted average gains last year of 34% and 25.5%, respectively. And thanks in part to the recent wave of mergers and acquisitions, financial sector funds rose 16.4%, on average. Despite predictions that this would be the year when large-cap domestic stock funds returned to dominance, small-cap stock funds again led.According to Morningstar, the average small-cap growth fund advanced 11.1% last year, versus 7.3% for the average large-cap growth portfolio. And while large-cap value funds outperformed their small-cap counterparts for the full year, they trailed small-cap value funds in Q4. “This appetite for risk has me a little worried,” Mr. Swanson said. He asserted that investors aren’t simply expecting a so-called soft landing in the economy — in other words, the avoidance of a recession. “The market is bracing for the plane to circle and take off again — and I think that’s too optimistic,” he said. Another reason that speculative investments are doing so well is that despite 17 interest-rate increases since June 2004, ample liquidity continues to slosh around the global financial markets. “Right now, there’s still too much money chasing too few financial assets,” said Stuart Schweitzer, global markets strategist at J. P. Morgan Asset and Wealth Management. James Paulsen, chief investment strategist at Wells Capital Management, agreed. “This is the only time in postwar history where a recovery has taken place without any rise in long-term borrowing costs,” he said. He noted that yields on 10-year Treasury notes were virtually unchanged from June 2004, when the Fed began its tightening cycle in an effort to slow the economy and tame inflation. Until this changes, Mr. Paulsen argues that the markets will continue to be led by small-cap stocks that are economically cyclical. He is in the minority. A vast majority of money managers and market strategists are banking that investors will regain interest in large-cap stocks as attention turns to the slowing economy and corporate profit growth later in the year. Indeed, a recent survey of money managers by the Russell Investment Group showed that investors were more bullish on large-cap growth and large-cap value stocks than they were on small-cap growth and small-cap value shares. And investors are anticipating a fifth consecutive positive year for equities. Yet bull markets rarely survive to this age. Of the last 14 bull markets in domestic equities, only four lasted five years or longer. And the average bull lived only 3.7 years, according to InvesTech Research. According to the Russell survey, 8 in 10 investors believe that domestic stocks will have another positive year in 2007. And a third are predicting gains of at least 10%, in part because of a slowing-but-still growing economy and a possible rate cut by the Federal Reserve. But all of this bullishness has some market watchers nervous. “There’s certainly less pessimism today about 2007 that there was a year ago,” Mr. Paulsen said. While that may be good news for investor confidence, he added, “it means the risks in the market are higher.” For instance, what if corporate profit growth — estimated at 15.5% last year, versus 13.7% in 2005 — slows more than expected? Mr. Schweitzer points out that six months ago, Wall Street analysts were expecting corporate profits among S&P500 companies to jump 10.5% to 10.75% in 2007. “Now, the latest forecasts are for growth of a little more than 9%,” he said. While this is none too shabby, “the ebbing of corporate profit growth expectations may continue in 2007 and unsettle investors,” he said. At the very least, Mr. Schweitzer said, the worrisome degree of optimism among investors means that “the chances of a bumpy ride on Wall Street are quite high.”
This defense of the average fund manager comes from a new study called “Does Motivation Matter When Assessing Trade Performance? An Analysis of Mutual Funds.” The authors of the study are three finance professors: Gordon J. Alexander of the University of Minnesota and Scott Gibson and Gjergji Cici, both at the Mason Business School of the College of William and Mary. A version is at papers.ssrn.com/sol3/papers.cfm?abstract-id=641743. The professors’ research builds on fund managers’ motivations to buy or sell a stock. The most obvious, of course, is that they believe that the stock they’re buying will climb and that the stock they’re selling will fall. But only some trades purely reflect such convictions. When investors are pouring money into the fund or selling in droves, managers have to buy or sell stocks that they would not have traded otherwise. The study used a new method for segregating fund trades according to these different motivations, allowing the professors to measure managers’ pure stock-picking abilities as well as the effects of fund inflows and outflows on fund performance. The key to the approach was measuring how much money was being invested in a fund, or withdrawn from it, at the time of each transaction. A large purchase made during a period when investors were withdrawing money from the fund - thus the manager didn’t have to buy the stock in order to invest a large inflow of cash - was a “valuation-motivated buy,” in the professors’ parlance. Similarly, a “valuation-motivated sell” would be a big sale that occurred when there was a large net inflow of cash into a fund. The professors built two hypothetical portfolios, one for the valuation-motivated buys and the other for the valuation-motivated sells. The portfolios changed composition every quarter. From January 1980 through December 2003, the professors found, the first portfolio performed 2.8 percentage points a year better than the stock market as a whole, on average, while the second trailed the market by an average of 0.7 percentage point a year. The study says this means that “when fund managers make purely valuation-motivated trades, they beat the market by a substantial margin.” The professors assume that “liquidity-motivated buys” are those that occur when there is a large inflow of new cash, while “liquidity-motivated sells” occur amid a large number of redemption requests. They acknowledge that some of these trades may be motivated by considerations other than liquidity. The professors built two portfolios of stocks in these liquidity-motivated categories, one for the buys and one for the sells. The relative performance of the two liquidity portfolios was nearly opposite that of the valuation-motivated versions, with the buys now lagging the market and the sells outperforming it. In fact, the liquidity-motivated sells outperformed the buys by two percentage points a year, on average. In other words, the transactions that managers must make to meet liquidity needs eliminate much of the profit from trades made for valuation reasons. Transaction costs, which were not included in the calculations, coupled with management fees, eliminate the rest of that profit for the average fund. The professors interpret their findings to mean that mutual fund investors pay a high price for the chance to invest or withdraw money at any time. And the cost is borne by all investors, whether or not they take advantage of the opportunity. The investment implication is clear: don’t pay for liquidity unless you need daily access to your money. Are closed-end funds the preferred alternative for long-term investors? It might appear that way. After all, the amount of assets under management at closed-end funds doesn’t change when investors buy or sell shares, because the number of shares outstanding is fixed. This means the managers of closed-end funds are immune from rapid inflows and outflows of cash. But Professor Gibson said that he did not think closed-end funds were the way to go. Because the funds’ assets under management don’t change even when performance is awful, the closed-end fund industry “helps entrench poor-performing managers,” he said. And because these funds won’t receive new money even when performance is spectacular, he said, they tend to “turn away the best managers who want to grow asset-based fees.” Because of those considerations, Professor Gibson says he instead favors open-end mutual funds that significantly restrict short-term trades. Such funds, he says, are more likely than closed-end funds to attract better managers and offer a powerful incentive for them to beat the market. And because of the restrictions on short-term trades, long-term investors don’t subsidize the liquidity needs of the short-term traders. Professor Gibson says he particularly likes funds that charge redemption fees on short-term trades, especially when the fees go back into the fund. It’s easy to see why short-term traders don’t like these fees, he said, but “if you’re a long-term investor, they are your best friend.”
Merrill Lynch, which pioneered such tactics starting in 2000, is expected to report next week that its profits derived mainly from reinvesting customers' cash will top $2 billion for 2006, up from $1.3 billion two years ago. Last year Morgan Stanley ramped up the same strategy of "sweeping" client cash to insured bank deposits, which pay rates as low as 1.25% on the smallest accounts. And Smith Barney in September also began paying rates as low as 1.51% for cash in smaller accounts. Wachovia pays just 1% on bank-sweep cash for accounts with under $100,000 in assets and 1.3% for accounts under $250,000, while accounts with over $1 million get 4%. Schwab had used its own interest-bearing account, effectively a Schwab IOU, as an alternative to money-market funds for client cash, earning a profit by reinvesting the funds at higher rates. Currently, Schwab and other online brokers earn more in interest income from cash balances and margin loans than from commissions. Bank deposits are more profitable for Wall Street because they can be reinvested at profits of roughly three to four times the fees on money funds. But the bank deposits where the money is swept all pay less than 2% annually for the smallest accounts, far below current money fund rates of 4.72%, where Wall Street firms could put clients' idle cash. Analysts estimate that such bank sweeps can be reinvested at a profit of 2% to 2.5% of balances. By comparison, fees and expenses for taxable money-market funds currently average 0.58% of assets, according to iMoneyNet. Merrill has about $78 billion in bank deposits, which pay as little as 1.51% for small brokerage accounts. Last year, Morgan Stanley's total deposits rose to $13.3 billion from just $1.7 billion in 2005.
This year, several themes already have emerged. The U.S. economy will achieve the "soft landing" aimed for by the Fed. The stock market will have a positive, if unspectacular year, gaining about 7% to 8%. Energy and commodity prices will continue to drop as inflation fears abate. Technology will outperform. Interest rates will remain low, with the Fed likely to be reducing short-term rates by summer. Foreign stocks and especially emerging markets remain attractive. The dollar will continue to fall, though not precipitously, enhancing returns in foreign currencies. Let's consider last year's conventional wisdom that U.S. markets were overvalued. I disagreed, arguing that "with profit growth expected to continue, U.S. stocks look like relative bargains." With last year's strong gains in hand, I rest my case. This year, the first week's trading was an indication how much of the conventional wisdom rests on the assumption that the Fed has stopped raising rates, and will likely begin reducing them in 2007. To me, this is the biggest risk for believers in the conventional wisdom for 2007. Higher-than-expected rates could slow or reverse the drop in the dollar, dampening returns for foreign investments. The sharp pullback in emerging markets last year was triggered by rising longer-term interest rates in the U.S. and fears this would dampen the global expansion. My hunch is that a similar scare will afflict markets at some point this year, which will likely represent a buying opportunity. But longer term, I think the conventional wisdom is right. Sooner or later, the Fed will begin to reduce rates, and the conventional wisdom will be vindicated. So, even though the bull market that began in October 2002 is reaching old age, I, too, am bullish on the U.S. stock market, maybe even a little more so than the conventional wisdom. But not so much as to provide much of a contrarian profit opportunity. The key will be to reduce exposure at overoptimistic market peaks, and take advantage of corrections to buy. That's the standard Common Sense playbook: Buy lower and sell higher. It's an approach that doesn't require any gazing into a crystal ball, and which I'll be pursuing throughout the year. Stock sectors are another matter. Despite the recent sharp pullback in oil prices, energy stocks have held up surprisingly well. I don't expect that to continue over the near term. The conventional wisdom now is that oil prices are in a long-term cyclical decline. As investors flee and prices drop, I'll be adding to my energy and commodity positions. I'm not saying oil will rebound by the end of 2007, but eventually the fundamental forces that drove oil to $77 a barrel in July will reassert themselves. None of these factors — from growth in India and China to instability in Africa and the Mideast — have gone away. Once again, I'll take a contrarian view by recommending the health-care sector. Now that the Democrats have control of Congress, it's more out of favor than ever. And yet I continue to believe that sheer demographics will propel these stocks to outperform one of these years. In my view, plans that expand prescription-drug use and still allow a profit to drug manufacturers should compensate in increased volume and revenue for what they cost in lower margins. With rampant pessimism clouding the sector, this strikes me as a good time to invest. As I did last year, I embrace the conventional wisdom that foreign stocks continue to represent excellent opportunities. But this year I'm shifting away from emerging markets toward the more mature economies of Europe and Japan. Emerging markets have simply risen too far too fast. Sooner or later, something is going to happen to remind investors that these fledgling economies and political systems are riskier than centuries-old democracies.
For nine years, I have been studying the annual performance of the four stocks that analysts most unanimously recommend, and the performance of four stocks on which they issue an unusually large number of `sell' recommendations. The analysts' darlings lost 3.7% a year, on average. The stocks they hated declined 0.2 percent. Both groups of stocks did worse than the S&P 500, which returned 7.4% a year, on average, during the period of the study: 1998 through 2006. Analysts are tastemakers in the investment world. They set the frame of investors' expectations, provide much of the information on which the public invests, and move stocks with their `buy' and `sell' recommendations. Yet as my little study shows, they are far from infallible. I don't begrudge Wall Street analysts their successes when they have them. I simply say that you should make an independent decision when you invest.
Joey Fundora, a 32-year-old computer network architect in Miami, logs in every morning to StockTickr, which so far has about 2,500 users. "The first page that comes up is a list of stocks that my 'friends' have recently added. If you know that there's a user that you have a lot of similarities with, often they'll bring up stocks that aren't on your radar." Taking their cue from such social-networking sites as MySpace.com, the new financial Web sites, with names like BullPoo.com, SocialPicks.com and FeelingBullish.com, aim to provide a forum for individual investors to share research on stocks that may not be covered by professional analysts, get a second opinion on investment ideas, or merely to show off one's stock-picking prowess. The sites, several of which were started by individuals whose backgrounds vary from engineering to software design and finance, are so far free to member participants, though some offer additional analytical tools for a fee. "Trading is a lonely profession," says Richard Todd, a 29-year-old day trader in Dallas, who uses StockTickr. "Serious, active full-time traders tend to flock to sites like this because it gives us a chance to interact with people and we can talk shop all day." The idea has gained steam. Motley Fool, best known for its online stock-investment advice, started its CAPS stock-rating site last fall, which has so far attracted close to 20,000 active users. Other firms are adding similar services. Zecco Holdings Inc.'s Zecco.com, a budding discount broker, shares advertising revenue with investors whose blogs the company features on its Web site. And established brokerage firms such as Charles Schwab, Fidelity Investments and optionsXpress Holdings, say they are looking for ways to permit online customers to share more information with each other. But skeptics say there is a risk of fraud from discussing your financial affairs with a group of strangers on the Internet, and it's best not to be too revealing. And the usefulness of the sites depends in large part on the size of the communities. Here's how the sites work: After registering, members create their own profiles, including details of their investing experience and preferred trading styles. They typically can search for other users based on a menu of attributes contained in the profiles. Individuals can email each other to share investment ideas or sign up to get email notifications of other members' favorite investments. For the most part, users exchange tips on stock holdings that are in virtual portfolios that may not reflect their actual investments, though some participants choose to keep the holdings identical. People who wish to remain anonymous can visit the Web sites without logging on to see what other people are buying and selling, but won't be able to offer opinions or affect other people's ratings. Beyond that, each site works slightly differently. At BullPoo.com, which started last spring, new members are given a virtual investment kitty of $1 million to trade stocks listed on major U.S. stock exchanges, and are ranked based on how well their virtual portfolios perform. The site allows members to share their stock picks and analysis through blogs, discussion boards and other communications. Participants at FeelingBullish.com can rate individual stocks, ranging from strong buy to sell, and earn a score based on how the stocks perform. The site currently has about 400 users. Motley Fool's CAPS service, which bills itself as an online stock-research tool, provides ratings on more than 3,200 stocks from individual investors and established brokerage firms. The company says it has safeguards to prevent someone from trying to hype a particular stock: Investors must provide predictions on at least seven different stocks before they are assigned a performance ranking, and investors with the highest rankings have a bigger influence on a stock's rating. What's more, many of the tiny bulletin-board-listed stocks, whose prices are easier to manipulate, are excluded. At least one firm, discount broker TradeKing, has taken investor networking a step further, by allowing its customers to share the contents of their actual brokerage accounts. One participant is Sean Jackson, a 39-year-old owner of a technology company in Dallas, who says he lets other people view his trades. "I'm putting my money behind what I'm saying," says Mr. Jackson, who adds that he tends to listen more closely to the advice of others who are also making their trades public. Mr. Jackson also started keeping an investing journal at the TradeKing site, which he says is read by between 10 and 20 other investors. Big brokerage firms are also looking to expand their community features. Charles Schwab hosted several online forums last year to get customer feedback on the company's services and to talk about other topics. But the firm noticed that clients also used the forums to discuss investment strategies with other investors. Now, Schwab says it plans this year to find additional ways for investors to communicate with each other.
On average, the economists predict that inflation-adjusted gross domestic product will grow at an annualized rate of 2.3% in the first half of 2007 and 2.8% in the second half. That's up from a sluggish 2% in the third quarter of 2006, but still far below the robust annual growth rates of 3.2% for 2005 and 4.1% for early 2006. In the consensus scenario, nonfarm businesses will add about 100,000 jobs a month in 2007. That should be strong enough to slowly lift wages, but not to keep the unemployment rate from creeping up to 4.9% from 4.5% in November. The economists surveyed expect year-to-year inflation to decline to 1.7% in May from 2.0% in November. As a result, they expect the Fed to shift its focus from fighting inflation to helping the economy grow, lowering short-term interest rates to 4.75% by the end of 2007 from the current 5.25%.
"Junk bonds used to be a bad word on Wall Street," says Joe Bencivenga, who used to be a bond analyst at Wall Street's junk-bond house Drexel Burnham Lambert in the 1980s. "They have since gained a lot more respectability." Mr. Bencivenga is a co-founder and head of research at Plainfield Asset Management, a hedge fund. The rising tide of junk points to glacial changes in the nation's financial markets, and to more explosive short-term trends. Back in the 1970s, many companies needed high credit ratings to persuade debt investors to lend them cash. Otherwise, they had to rely on banks. As financial markets became deeper and more sophisticated, investor tolerance for risky bonds rose. Investors get bigger interest payments on bonds from riskier companies, to compensate them for the possibility of a default. Today, many bank loans even fall into this risky category, and they are bundled together and sold to investors almost like bonds. More recently, a boom in leveraged buyouts is pushing a growing number of companies into speculative territory, a worrisome development to some. Junk-bond booms in the late 1980s and late 1990s ended painfully. "People forget the bad times and remember only the most recent good times, and I fear that's the case right now," says Edward Altman, a finance professor at New York University who was one of the first academics to study junk bonds in the 1980s. Ratings services like S&P, Moody's Investors Service and Fitch Ratings assign a range of rankings to companies based on their perceived ability to repay debt. S&P's rankings go from triple-A -- rock-solid companies like General Electric that are sure to pay it off -- to single-D, which are already in default. Companies with the highest credit ratings pay lower interest rates. Bond investors make money on interest payments. They can also make or lose money on the underlying value of the bond, which goes up if the perceived risk of default goes down and vice versa. These days, triple-A companies are nearly extinct. Just six nonfinancial corporations bear the label. Now the common currency is single-B, a level one step below the official junk standard of double-B. Single-B companies have grown to 42% of the 2,000-odd nonfinancial, nonutility corporations tracked by S&P today, from 7% in 1980. More than 70% of U.S. companies rated by Standard & Poor's have below-investment grade, or junk, ratings. That's a record. In all, 70 of the large companies that make up the S&P 500 have junk ratings. The club includes names like Neiman Marcus and Toys "R" Us, both recent debt-heavy buyout targets. It also includes Ford and General Motors, whose low ratings result from auto-sector troubles. Four Seasons Hotels, Gap and even Nasdaq Stock Market Inc. hover a wrung above at double-B. Among a sample of around 120 single-B companies that tapped the debt markets for the first time in 1996, just 6% have paid off their debt, according to S&P. A third of the group defaulted or went into bankruptcy proceedings. Another third have been acquired. On average during the past 20 years, 4.5% of junk bonds have gone into default. In 1991 and 2002 defaults spiked to more than 10% of junk bonds outstanding. The default rate was only 1.3% last year, one reason for the surge of interest in the lower-rated debt. Monthly Employment Stats
Professional and business services employment continued to expand in December with a gain of 50,000. Job gains occurred in services to buildings and dwellings (13,000) and in management and technical consulting services (7,000). Employment continued to trend up in architectural and engineering services and in computer systems design and related services. Temporary help services employment was little changed over the month and over the year. Health care added 31,000 jobs in December. Employment rose in ambulatory health care services (14,000), hospitals (11,000), and nursing and residential care facilities (7,000). Over the year, health care employment increased by 324,000, with gains spread throughout the component industries. Job growth continued in food services and drinking places (23,000) in December. In the past 12 months, food services added 304,000 jobs, accounting for most of the over-the-year increase in leisure and hospitality employment. In financial activities, commercial banking added 5,000 jobs in December. Employment in financial activities was up by 153,000 over the year; job gains occurred in insurance (46,000) and in credit intermediation (62,000), which includes commercial banking. Employment in transportation and warehousing continued to trend up in December. Over the year, the industry added 106,000 jobs. Telecommunications employment was up by 6,000 in December; over the year, however, employment in the industry was essentially unchanged. Employment in retail trade was little changed over the month after rising by 39,000 in November. Building and garden supply stores lost 8,000 jobs in December. Over the year, retail trade employment edged down. In the goods-producing sector, employment in mining continued to trend up in December. Job gains in the industry averaged 4,000 per month in 2006. Employment in construction was about unchanged in December following losses in October and November that totaled 53,000. After increasing by 295,000 in 2005, construction employment was little changed in 2006. Over the year, gains in nonresidential speciality trades and in heavy construction were largely offset by a decline in residential specialty trades. Manufacturing employment continued to trend down over the month with declines in motor vehicles and parts (-5,000), primary metals (-3,000), and textile mills (-2,000). Over the year, manufacturing employment fell by 72,000 with declines widespread throughout the component industries. The average workweek for production and nonsupervisory workers on private nonfarm payrolls remained at 33.9 hours in December. Weekly hours for factory workers were unchanged at 41.0 hours while overtime increased by 0.1 hour to 4.3 hours. Average hourly earnings of production and nonsupervisory workers on private nonfarm payrolls increased by 8 cents, or 0.5%, in December to $17.04. Average weekly earnings also rose by 0.5%, to $577.66. Over the year, hourly earnings were up 4.2%, while weekly earnings were up 4.5%.
Quick Facts, Stats & Opinions Retirement Planning Martha Hamilton, Washington Post 1-14 One in four workers currently in their 50s will need to work an extra two years because retirement won't be affordable, according to a survey of employers published last month by the Center for Retirement Research at Boston College. The prospect of working longer is not necessarily bad news for many of us. After all, the world of work has many satisfactions beyond the paycheck. And increased longevity and better health argue for remaining engaged in the world of work longer than in the past. But the truth is that finding or even retaining a job after the age of 40 isn't always easy. An earlier study by the Center for Retirement Research found that one in five adults age 51 to 61 lost his or her job between 1992 and 2002. Right now, most folks work 40 years to fund a retirement approximately 20 years long, which is a 2 to 1 ratio. If the balance changed to 45 years of work and 15 years of retirement (a 3 to 1 ratio), then the arithmetic looks a lot easier. The arithmetic doesn't look so good today: The median balance in 401(k) plans and individual retirement accounts for workers in their 50s is just $60,000, which won't pay the bills for many years. Tax Law Changes for 2007 Tom Herman, WSH 1-03 For 2007, the maximum amount you can contribute to a 401(k) plan increases to $15,500 from $15,000 in 2006. If you're 50 or older by the end of the year, you can stash away an additional $5,000, for a total of $20,500. The maximum contribution limits for individual retirement accounts remain the same: $4,000 if under age 50, and $5,000 if you're 50 or older this year. The income limits rose for making contributions to a Roth IRA. For joint filers, the amount you can contribute phases out if your income is between $156,000 and $166,000, up from $150,000 to $160,000 in 2006. For most singles in 2007, the range has increased to $99,000 to $114,000. For 2006, it was $95,000 to $110,000. Two new consumer turntables on the market at $200 or less connect directly to computers to transfer vinyl to MP3 files and CDs. Learning how to use these systems takes time — up to three or even four hours. The turntable also has to be assembled. And the software requires some attention even after you learn its ways. For example, it can’t automatically detect the end of each track between two songs or movements of a symphony. You have to mark these spots yourself in the program before burning a CD. If you are ambitious, you can edit the file, deleting some of the scratches, for instance. Once the files are on the hard drive, they can be burned quickly to a CD. There are other ways to digitize old LPs. Commercial services will transfer them, typically for $15 to $50 each, depending on the number of extra services. TEAC makes an all-in-one $400 machine that doesn’t require a separate computer to convert LPs to CDs. (Anne Eisenberg, NY Times 1-21) The CXO Advisory Group, in its investing blog, finds interesting research that suggests that we ink-stained wretches aren’t much for stock-picking. “Much as do individual investors, journalists focus on recent attention-grabbing events (news, unusual returns, unusually high trading volume) in their buy and sell recommendations,” they write. “In summary, journalists amplify the attention bias of individual investors, especially for sell recommendations.” (David Gaffen, WSJ 1-16) The surge in emerging markets in 2005 had some strategists worried — but investors continued to plow their money into global equity funds (about $136 billion through November, accoridng to the ICI). Those markets had another stellar year in 2006 as a result, and while some are concerned, Merrill Lynch strategists believe emerging markets have more gains in store for 2007. They call the current four-year bull run “young by historical standards.” They compare it to the nine-year boom in small-cap equities in the U.S. in the 1970s and the 12-year run in Japanese equities in the 1980s. (David Gaffen, WSJ 1-16) Merrill Lynch says the best investing strategy (among 40 different ones the quantitative folks there follow) was to simply invest in the 50 stocks least-covered by analysts among the S&P 500. Those names produced a gain of 24.6% on the year, handily beating the S&P’s 13.6% gain. (David Gaffen, WSJ 1-04) Some 900-plus funds were liquidated or merged out of existence in 2006, down about 25 percent from 2005 and the lowest extinction level in several years. (Chuck Jaffe, MarketWatch 12-31) Home Page Previous Factoid Top Sites
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