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Ah, to go back to last January. Investors were feeling
good. It was the start (unofficially) of a new millennium. We had low inflation, low
unemployment, and good projected economic growth. The NASDAQ was coming off a record year.
The Dow was at an all-time high. The film "Autumn in New York" had not yet been
released.
And now? Y2K did not cause the technological mayhem that
some had predicted, but it sure was an unsettling year for most investors.
What Happened
Early in the year, analysts were mainly focused on the
level of interest rates determined by the Federal Reserve Board, or "Fed." The
market oscillated during this time, culminating in a sharp decline in mid-April. Then,
after the Fed's last rate increase in May, stocks rose relatively steadily until the
beginning of September. The market has fallen since then, mainly because of analysts'
concern about lower company profits and slowing economic growth. The decline has been felt
most sharply in the high-technology sector, as evidenced by the 39 percent drop in the
NASDAQ Index for the year. The S&P 500, which measures the broad market, declined by
10 percent for the year. Nearly all sectors of the market fell during the year —
small-cap stocks as measured by the Russell 2000 declined by 8 percent for the year.
However, value stocks actually rose during the year. The concern about waning economic
growth impacted international stocks, which were also hurt by a rising U.S. dollar —
the MSCI EAFE Index, a benchmark for international stocks, declined by 14 percent.
The risks of investing during the year were apparent to
many analysts. In my commentary at the beginning of 2000, I said that there would be a
decline in stock values when growth in corporate profits slowed, particularly in the
technology sector. While no analysts were predicting the massive decline in the NASDAQ,
the risks were readily apparent.
Is Now a Good Time to Invest?
I know that many of you are discouraged about investing
— surveys during the year found that most investors thought they would earn a 20
percent or greater return for the year. But, the events of the past year should not deter
you from your investing plan. In fact, I would say there are more good reasons to invest
now than there were a year ago.
Last year saw major concerns about how much the Fed would
increase interest rates, and whether the rapid economic growth would end (which was the
goal of the Fed's rate increases). Today, those uncertainties are gone. The Fed
accomplished its goal of slowing the economy, and there is very little threat of an
interest rate increase. In fact, today (Jan. 3, 2001), the Fed announced a decrease in
interest rates because of weakening sales and production and lower consumer confidence.
The stock market responded immediately to the surprise announcement by rallying.
The health of the economy is the main factor impacting
stock values. Here's a comparison between last year and this year of the main three
economic indicators:
Inflation: Last January, inflation was 2.6 percent,
although nearly every analyst was predicting it would rise in the near future. That's why
the Fed was raising interest rates — to slow the economy and reduce the pressure on
inflation. Today, inflation is 3.4 percent, which is high compared to the recent past but
much lower than the 6.2 percent average level during the 1970s and 1980s. With the slowing
of economic growth, the upward pressure on inflation has been reduced.
Economic growth: Last January, economic growth was
5.7 percent. Today, it is 2.2 percent. While that is a large drop, keep in mind that the
main goal of the Federal Reserve was to slow growth. The slowing of economic growth is not
a sign of an impending recession — it is the result of a planned easing of
inflationary pressures.
Unemployment: Last January, unemployment was 4.1
percent, the lowest level in 29 years. It is now an even lower 4.0 percent. Hence, despite
the slowing of economic growth, businesses are still hiring.
So, last year we had outstanding economic statistics, but a
strong potential that they would worsen. This year, we have good economic statistics
without the likelihood that the situation will erode. Last year, we had the highest
valuations (based on earnings and book value multiples) in U.S. stock market history. This
year, the record values have subsided. In my mind, today is a much better time to invest
than a year ago.
What to Expect
Hopefully many of you have realized that the expectations
of 20 percent returns over a long term are misguided. You should plan on an average return
of 10 percent over the next 20 years. "Average" means some individual years will
be better, while others will be worse.
More specifically, for the next year I would anticipate
more volatile markets, particularly in the first half of the year. There is still much
concern over the correct valuations of high-technology stocks and the impact of those
valuations will be felt across the market. It is likely that with a more stable economy,
the extreme volatility will subside as the year progresses — but 5 percent or greater
swings in the NASDAQ will be commonplace. The focus of analysts will be mainly on growth,
productivity, efficiency and profitability of companies. There is little worry about
interest rate increases — in fact, if there is any further slippage of economic
growth, the Fed may cut interest rates again.
Lessons Learned
Last year was a good learning opportunity. Most investors
who got burned were poorly diversified. Some owned only a couple of stocks that performed
very poorly (it was not uncommon for dot-com stocks to lose 90 percent of their value).
Others held unreasonably large amounts of stock in the overall technology sector, which
was expected to be highly risky. Still others focused on only growth stocks, while the
average value stock actually increased in price. Investors who were broadly diversified
across all equity sectors lost only about a tenth of the value of their portfolios.
Some Perspective
I want to say one last thing. The year wasn't all that bad.
Large-capitalization stocks lost 10 percent (less when you add dividends back in). In 16
of the past 75 years (more than one in every five years), the market has lost at least 7
percent of its value. If you are a long-term investor, you will experience many years like
2000.
You have to keep your eyes on the prize — your
long-term goal. If you invested consistently in stocks over the past 10 years, you could
have earned 17.5 percent. That means if you had invested $100,000 in January of 1991, you
could have $500,000 today — a quintupling of value, despite the recent decline.
One year does not a lifetime make. |
