| From March 10 until
last Friday, the Nasdaq declined by an aggregate 33%. Although the Dow has risen by 3%,
and the S&P 500 has fallen 2% since that time, our eyes (and those of the press) tend
to follow movement, and the Nasdaq has been the mover.
So the focus has been on the amount of value lost among
Nasdaq stocks. Now let's spend some time focusing on two issues — what is happening
with the Nasdaq and how it impacts a well-constructed portfolio.
The Nasdaq
It is not surprising what is happening with the Nasdaq in
terms of a general trend. At the beginning of the year I said that we would likely
experience heightened volatility and lower returns for the Nasdaq, although the degree of
this volatility could not be anticipated. The index is primarily comprised of smaller
companies and larger businesses in the computer, Internet, telecom, and biotechnology
sectors. Some of the larger companies in these industries are Cisco Systems, Microsoft,
MCI Worldcom, Dell, Amazon.com, and Amgen, Inc.
These companies tend to be riskier — many of them are
currently generating operating losses — but the expectation is that high revenue
growth will make them profitable. For companies that are currently generating earnings,
analysts still tend to focus on their long-term future instead of present fundamentals.
The long-term prospects for profits of high-growth companies are based on a myriad of
factors, including long-term economic outlook, demographic changes, expectations of
technological advances, competitive landscape, and individual company operations.
Trying to assess the value of these firms is much more
difficult then valuing, say, a utility. A company with relatively low growth prospects
will have its value based on recent- and near-term earnings, because the long-term
expectations will not be widely different than the short-term. And, short-term earnings
are much easier to predict than the long-term earnings of an Amazon or an Amgen.
Since the valuation of high-technology companies is
difficult and imprecise, it is reasonable to expect that changes in any of the valuation
assumptions will have a dramatic impact on a stock's price. So, given the events of the
past few weeks, during which we have seen a reduction in revenue forecasts, an increase in
inflation, a likely related increase in interest rates, and a possible major operational
shake-up of the largest software developer forced by the government, estimated valuations
will swing widely. And, although the impact of these changes will be felt by businesses
with a lower reliance on technology, their reactions will be muted.
A Reality Check
But let's step back from the turmoil over the past five
weeks and consider some basic questions.
I have read more analyses of the economy than I care to
admit. No analyst I have seen is predicting that these high-tech industries will not be
viable and successful. The current level of interest rates, or short-term profits, does
not overly affect the very long-term prospects for most of the businesses. Long term, the
economy's use of the Internet, computers, telecommunications, and advances in medical
treatments will expand. The only question is what this rate of growth will be.
Many of you have a portion of your investments in high-tech
stocks. A month ago, the average market participant thought that, in general, companies in
these businesses were worth 50% more than they are today.
Now I sympathize with your pain. But the question you need
to ask is, if you were motivated to purchase or hold onto these stocks a month ago, why
should you sell today?
There really isn't a good reason.
Your Portfolio
If you have been following the investment suggestions
outlined weekly in this column, you probably are holding a well-diversified portfolio that
is not in too bad of a shape.
At mPower, we thoroughly analyze the stocks in the funds
that we recommend, to make sure that there is not an abundance of exposure in any one
sector, particularly high-risk sectors such as high technology. We follow this investment
philosophy to help control the risk of our clients' portfolios. We follow this investment
philosophy in all economies, so that when high-tech stocks do very well, as they did in
January and February of this year, the returns resulting from our recommendations lag the
high-growth indexes. But, the pay off is in very volatile markets, when our results should
be steadier. That's our job as an investment advisor.
However, please keep this in mind: diversification is not a
sure thing. Even a well-diversified equity portfolio will lose money in about 15% of
one-year periods. Remember, the goal of retirement investing isn't to eliminate the risk
of losing money over the short term, the goal is to get you to the best place possible
over your retirement horizon, taking into account your attitude about risk.
Now some of you may have not followed the diversification
suggestion. If that's the case, what should you do now? Well it's not too late. If you
have all of your money in the Nasdaq, accept your losses and climb aboard the
diversification train.
The Nasdaq may recover entirely this week — I don't
think it will, but I suspect that it might produce some good returns (it had a nice start
on Monday). But, it also may continue to fall, and there is no doubt it will fluctuate
wildly. Now, more than ever, is the time to achieve some balance in your portfolio.
 Lummer's Logic Archives
Scott L. Lummer, Ph.D., CFA, 401k Forum's Chief Investment
Officer, is a recognized expert in the investment field. He has conducted extensive
research on asset allocation, international investing, risk management, mutual fund
analysis, ethics and valuation, and is a co-author of The Pension Investment Handbook.
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