The Experts
| Lummer's Logic |
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| Third Quarter 2001 Marked by Tragedy, Uncertainty
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By Scott Lummer
Chief Investment Officer, mPower |
October 2, 2001
September was an awful month — awful for the personal
loss, awful for the political consequences, and, least importantly, awful for the
financial markets. The short-term economic impact of the terrorist attacks is affecting
many people in a number of ways, including through job insecurity or job loss. But purely
in terms of the investment universe, which is what we are focusing on, we need to
recognize that when the events of the past month are recorded in history books the stock
market reaction will not even rate a footnote.
Volatility and Uncertainty
All sectors of the stock market were down for the third
quarter of 2001 — from July 1 to Sept. 30 — and for the year. During the
quarter, the S&P 500 fell by 15 percent, the NASDAQ Composite declined by 31 percent,
and the Russell 2000 (an index of small company stocks) dropped by 21 percent.
International stocks also declined in value, with the representative MSCI EAFE index
falling by 14 percent.
While most of the decline for the quarter was during July
and August, analysts have focused most of their attention on the Sept. 11 attacks and
their impact on the economy. The uncertainty about the magnitude of the economic loss and
its duration has, not surprisingly, increased the degree of daily volatility of stock
prices. This increase in volatility will continue for the next several weeks, as more data
on the economic impact becomes available. While we know volatility will be higher, no one
knows whether the end result of these price changes will be up or down.
Stick to Strategy
At mPower we have taken a very public stance about the
impact of this national tragedy on individuals' investment policies. For investors who had
developed a well thought-out strategy for their retirement plan — either through us,
through another investment advisor, or by themselves — we have continually suggested
that they stick to that strategy. We continue to recommend a stable policy despite the
heightened interim volatility. There are three reasons for this.
First, it is important to focus on the investment time
horizon of your retirement plan. The balances you should be concerned about are not the
balances next month or even next year, but the balances during your retirement years. And
that means the economic numbers you need to worry about are the ones affecting the stock
market during your retirement, which for many people may be well in the future. While no
one doubts that last month's tragedy will affect many companies over the next several
months, I know of no analyst who is predicting an impact on the economy 10 years from now.
I realize it is difficult to maintain that focus while your investments are fluctuating,
particularly when the emotional impact might not have fully settled in (I must admit that
I have not completely come to terms with the personal impact of the attacks). Nonetheless,
it is logical and important for you to keep focusing on the long-term economy.
Second, while the short-term impact on the economy will be
severe, so was the immediate stock market reaction. On the first day of trading after the
attack, the aggregate market value of U.S. stocks declined by $600 billion. If you stayed
invested in stocks it didn't mean you thought the attack would have no economic impact
— it meant that you thought the decline in values was a reasonable reflection
of the impact. Consequently, even for investors with relatively short-term time horizons,
either because they are nearing retirement or because they have other short-term goals, we
are not recommending a change in investment strategy. It should be noted, though, that we
currently recommend, and have always recommended, that investors with short-term time
horizons allocate a generous proportion of their portfolio to fixed-income investments.
Market Timing Doesn't Work
The third reason we recommend sticking with your policy is
that not sticking with it is dangerous. During the first week of trading after the
attack, we actively approached our clients and urged them not to reduce their equity
allocations simply because of the market volatility. As a result, I received an
unprecedented amount of correspondence from our clients. While the vast majority of the
e-mails were positive and encouraging, there were a few investors who indicated that they
were reducing their equity allocation at the end of the week, either because they thought
they could predict market movements or they feared a potential continued downturn. No one
who sold equities a week ago said they were doing so permanently — the intent was to
buy back equities after they declined further. Well, stocks increased in value by 8
percent last week, so those investors who sold with the intention of buying back later
lost up to one-twelfth of their portfolio value.
That's the problem with timing the market. While the goal
may be either to gain returns or to reduce risk, market timing usually fails to accomplish
either.
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The information provided here is intended to help you understand the general issue and
does not constitute any tax, investment or legal advice. Consult your financial, tax or
legal advisor regarding your own unique situation and your company's benefits
representative for rules specific to your plan.
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