Is the bull market back?

The economy is poised for an upswing. Re-evaluate your situation and stand by your commitment to long-term investing.

Issue: May 1, 2002

ByFred L. Dowd

Is the bull back? Should I invest in the stock market again? Is there some sector that would have protected my portfolio from the downward trend of 2000 and 2001? These are some of the questions investors are asking themselves, as our markets seem to be over the correction bump and beginning to improve.

I believe that Alan Greenspan and the Federal Reserve artificially created this downward spiral of our markets. I also believe the recovery was artificially slow in rebounding due to Mr. Greenspan and the Federal Reserve. Now that they have bowed out, I believe our free markets will rebound and our economy will improve. I also believe that growth stocks are still the best means to creating wealth.

New technology economy

Mr. Greenspan did not understand our new technology economy and how it works. He was still working from the old Philips Curve. The Philips Curve states that if an economy has full employment, in order to produce more goods and more growth, companies must hire workers away from competitors. To attract these workers, the companies must offer higher wages. Higher wages are passed to the consumer via higher prices of the goods produced. Thus, full employment with continued growth leads to inflation.

However, in our new technology economy, a company can produce more goods with higher growth without hiring huge numbers of workers. If a computer manufacturer automates the assembly line, that company can produce many more computers with only a few more workers. In my securities office, we are handling 10 times the business with only one new employee because all of our trades are now completed with the click of a mouse instead of traders sitting on the telephone talking to other traders.

This type of growth without need for as many workers does not lead to inflation. Just the opposite! As more work is completed and more products are manufactured with only a few new workers, prices can be cut because the cost of producing each new item is lower.

As Mr. Greenspan raised interest rates again and again, he slowed our economy by tightening money needed by companies to buy new technology and grow. This led to a “man-made” recession, rather than a correction based upon real company values.

Lowered interest rates

Upon determining that our economy was in trouble, Mr. Greenspan again caused a slower-than-normal recovery by lowering interest rates a little at a time with the promise of more cuts to come month after month. Are you going to purchase an automobile or a house if you know that next month or the month after that it will be considerably cheaper? Of course not! You will wait until the final cut to lock in your more expensive purchases. And that is just what buyers did. Now that the final cut has been completed, people are buying again. This means the bull is at least rising from his sleep and will begin to move forward.

As Mr. Greenspan gradually lowered interest rates over the past year, certificates of deposit and money market funds significantly cut the rate of interest they paid to investors. Those investors owning fixed income securities saw interest income cut by as much as 60%. Investors depending upon fixed income securities for spendable dollars constitute a significant portion of our economy. These people had fewer spendable dollars, so they purchased less in goods and services. This also put strain on our faltering economy.

Those investors living on fixed income interest or dividends saw their income dry up as these products paid lower rates. But the bonds and fixed income products themselves did well as interest rates moved consistently lower, making the value of the bond locked in at the higher rate more valuable. Stocks were hammered as company profits and growth slowed due to tight money. Money markets held principal value, but they certainly did not produce decent returns over these 2 years.

Invest for long term

I do feel that the long-term investor should still be invested. I still believe in technology and the technology sector of our markets, as well as other sectors such as health care and consumer goods that are benefiting from demographic trends. Technology was not the cause of the recession. Investing in technology stocks makes sense because this is the trend of the future.

However, when investing in technology it is important to recognize that the companies engaged in the communications and technology industries are subject to fierce competition. Their products and services are often subject to rapid obsolescence, which requires a good grasp of the investment backdrop. Technology is a part of our lives and will continue to be integrated into both our work and leisure time.

While some investors were caught in the dot.com bubble, that bubble would have burst as investors realized that some companies had real value and real assets while others had no tangible assets to back the stock prices. This is our free market at work.

Potential problems lie not in being fully invested, but in understanding your risk tolerance and your comfort level. Many investors stated they understood that markets go up and down. They said and truly believed they could ride the cycles down as well as up, knowing that the long-term time frame (5 to 10 years) would see them through the bottom and up the next rise.

However, some of these investors had difficulty sleeping and were worried literally sick. Some actually bailed just as we turned the corner in early 2002. Chasing returns became more important than their long-term goals or their true risk tolerance as they watched their portfolios lose as much as 40% or 50% or more.

My advice is to stay invested because I believe our markets and economy will continue to improve. I believe the Federal Reserve may not have learned to stay out of our free markets and stick to their job, but I believe that both the government and investors will insist that they stay focused only on the money situation. Over the 5-to-10-year perspectives, these 2 years of 2000 and 2001 will seem like a strong correction, not the end of the world. Over the long term your portfolio will still have positive returns.

Re-evaluate your situation

Now is the time to re-evaluate your personal situation. Determine how much of your total net worth you are willing to invest for growth. Determine how much downside you are willing to allow. Set a plan and limits.

But remember that if you determine that 20% is your downside limit, that you will bail out of the market at a 20% correction, you must also be willing to risk missing the potential gains of a swift recovery. No one has a crystal ball. Neither you nor your advisors can time markets to take advantage of the recoveries if you are not willing to endure the corrections.

The next decision is whether to invest in your own personal portfolio of stocks or a mutual fund. A stock portfolio is not limited to the percent of assets that can be held in any one stock. This means you can hold your winners without selling shares in your position on the way up, and that is what can really bump up returns. It also means that the winners become a larger and larger percentage of your overall portfolio, leading to less diversification. While a stock portfolio should significantly outperform mutual funds in a bull market, this portfolio can also significantly underperform the mutual funds in a bear market.

There are other considerations in owning your own stock portfolio. You control the capital gains tax selling, not the fund manager. You do not have to worry about embedded capital gains such as when you buy the fund. You and your advisor determine the companies you choose to own. You can decline to own companies you do not like or agree with. You and your advisor have total discretion.