Fourth Quarter Huddle
Stock Market News
Fourth Quarter Huddle
As rational investors, should we jump in with both feet to catch the next bull market wave? Maybe, maybe not. These are complex times and such times dictate that a measured approach is a wise approach. It will serve us well to consider all of the probabilities before we act.
GDP growth will likely hit bottom this quarter and continue in the negative column through the first half of next year. Unemployment will most likely worsen through the first quarter, ending with joblessness cresting at 6.0% to 6.5%. The average price-to-earnings ratio, one conventional measure of market risk, is still relatively high. Consumer debt is peaking. Housing starts are down. And, now for the bad news: the labor market has persistently maintained its pricing power during this economic slowdown, making it difficult for companies to pick up gains in profitability margins.
Setting aside negative views for a moment, let's look at some of the current phenomena. As we said, the market is showing signs of being bullish. And we have learned from history that price-to-earnings ratios sometimes spike just before the start of a bull market. However this phenomenon is not due to rising prices, but rather to falling earnings estimates. Also, corporations have already started to work through (or write off as the case may be) inventory built up during year 2000. Lastly, and somewhat expectedly, cash levels have been building. Both investors and consumers have been stockpiling cash. Were not paying off balances even though we have the money. This is because lower interest rates and fear of job loss are strong inducements for us to leave our debt alone in favor of having a nice cushion in the bank. This helps explain high consumer debt levels.
It is our expectation and the general consensus among other economists that the economy and the markets will recover in a deliberate and selective manner. It is unlikely the market will burst ahead for a 20% gain several months in a row and it is unlikely that when the recovery does occur that all boats will be lifted by the tide. The sad reality is that some of the stocks damaged in the market sell off will not recover. This is due to the fact that most investors will now be looking for opportunities in smaller companies. This is in direct contradistinction to the strong interest investors had in huge technology companies; an investment strategy that dominated the late 1990s and early 2000. This is very much the same pattern as the in the 1974 through 1984 period of recovery. So while some of these large capitalization companies will do well operationally in the next few years, they may not fare well as near-term investments. The jury is still out.
We anticipate more months ahead like November where stocks are generally buoyant with some notable winners and also some notable losers. It is important to be aware of the differences in market perspectives, and therefore the buying and selling patterns, between fund managers and those that handle investment funds directly. Mutual fund managers have the luxury of operating behind a veil. Their performance is being judged from a perspective of the bottom line on overall return performance rather than the performance of each stock. Those who manage money directly in stocks, on the other hand, have each of their buy and sell decisions open to scrutiny. Each transaction is judged on its own merit. Sometimes the brokers who manage money directly in stocks dont look too smart on individual transactions, but remember to stay focused on the big picture, the overall portfolio performance over time. This is particularly important now as we begin to harvest losses for tax purposes. The ideal tactic is to sell losing positions for their tax advantage and let the winners ride into 2002.
One word of caution. Since the market may be on an upward trend, optimism may fuel further overall market gains and therefore impel some investors to chase the market up. From our viewpoint, this would be a clear indication that those investors didn't learn much from this most recent slump. A case in point is when Cisco's price was 100 times its earnings, we as investors procrastinated, cutting the behemoth some slack. We tend to think that the bigger a company is the less likely it is to fall (Enron stocks anyone?). We were invested because of a sense of optimism, which we tried to hold onto by keeping our position. Such self-imposed disasters can be avoided if we discipline ourselves to look carefully at each stock individually. And the higher the price/earnings ratio, the more we should demand of that company. If the stock begins to falter, we should sell right away and not look back. We should demand the company be held accountable for the high value their price/earnings ration reflects.
What we are suggesting is that each investor be a more prudent investor in that each transaction should be judged on its own merit and not because someone thinks that the stock will rise just because the rest of the market is on a rise. This thinking is little more than action by mob rule. And we see no need to rush in and load up on bargains with the recent rise in the market in that there will be plenty of opportunities in the future to purchase at good prices. It is the overall strategy characterized by careful evaluation of each company and their stock that we see as the sure sign that someone has indeed learned their lesson from recent history. History shows that prudence pays.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.