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2001: A Perfect Storm?

Stock Market News

January 2002

2001: A Perfect Storm?

Another year has come and gone, but it was not just any year. A fitting title might be The Perfect Storm. The year started with a bang and never let up. The Federal Reserve Bank embarked on an aggressive rate-cutting odyssey, the balance of power shifted in Congress with the Jeffords’ political defection, the GE-Honeywell deal disintegrated, our economy fell into recession after ten years of growth, we were hit flat-footed by murderous terrorists, and Enron collapsed. Did we leave anything out?

When the dust settled, the U.S. equity markets posted their worst results in 23 years, ending the year 2001 down for the second straight year. There is a silver lining to note, however. The fourth quarter, including the month of December, was strong for U.S. markets. The strength was impressive despite plenty of tax-loss selling pressure and emotional overhang from September. The month was marked by wild swings in trading volume. We experienced paper-thin volume surrounding the holidays only to see huge volume spikes other days. The net result was a slight gain across the board.

The market seemed particularly sensitive to news from the Middle East during the month, not only reacting to news of U.S. forces in Afghanistan, but also other trouble in the region such as tension between Pakistan and India and the chronic feud between Israel and the Palestinians. Given enough time, the market will begin to ignore these issues in terms of day-to-day reaction. If Bin Laden is put out of business, the markets should rally significantly, not because it's an economic event, but because it will make us feel better about ourselves.

We need to keep in mind that January signals a return to business as usual for many who took extended time off during the holidays, and accordingly, we may see a surge in trading volume lead to volatility. Historically January is a good month for stocks, but with the exceptional recovery throughout the fourth quarter of 2001, January might play witness to short-term profit taking. Once again, expectations may have jumped ahead of reality. The action will most likely be choppy between customary first-of-year demand and the concern of near-term overvaluation.

Interest rates settled down somewhat during December, a sign that possibly the Fed might be finished lowering rates. It's a little less clear now what data the central bank is relying on to make rate decisions, but we have formed some expectations about the future. Of significant concern is the fact that the Fed has adjusted interest rates the equivalent of 26 one-quarter percent increments in the last 30 months. At issue is whether the Fed has started a vicious cycle of over-tightening followed by over-loosening in an egotistical attempt to micro-manage the economy. It is very likely the Fed is about to find itself out of position once again by the end of 1Q 2002 and be forced to raise rates to stave inflation. In essence, the Fed maybe creating the very environment of instability it is designed to combat.

So what most wise investors do, typically, is avoid chasing movements in the markets (either up or down) in January. Instead they will most likely focus more attention on how rising interest rates will impact their portfolios during 2002. Bond investing will become treacherous during the next six months, as will investing in financials — such as bank stocks because their cost of goods sold is the cost of money itself. We are indeed entering a tricky inflection period where data is indicating active recession (GDP contraction and rising unemployment), while simultaneously seeing evidence that inflation could actually accelerate as a result of exceedingly low current interest rates.

What to do with all this volatility? An old strategy is to look for stocks that are devalued primarily by the market and less for internal reasons. Following this path, the logical stocks to consider would be high tech stocks. Fred Hager (www.fredhager.com) agrees. He suggest considering high tech stocks –– but considering them very carefully. You can still lose your shirt. And as a great many investors are weeping over their investment in high tech stock, we hope you don't join them. But, and this is a big but, there are stocks out there that have dropped up to 80% in value, primarily because of the market and not because of overspending, or poor management, or pie in the sky marketing plans. Fred Hager maintains that there are some good, solid companies out there that have been deeply oversold and will bounce back to original levels in the coming months. To this we want to add a universal and timeless caveat: The basic rules of investing still apply. Here we'll mention the three basics:

  • Know your company. Know it's history, it's cash to earnings ratios over the years and how the management is responding to the current circumstances. Look carefully at operations management.

  • Know your market. This is harder, like a history of the weather. The rule here is to listen to those who tend to be right at least 80% of the time.

  • Know your company in light of the current market. Find out how the company has fared in similar markets, what strategies are being employed by management as remedies for the current troubles in the market, and are they innovative and likely to find a creative solution to their current challenges?

The above questions, and other prudent inquiries, can prevent you from making any more decisions that will put you further behind, if you were among the multitudes of investors that lost a lot of value over the last year. Being levelheaded now can help you regain some of your lost equity and perhaps even surpass your previous watermarks and avoid sinking you ship.

Remember in the story of A Perfect Storm our hero was sunk because he refused to give up his catch. Greed sank his ship. He tried to make up for his past poor performance by holding on. Let's learn from his lesson. Take your losses and move on, with more prudence and care than in the past.

We hope you will invest wisely and have a happy and prosperous new year!

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.

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