Second Quarter Commentary — Summertime Blues

By Scott Lummer
Chief Investment Officer, mPower

In This Story What Happened? The Next Quarter What to Do?

The stock market showed signs of recovery during the second quarter, although overall results are still down for the year. The S&P 500, a broad measure of the market, gained 6 percent but is down 7 percent for the year. The segments of the market that did the worst in the months leading up to April 2001 performed the best during the second quarter (April 1-June 30). The technology-heavy NASDAQ rose by 18 percent, but is down 12 percent for the year, while large-company growth stocks increased by 8 percent, but are down 11 percent for the year. Conversely, large-company value stocks rose only 4 percent during the past three months yet are only down 2 percent for the year.

Despite the solid returns produced by stocks during the second quarter, many investors are disappointed. One reason is that despite the gains, the market has lost ground over the past 12 months. For example, the S&P 500 lost 16 percent over the last year. Another reason is that the market was much higher in mid-May than it is now — over the past six weeks the S&P 500 has fallen by 7 percent.

Technical Terms Federal Reserve Board NASDAQ Risk Standard & Poor's 500 (S&P 500)

What Happened?

At the beginning of the quarter, there was much concern about a potential recession, and the focus was on any economic data that shed light on the likelihood that such a recession might occur. In my April commentary, I said that I believed the worst was over, although we would see much daily volatility because of the focus on economic news. Although there were mixed signals, the economic news has improved, and the stock market has reacted accordingly.

The Next Quarter

I am cautiously optimistic about the next three months. Most of the economic data is promising. Consumer confidence has been slowly rising. Unemployment is still at a relatively low rate of 4.5 percent (to give you some perspective, from 1974 to 1996 unemployment was never lower than 5 percent). And the index of leading economic indicators has been gaining.

The main concern is the economy's relatively low growth rate, currently at 1.2 percent. However, the Federal Reserve has cut interest rates six times during 2001, and the impact of those cuts is just beginning to be felt. There is also legitimate concern about the inflation rate of 3.5 percent, which has been heavily influenced by the rapid increase in energy prices. The interest rate cuts may cause inflation to increase.

As for the stock market, I think we will likely see continued slow growth with a high degree of volatility. The stock market growth will mirror economic growth. However, there are two significant risks — one for the broad market and a larger risk for the technology sector of the market.

Regarding the broad market, since the economy is still relatively fragile, any significant negative economic news could cause a quick 5-10 percent drop in the major market indexes. What's more, I don't foresee any more interest rate cuts — the potential for higher inflation will cause the Fed to proceed cautiously.

With respect to the sector risk, the potential volatility of technology stocks is particularly worrisome. Tech stocks are always unpredictable, as evidenced by the NASDAQ's decline of over 60 percent last year. However, the reason for my specific concern is that their rise over the past three months has not been justified by the stocks' fundamentals. We have not seen increases in company profits for most of the industry, and many of the larger technology companies are still making budget cutbacks. I don't see reason for panic, but increases in value by one-fifth do not seem warranted. Of course, there is always the potential for huge gains in this sector, but investors should be conscious of the downside.

What to Do?

In light of what I just wrote, this certainly isn't the time to be loading up on technology stocks. I think having a broadly diversified portfolio that includes some tech stocks is prudent. And, as is always the case, it makes sense to be heavily invested in equities for the long-term. All of the movements we have seen over the past year will be long forgotten by the time most of you begin your retirement.

Related Reading First Quarter of 2001 was Tough, but the Worst May Be Over Nas-blachhh 2: The Sequel What a Difference a Year Makes

Although I have seen no hard data to support this, my anecdotal evidence suggests that most investors are a little less focused on the daily movements of their portfolios than they used to be. News articles about the stock market have been pushed off of the front page and into the business section, and I have received fewer panicky e-mails. I think this is a good thing. Being overly focused on the stock market can lead to destructive behavior, such as attempting to time the market. Indeed there are investors who owned equity funds in March 2000, moved out of them a year later when the market was at its low point, and bought back in when the market was at its high.

The problem with reading a lot of information is that you start to think you should act on it. But the key to successful investing is not to overreact to short-term events.

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.

Second Quarter Commentary — Summertime Blues

By Scott Lummer
Chief Investment Officer, mPower

In This Story What Happened? The Next Quarter What to Do?

The stock market showed signs of recovery during the second quarter, although overall results are still down for the year. The S&P 500, a broad measure of the market, gained 6 percent but is down 7 percent for the year. The segments of the market that did the worst in the months leading up to April 2001 performed the best during the second quarter (April 1-June 30). The technology-heavy NASDAQ rose by 18 percent, but is down 12 percent for the year, while large-company growth stocks increased by 8 percent, but are down 11 percent for the year. Conversely, large-company value stocks rose only 4 percent during the past three months yet are only down 2 percent for the year.

Despite the solid returns produced by stocks during the second quarter, many investors are disappointed. One reason is that despite the gains, the market has lost ground over the past 12 months. For example, the S&P 500 lost 16 percent over the last year. Another reason is that the market was much higher in mid-May than it is now — over the past six weeks the S&P 500 has fallen by 7 percent.

Technical Terms Federal Reserve Board NASDAQ Risk Standard & Poor's 500 (S&P 500)

What Happened?

At the beginning of the quarter, there was much concern about a potential recession, and the focus was on any economic data that shed light on the likelihood that such a recession might occur. In my April commentary, I said that I believed the worst was over, although we would see much daily volatility because of the focus on economic news. Although there were mixed signals, the economic news has improved, and the stock market has reacted accordingly.

The Next Quarter

I am cautiously optimistic about the next three months. Most of the economic data is promising. Consumer confidence has been slowly rising. Unemployment is still at a relatively low rate of 4.5 percent (to give you some perspective, from 1974 to 1996 unemployment was never lower than 5 percent). And the index of leading economic indicators has been gaining.

The main concern is the economy's relatively low growth rate, currently at 1.2 percent. However, the Federal Reserve has cut interest rates six times during 2001, and the impact of those cuts is just beginning to be felt. There is also legitimate concern about the inflation rate of 3.5 percent, which has been heavily influenced by the rapid increase in energy prices. The interest rate cuts may cause inflation to increase.

As for the stock market, I think we will likely see continued slow growth with a high degree of volatility. The stock market growth will mirror economic growth. However, there are two significant risks — one for the broad market and a larger risk for the technology sector of the market.

Regarding the broad market, since the economy is still relatively fragile, any significant negative economic news could cause a quick 5-10 percent drop in the major market indexes. What's more, I don't foresee any more interest rate cuts — the potential for higher inflation will cause the Fed to proceed cautiously.

With respect to the sector risk, the potential volatility of technology stocks is particularly worrisome. Tech stocks are always unpredictable, as evidenced by the NASDAQ's decline of over 60 percent last year. However, the reason for my specific concern is that their rise over the past three months has not been justified by the stocks' fundamentals. We have not seen increases in company profits for most of the industry, and many of the larger technology companies are still making budget cutbacks. I don't see reason for panic, but increases in value by one-fifth do not seem warranted. Of course, there is always the potential for huge gains in this sector, but investors should be conscious of the downside.

What to Do?

In light of what I just wrote, this certainly isn't the time to be loading up on technology stocks. I think having a broadly diversified portfolio that includes some tech stocks is prudent. And, as is always the case, it makes sense to be heavily invested in equities for the long-term. All of the movements we have seen over the past year will be long forgotten by the time most of you begin your retirement.

Related Reading First Quarter of 2001 was Tough, but the Worst May Be Over Nas-blachhh 2: The Sequel What a Difference a Year Makes

Although I have seen no hard data to support this, my anecdotal evidence suggests that most investors are a little less focused on the daily movements of their portfolios than they used to be. News articles about the stock market have been pushed off of the front page and into the business section, and I have received fewer panicky e-mails. I think this is a good thing. Being overly focused on the stock market can lead to destructive behavior, such as attempting to time the market. Indeed there are investors who owned equity funds in March 2000, moved out of them a year later when the market was at its low point, and bought back in when the market was at its high.

The problem with reading a lot of information is that you start to think you should act on it. But the key to successful investing is not to overreact to short-term events.

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.