What a Difference a Year Makes

By Scott Lummer
Chief Investment Officer, mPower

In This Story What Happened Is Now a Good Time to Invest? What to Expect Lessons Learned Some Perspective

Ah, to go back to last January. Investors were feeling good. It was the start (unofficially) of a new millennium. We had low inflation, low unemployment, and good projected economic growth. The NASDAQ was coming off a record year. The Dow was at an all-time high. The film "Autumn in New York" had not yet been released.

And now? Y2K did not cause the technological mayhem that some had predicted, but it sure was an unsettling year for most investors.

What Happened

Technical Terms Federal Reserve Board Growth stock NASDAQ Value investing

Early in the year, analysts were mainly focused on the level of interest rates determined by the Federal Reserve Board, or "Fed." The market oscillated during this time, culminating in a sharp decline in mid-April. Then, after the Fed's last rate increase in May, stocks rose relatively steadily until the beginning of September. The market has fallen since then, mainly because of analysts' concern about lower company profits and slowing economic growth. The decline has been felt most sharply in the high-technology sector, as evidenced by the 39 percent drop in the NASDAQ Index for the year. The S&P 500, which measures the broad market, declined by 10 percent for the year. Nearly all sectors of the market fell during the year — small-cap stocks as measured by the Russell 2000 declined by 8 percent for the year. However, value stocks actually rose during the year. The concern about waning economic growth impacted international stocks, which were also hurt by a rising U.S. dollar — the MSCI EAFE Index, a benchmark for international stocks, declined by 14 percent.

The risks of investing during the year were apparent to many analysts. In my commentary at the beginning of 2000, I said that there would be a decline in stock values when growth in corporate profits slowed, particularly in the technology sector. While no analysts were predicting the massive decline in the NASDAQ, the risks were readily apparent.

Is Now a Good Time to Invest?

I know that many of you are discouraged about investing — surveys during the year found that most investors thought they would earn a 20 percent or greater return for the year. But, the events of the past year should not deter you from your investing plan. In fact, I would say there are more good reasons to invest now than there were a year ago.

Last year saw major concerns about how much the Fed would increase interest rates, and whether the rapid economic growth would end (which was the goal of the Fed's rate increases). Today, those uncertainties are gone. The Fed accomplished its goal of slowing the economy, and there is very little threat of an interest rate increase. In fact, today (Jan. 3, 2001), the Fed announced a decrease in interest rates because of weakening sales and production and lower consumer confidence. The stock market responded immediately to the surprise announcement by rallying.

The health of the economy is the main factor impacting stock values. Here's a comparison between last year and this year of the main three economic indicators:

Inflation: Last January, inflation was 2.6 percent, although nearly every analyst was predicting it would rise in the near future. That's why the Fed was raising interest rates — to slow the economy and reduce the pressure on inflation. Today, inflation is 3.4 percent, which is high compared to the recent past but much lower than the 6.2 percent average level during the 1970s and 1980s. With the slowing of economic growth, the upward pressure on inflation has been reduced.

Economic growth: Last January, economic growth was 5.7 percent. Today, it is 2.2 percent. While that is a large drop, keep in mind that the main goal of the Federal Reserve was to slow growth. The slowing of economic growth is not a sign of an impending recession — it is the result of a planned easing of inflationary pressures.

Unemployment: Last January, unemployment was 4.1 percent, the lowest level in 29 years. It is now an even lower 4.0 percent. Hence, despite the slowing of economic growth, businesses are still hiring.

So, last year we had outstanding economic statistics, but a strong potential that they would worsen. This year, we have good economic statistics without the likelihood that the situation will erode. Last year, we had the highest valuations (based on earnings and book value multiples) in U.S. stock market history. This year, the record values have subsided. In my mind, today is a much better time to invest than a year ago.

What to Expect

Hopefully many of you have realized that the expectations of 20 percent returns over a long term are misguided. You should plan on an average return of 10 percent over the next 20 years. "Average" means some individual years will be better, while others will be worse.

More specifically, for the next year I would anticipate more volatile markets, particularly in the first half of the year. There is still much concern over the correct valuations of high-technology stocks and the impact of those valuations will be felt across the market. It is likely that with a more stable economy, the extreme volatility will subside as the year progresses — but 5 percent or greater swings in the NASDAQ will be commonplace. The focus of analysts will be mainly on growth, productivity, efficiency and profitability of companies. There is little worry about interest rate increases — in fact, if there is any further slippage of economic growth, the Fed may cut interest rates again.

Lessons Learned

Last year was a good learning opportunity. Most investors who got burned were poorly diversified. Some owned only a couple of stocks that performed very poorly (it was not uncommon for dot-com stocks to lose 90 percent of their value). Others held unreasonably large amounts of stock in the overall technology sector, which was expected to be highly risky. Still others focused on only growth stocks, while the average value stock actually increased in price. Investors who were broadly diversified across all equity sectors lost only about a tenth of the value of their portfolios.

Some Perspective

Related Reading Investing Strategies for the Next Millennium Nas-blachhh What's Going On with Tech Stocks?

I want to say one last thing. The year wasn't all that bad. Large-capitalization stocks lost 10 percent (less when you add dividends back in). In 16 of the past 75 years (more than one in every five years), the market has lost at least 7 percent of its value. If you are a long-term investor, you will experience many years like 2000.

You have to keep your eyes on the prize — your long-term goal. If you invested consistently in stocks over the past 10 years, you could have earned 17.5 percent. That means if you had invested $100,000 in January of 1991, you could have $500,000 today — a quintupling of value, despite the recent decline.

One year does not a lifetime make. 

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.

What a Difference a Year Makes

By Scott Lummer
Chief Investment Officer, mPower

In This Story What Happened Is Now a Good Time to Invest? What to Expect Lessons Learned Some Perspective

Ah, to go back to last January. Investors were feeling good. It was the start (unofficially) of a new millennium. We had low inflation, low unemployment, and good projected economic growth. The NASDAQ was coming off a record year. The Dow was at an all-time high. The film "Autumn in New York" had not yet been released.

And now? Y2K did not cause the technological mayhem that some had predicted, but it sure was an unsettling year for most investors.

What Happened

Technical Terms Federal Reserve Board Growth stock NASDAQ Value investing

Early in the year, analysts were mainly focused on the level of interest rates determined by the Federal Reserve Board, or "Fed." The market oscillated during this time, culminating in a sharp decline in mid-April. Then, after the Fed's last rate increase in May, stocks rose relatively steadily until the beginning of September. The market has fallen since then, mainly because of analysts' concern about lower company profits and slowing economic growth. The decline has been felt most sharply in the high-technology sector, as evidenced by the 39 percent drop in the NASDAQ Index for the year. The S&P 500, which measures the broad market, declined by 10 percent for the year. Nearly all sectors of the market fell during the year — small-cap stocks as measured by the Russell 2000 declined by 8 percent for the year. However, value stocks actually rose during the year. The concern about waning economic growth impacted international stocks, which were also hurt by a rising U.S. dollar — the MSCI EAFE Index, a benchmark for international stocks, declined by 14 percent.

The risks of investing during the year were apparent to many analysts. In my commentary at the beginning of 2000, I said that there would be a decline in stock values when growth in corporate profits slowed, particularly in the technology sector. While no analysts were predicting the massive decline in the NASDAQ, the risks were readily apparent.

Is Now a Good Time to Invest?

I know that many of you are discouraged about investing — surveys during the year found that most investors thought they would earn a 20 percent or greater return for the year. But, the events of the past year should not deter you from your investing plan. In fact, I would say there are more good reasons to invest now than there were a year ago.

Last year saw major concerns about how much the Fed would increase interest rates, and whether the rapid economic growth would end (which was the goal of the Fed's rate increases). Today, those uncertainties are gone. The Fed accomplished its goal of slowing the economy, and there is very little threat of an interest rate increase. In fact, today (Jan. 3, 2001), the Fed announced a decrease in interest rates because of weakening sales and production and lower consumer confidence. The stock market responded immediately to the surprise announcement by rallying.

The health of the economy is the main factor impacting stock values. Here's a comparison between last year and this year of the main three economic indicators:

Inflation: Last January, inflation was 2.6 percent, although nearly every analyst was predicting it would rise in the near future. That's why the Fed was raising interest rates — to slow the economy and reduce the pressure on inflation. Today, inflation is 3.4 percent, which is high compared to the recent past but much lower than the 6.2 percent average level during the 1970s and 1980s. With the slowing of economic growth, the upward pressure on inflation has been reduced.

Economic growth: Last January, economic growth was 5.7 percent. Today, it is 2.2 percent. While that is a large drop, keep in mind that the main goal of the Federal Reserve was to slow growth. The slowing of economic growth is not a sign of an impending recession — it is the result of a planned easing of inflationary pressures.

Unemployment: Last January, unemployment was 4.1 percent, the lowest level in 29 years. It is now an even lower 4.0 percent. Hence, despite the slowing of economic growth, businesses are still hiring.

So, last year we had outstanding economic statistics, but a strong potential that they would worsen. This year, we have good economic statistics without the likelihood that the situation will erode. Last year, we had the highest valuations (based on earnings and book value multiples) in U.S. stock market history. This year, the record values have subsided. In my mind, today is a much better time to invest than a year ago.

What to Expect

Hopefully many of you have realized that the expectations of 20 percent returns over a long term are misguided. You should plan on an average return of 10 percent over the next 20 years. "Average" means some individual years will be better, while others will be worse.

More specifically, for the next year I would anticipate more volatile markets, particularly in the first half of the year. There is still much concern over the correct valuations of high-technology stocks and the impact of those valuations will be felt across the market. It is likely that with a more stable economy, the extreme volatility will subside as the year progresses — but 5 percent or greater swings in the NASDAQ will be commonplace. The focus of analysts will be mainly on growth, productivity, efficiency and profitability of companies. There is little worry about interest rate increases — in fact, if there is any further slippage of economic growth, the Fed may cut interest rates again.

Lessons Learned

Last year was a good learning opportunity. Most investors who got burned were poorly diversified. Some owned only a couple of stocks that performed very poorly (it was not uncommon for dot-com stocks to lose 90 percent of their value). Others held unreasonably large amounts of stock in the overall technology sector, which was expected to be highly risky. Still others focused on only growth stocks, while the average value stock actually increased in price. Investors who were broadly diversified across all equity sectors lost only about a tenth of the value of their portfolios.

Some Perspective

Related Reading Investing Strategies for the Next Millennium Nas-blachhh What's Going On with Tech Stocks?

I want to say one last thing. The year wasn't all that bad. Large-capitalization stocks lost 10 percent (less when you add dividends back in). In 16 of the past 75 years (more than one in every five years), the market has lost at least 7 percent of its value. If you are a long-term investor, you will experience many years like 2000.

You have to keep your eyes on the prize — your long-term goal. If you invested consistently in stocks over the past 10 years, you could have earned 17.5 percent. That means if you had invested $100,000 in January of 1991, you could have $500,000 today — a quintupling of value, despite the recent decline.

One year does not a lifetime make. 

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.