Back to basics

The bull market of the 1990s has turned into a more restrained - but still energetic - version of itself, spurred briefly by last week's surprise interest-rate cut by the Federal Reserve.

Will fast times return to roost? Investor expectations remain high. According to a recent survey by the Securities Industry Association, investors, on average, expect their portfolios to grow by about 33 percent per year.

That appears unrealistic. Most economists agree a better estimate is about 10 percent at best. Pummeled by lower corporate earnings, soaring energy costs, and sagging consumer confidence, market indexes hit the skids in recent months.

Any stock-market surges - even if they're not sustained - could help battered investors forget the slump that began last March.

But should they forget?

The big swing that laid many portfolios to waste last year should serve as a reminder to the average market player that investing is fundamentally a long-term, slow-yield proposition, many experts say, more about stacking the building blocks than rolling the dice.

The sagging economy - with the stock market turning in its worst year in a decade for the Dow, the worst ever for the Nasdaq - prompted the Fed to slash a key interest rate by one-half of a percentage point Jan. 3. The market immediately roared upward, as many nervous investors traded worry caps for party hats.

The stock market exulted, but then showed weakness and extreme volatility on Friday. The big question is whether the enthusiasm for stocks will continue into the rest of the winter months. Many longtime bulls were noting that the Fed clearly indicated last week that it would make additional cuts in interest rates, if necessary, to get the economy out of the snowbank and back on track.

The stock market clearly showed its early responsiveness to the rate cut, says David Wyss, an economist with Standard & Poor's Corp., in New York. But for the larger US economy, the cut will take about a year to have any real impact in terms of additional economic growth, Mr. Wyss says. He expects additional rate cuts during the year, adding up to about a full percentage point.

Still, for investors, the unwritten rule remains the same: Invest with caution as rates rise, and invest more aggressively when rates head south.

Why the Fed finally acted: US economic growth fizzled from the 4 percent range early last year to around 2 percent. Manufacturing fell off. Pink slips are once again hitting worker in-boxes. Stocks have been sinking.

The 30-stock Dow Jones Industrial Average, the best-known measure of the stock market, fell some 6 percent in 2000; the large-cap Standard & Poor's 500 Index tumbled 10 percent; and the technology-heavy Nasdaq Composite Index sank 39 percent. Even the Russell 2000 Index, which measures small companies, was in the red, down 4 percent.

"A slowing economy and slowing earnings add up to a slowing market; it's that simple," says Larry Wachtel, an analyst with financial house Prudential Securities Inc. "There's an unwillingness by investors to buy companies with [inflated] valuation levels that are out of whack with actual earnings. Each stock is now having to find its proper valuation level, which means that the market still has to find its overall valuation level."

There are assertive sectors, he says, including pharmaceutical firms, healthcare enterprises, beverage companies, and foods.

Investment house Goldman, Sachs & Co., where Abby Joseph Cohen is chief investment strategist and perhaps the best known "bull" on Wall Street, is upbeat about the impact of last week's surprise rate cut on equities.

Goldman Sachs now favors three broad investment areas:

1. Economy-sensitive issues. Back in March, it was real estate. But today it is basic materials, including chemicals, housing-related issues, and retailers.

2. Financial-services stocks.

3. Technology (surprise!).

Investors quickly discovered what a down market could feel like in the fourth quarter of last year. Virtually every major mutual-fund sector with the word "growth" in it sank. For the year, the carnage was clearly evident. Large-cap growth funds, for example, were down 20 percent according to Lipper Inc. But value funds were up. So, too, were health and biotech funds, utilities, financial-services, and real estate funds.

Gold rose in the fourth quarter (up nearly 4 percent according to Lipper), but the precious metal was down 17 percent for the year. Gold may have shined in the short term, but everyone wanted a barrel of oil. Natural-resource funds rose 5 percent in the fourth quarter and almost 30 percent for the year.

Bottom line: This is clearly a buyer's market, where careful choices are more important than ever, and diversification across a broad spectrum of investment is essential. "If anyone is still 100 percent in equities, they clearly have some problems," says Sheldon Jacobs, editor of the No-Load Fund Investor in Ardsley, N.Y.

"On our case, we've had a 45 percent cash position now for months," Mr. Jacobs says. "If a person is overexposed to equities, they should use the opportunity of that rally to lighten up a little on equities, and diversify into cash and bonds." (For the outlook on bonds, see page 12.)

If people are already diversified, he says, they should make certain they are in sectors that fit their own needs. Certainly, there are a number of promising market segments now, including investment-grade bonds, real-estate trusts (REITS), value funds, index funds, and, for defensive purposes, money-market accounts. But this does not seem like a good time to be overweighed in technology," Jacobs says.

Still, Nasdaq joined in the market gains following last week's rate cut.

If bonds now appear attractive, overseas stocks look more risky, experts say (story, page 16).

Bonds, for now at least, have been shored up by high interest rates. But overseas issues face a number of nagging challenges, including the slumping euro, higher energy costs, and - in the case of Europe and the larger economies of Asia - close trading ties with the US, where economic growth remains a question mark.

For now, however, the new impetus toward rate cuts by the Fed "should boost financial stocks, utilities, technology companies, retailers and industrial firms," says Shannon Reid, portfolio manager of Evergreen Select Strategic Growth Fund in Charlotte, N.C.

(c) Copyright 2001. The Christian Science Publishing Society