Happy New Year

There is an axiom on Wall Street that says ‘as goes January, so goes the year.’  Yesterday certainly got January off to a good start.  The first trading day of the New Year saw the Dow rise by 3.2%, the S&P 500 by 3.3% and the NASDAQ by 3.7%.  Volume was heavier than the preceding week, but was still well below normal.  However, the buying volume was six times the selling volume; further proof that selling is on the decline. 

Looking back though, the S&P 500 and Dow recorded their worst Decembers since 1931.  They dropped 6.2% and 6.4% respectively.  For the year, the S&P 500 dropped 24%, the Dow 17%, and the NASDAQ 31%.  Last year market the third year in a row of declines  – a distinction not suffered since World War II.

Previous long-term market troughs were driven by much poorer economies than our current one.  By most measures, our economy is not doing so badly.  In the past three years it suffered numerous body blows, but it still stands, and appears poised to gain strength rather than succumb to threats.

Uncertainty about certain significant risks holds our economy back.  The recent images of once-respected corporate chiefs being hauled to jail before live television cameras, numerous federal and state court victories against energy companies, New York Attorney General Elliot Spitzer’s mounting list of ‘settlements’ with Wall Street brokerage firms, and the continuing disappointments in earnings reports against falling expectations.  All of these factors have served to reduce our once-bullet-proof confidence in America, Inc.

But the biggest risks controlling the near-term future of our markets lie in the hands of a very few people.  Saddam Hussein of Iraq must decide to disarm or suffer the U.S. military doing if for him, Kim Jong-il of North Korea must step outside his huge ego and end his nuclear posturing or face devastating economic hardships among his people, Hugo Chavez of Venezuela must find a solution to ease the tensions with his opposition, Sharon of Israel and Arafat of Palestine must demonstrate peace as their objective, rather than blowing up civilians, and finally, but certainly not least, bin Laden and/or al Qaeda leadership must be disrupted by all means necessary to end their influence of terror throughout the world.

None of these issues is simple, but each must be resolved in time.  It is not an overstatement to say the worlds’ economies depend upon their resolution.  Commerce, indeed peaceful co-existence cannot flourish when nuclear threats are bandied about, or when dictators, with a history of using weapons of mass destruction, continue to amass them in so unstable a region as the Middle East.  The constant fear of terrorism has both measurable and immeasurable ill effects on people – consumers and business people.  The Dow Jones lost nearly 100 points in the days leading up to New Years’ as investors feared possible terror events.  It rallied 265 points when they did not occur.

What does the future hold?  Last year this time Wall Street’s top prognosticators were all quite bullish.  As the Barron’s chart below demonstrates, nine of ten Wall Street strategists incorrectly expected the market to rise this year.  Only one, Douglas Cliggott, then of J.P. Morgan Securities, correctly forecasted a sharp decline and remains bearish today.  The S&P 500 finished the year at 875.

Missed By a Mile

S&P 500
Strategist Firm 2002 Target
Edward Kerschner UBS Warburg 1570
Thomas Galvin Credit Suisse First Boston*** 1375
Abby Joseph Cohen Goldman Sachs 1363
Jeffrey Applegate Lehman Brothers*** 1350
Tobias Levkovich Salomon Smith Barney 1350
Edward Yardeni Deutsche Bank* 1300
Steve Galbraith Morgan Stanley 1225
Richard Bernstein Merrill Lynch 1200
Thomas McManus Banc of America Securities 1200
Douglas Cliggott J.P. Morgan** 950
S&P 500 875

*Now at Prudential Financial
**Now at B&P Research Office
***No longer at the firm
As of 12/27 close

Source: Barron’s 

Could they have predicted the meltdown of corporate trust, the relatively sudden need to rid Iraq of Saddam Hussein, or the energy-trading shenanigans in California? – Perhaps not.  When you get right down to it, predicting the course of the market over a year or two is mostly guesswork.  There is simply too much randomness in the world to offer any certainly over so short a time.  But as time is extended, history proves the benefits of equities over other forms of investing.  From 1926 through 2001, for instance, stocks returned 6.9% versus 2.1% for Treasuries, according to studies by Jeremy Siegel, a professor at the University of Pennsylvania’s Wharton School.

Look at what stocks offer investors today.  As Don Hays points out, the 91-day T-Bill yields a sub-inflation 1.13%.  Money market funds, impacted by management fees, yield less than 1% and the 10-year T-Note yields only 3.81%.  Hays adds that it is not the yield that attracts investors, but the safety of these investments.  Investors are nervous and fear losing even more of their net worth.  So they are socking money in these perceived bomb shelters, even though the S&P 500 is now offering them 6.28% earnings yield based on 12 month forward expected earnings.

So the stock market now offers better returns than the bond market, but investors are not yet taking the bait.  Stock avoidance will likely continue until some of the risks stated above are resolved.  President Bush will announce his stimulus package next week.  It should be favorably received by investors and will likely be passed in large measure by the Congress.  But the stimulus will probably not have the desired effect on business investment until geopolitical risks are reduced.  Some of those questions will likely be answered by March.  Until we get some of those answers, we will remain very cautious.  For the year as a whole though, we are CAUTIOUSLY optimistic.  Happy New Year.