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Savvy Investor Column-5-9-02

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What has been going on in the market?  

Most analysts believe the world economy is responding, indicating that stock prices should rise.  It also means that interest rates will start to gravitate higher as the economy improves. When interest rates rise, equities normally suffer at the beginning of the bull market, and the market value of  bonds decrease, so that their rate of return will match that of the market.

But what has actually happened to the market?  

After all, in March alone, the S&P 500 gained 3.76%.  The net result was that for the first quarter of 2002, the S&P 500 was in positive territory.  The reality is though that the largest 100 stocks in the S&P, which represent more than 70% of this particular index, actually were down 1.5% for the first quarter.  The smallest 100 stocks that comprise the index actually gained 8.5% during the last quarter.  This is what actually caused the increase in the S&P 500.  It was not an increase in each stock in the index.

Economists are also pointing to an alarming factor on the world market.  The United States dollar is at a 16 year high, on a Trade weighted basis compared to foreign currency.  According to the Wall Street Journal, the increased US dollar now accounts for 68% of global currency reserves.  Additionally, US stock values were reported to be at a 25 year high relative to the European Market.  As the over inflated US dollar was an enormous percentage of global currency reserves, 68%,  the US equity market also represented 56% of total global market capitalization.  This is an issue that may cause foreign investment to depart the United States markets to the extent that it will inhibit consistent gains as dollars leave the market.

Aside form the NASDAQ increases one can also take a look at other indexes to determine their relative strength and weaknesses, in relation to our recovering economy.  The Russell 2000 appears to be the index that has increased far more rapidly than either the Dow Jones Industrial Index or the NASDAQ.  If one goes back in time since the September 11thmassacre and the market low, the Russell 2000 has actually improved 36% since September.  The Dow Jones has increased from that point in time by 24% and the S&P 500 by 15%.  

Why has there been such a cause of confusion in the market where increases do not appear headed in a steady direction?  

This may be due to the fact that profits and Gross Domestic Product growth continues weak.  In fact, the S&P 500 operating earnings in the year 2000 to 2001, showed a record decline in actual profits.  This does not mean that a recovery is not occurring, but it does mean that the recovery itself is very fragile in that true actual second quarter growth will be moderate.   Analysts are still predicting that second quarter growth and business rebounding will not be evident until the second or third quarter of this year.  Additional profitability appears to be needed to get the market on a steady upward trend, versus the sideways pattern it has been following.

Aside from the equity and debt market, The economy has also had a dramatic effect on the real estate market.  Non-residential construction has been in a steep decline since the 2000.  The national office vacancy rate touched 7.5% in the year 2000, a level that caused a rise in construction activity.  With the change in the economy since 2000, vacancies have increased to approximately 13%, which has put a chilling effect on commercial lenders relative to real estate projects.

Construction is moving at a reduced pace as lenders are weary of overbuilding and rising vacancies.  As the market also continues to move sideways by most measures, strategies tend to be more defensive than offensive.  Many market managers are recommending moving to companies that are market leaders with strong balance sheets and growing sales.  Industries, such as food retailing, drug retailing, discount hard lines, home improvement, integrated oils, drugs and medical products, as well as electric and gas utilities, seem to be prime for an economic rebound.  The issue is still that sales and earnings must increase in order to have market stability.  The high tech companies, though many are still suffering from the burst of the tech bubble, have the potential to be future leaders as technology continues to offer new products.  

Some analysts are pointing to MMS cell phones, handheld computers, and wireless networks.  Nokia is building its next generation cell phone with an installed digital camera.  How many people will buy it? Cellular pocket PCs also have potential to be a new super star on the horizon, if people embrace the technology and its price tag.  Many of the big names in the industry, such as Microsoft, Nokia, Sun Microsystems, IBM, and Cisco Corporation, are companies that are mentioned by some market analysts as ones with upside potential.  The question of course is when?

The volatility in the market makes it more difficult to be focused on the long range.

Some investors are looking for higher dividend yields, so that they will be receiving some rate of return from their stocks while they remain in the market.  Some strategists recommend hybrid securities, which combine elements of stocks and bonds including preferred stock, convertible securities, or publicly traded partnerships.  There is additional risks with these products, compared with fixed income securities; however, there is some performance, some track record, and a bit of flexibility.  

As the market has not had sustained growth in some time, It appears that it does make sense to at least pay attention to alternative types of investments.  For example, compare convertible securities to the S&P, the Dow Jones, or the Russell 2000.  Further, compare current T-Bill yields to other rates of return.  You must still address your investment risk and your expected return.

The only thing that you can be sure of, is that the market will change.  Most analysts will agree that recovery is underway, but how long it will take and what the long term gains will be, remains to be seen.

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