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Client
Communication Briefings Given
the recent events that again have negatively affected the stock market and
overall investors’ confidence, I feel that a review is in order. The major
stock market indices are back down to the levels we saw immediately following
September 11. After a recovery in the first quarter of 2002, stocks turned
negative the second quarter wiping out all progress and delivering big losses
for the year. After six months the Dow lost 7.77%, the S&P 500 dropped 13%
and the NASDAQ collapsed by 24%. While economic indicators paint a positive
picture for the future, the current stock levels illustrate more of a stormy
portrait. The
answer for this apparent disconnect can be summarized as total lack of
confidence and collapse of faith in the future. The reasons for this are
valid – Enron, Arthur Anderson, analysts’ conflicts of interest, corporate
CEOs charged with fraud, tax evasion and insider trading. Every day a new
revelation hits the news and investor confidence with hard-to-take punches.
The latest -- WorldCom’s accounting fraud, looks like it will end with the
largest bankruptcy case in history. This
lack of confidence and reduced faith fosters fearful emotions in investors
and it is fear and greed that drives markets in the short run. While the
current level of fear is higher than I have ever experienced in the 22 years
I have been in business, history provides us with case studies of how this
lack of confidence plays out in the markets. Over
the past 75 years, we have experienced three instances when stocks have
declined for successive years. The most recent was 1973-74. Prior to that, we
have to go back another 35 years to World War II when stocks declined for
three consecutive years from 1939 to 1941. The biggest run of negative
returns was experienced 1929-32, the Great Depression. The
one thing in common with all of these past protracted bear markets is that
they eventually ended, and when they did the four years that followed were
big gainers averaging close to 20% per year. Let’s
look at what happened during each of those protracted bear markets and at the
response of investors during those trying times. Using the research provided
by Dimensional Fund Advisors through their Global Investment Dimensions
1926-2001 publication we find the historic returns of all the major asset
classes. During each of those protracted bear markets, investors pulled money
out of stocks and sought the safety of some other asset class. In the 1929-32
bear market leading to the Great Depression, investors dumped stocks and
sought the safety of banks and bonds. During the 1939-41 bear market,
investors bought Government Treasury bills bidding down the yields to zero.
That’s right; investors were willing to take no interest on their investment
so long as they could get the government guarantee of return of their money.
This represents what I call Will Rogers investing. After
the 1973-74 bear market, investors lost faith in all paper assets including
U.S bonds. Instead gold, silver, and collectibles were viewed as their safe
haven. The flight from financial assets drove the price of gold to over $800
per ounce and silver to the dizzying level of almost $50. By 1980, you could
not give away long-term bonds -- the yield on the thirty-year government bond
soared to over 13% with still few takers. With
the benefit of hindsight, we now see that the right move for investors at
those low-confidence times was to resist the urge to buy the safe haven of
the day and keep a balanced portfolio of stocks, bonds, and cash. As
mentioned earlier, the 1939-41 bear market saw investors seek the safety of
cash with short-term interest rates dropping to zero. The next four years saw
stock returns averaging 25% per year, long term bonds at just under 5% and
the safe haven investment of that time, cash, only returning one third of a
percent. The
gold bugs of the 70s watched their investment in hard assets plummet 70%
during the decade of the 80s. Twenty-two years later gold is at $315 and
silver is selling for less than $5.00. From the bottom of that bear market we
saw stock returns averaging 14% over the next four years, 17% over six years
with the first two years averaging 30% per year. Let’s
look at the parallels today. No doubt we are experiencing a lack of
confidence and limited faith in the future. The rate on three-month bonds is
1.70%, money funds less than 1.30% but yet money fund balances are at record
levels. Sounds similar to the 1939-41 bear market. Based on the calls I am
getting and the ads in the papers, CDs, money funds and fixed annuities are
vying for the safe haven asset this time. Look back at what happens to safe
haven investments when stocks recover. The lost opportunity is a real cost –
that is the price to be out of stocks when they recover. Locking up money
into CDs or annuities will guarantee those funds will not be available to
invest when the markets recover. Granted,
these times are scary, with terrorist warnings compounding the ethical
failure of some highly visible companies. History shows us that as good
overcomes evil, so lack of confidence and faith will be replaced with a new
found faith that tomorrow will be a better day. Sincerely, Michael
P. Haubrich, CFP |