Wake Up and Smell the Recovery
By James B. Stewart
June 25, 2002
StockCompare
AS MIDYEAR nears, it's a good time to step back from the scandal of the week (currently Martha Stewart Living Omnimedia (MSO)) to assess your portfolio and try to make some sense of recent market moves. The markets lately have been as illogical as any in my memory, and however disconcerting this may seem, it means opportunity for patient investors. Eventually, reason will reassert itself.
Let's take a look at the bond market. Since I recommended bonds, first on Jan. 15, and again in May, there has been a largely unheralded but still significant rally in the bond market. Yields have recently dropped, causing the face value of most bonds and other interest- and dividend-bearing securities to rise. Many of you may be looking at relatively short-term gains in your bond portfolio, as I am.
Meanwhile, I'm sure that I don't need to remind you that the stock market, for the most part, has been terrible, with many indexes nearing the panic lows set in late September after the terrorist attacks. An exception is the cyclical sector I recommended back in February. DuPont (DD), for example, significantly raised its earnings estimates this week, citing strong sales in nearly all of its business segments.
DuPont's performance, and that of many other cyclical industrial companies, mirrors the performance of the broad economy, which now shows nearly incontrovertible signs of growing strength. Talk of recession has all but disappeared.
So what's so irrational about all this? Put simply, a rising bond market and falling stock market ordinarily predict a weakening, not a strengthening, economy. If broad economic weakness is imminent, DuPont should be lowering its guidance, and at least some leading economic indicators should be turning down.
I'm certainly not disappointed by the gains I see in my bond portfolio and in some of the cyclical stocks, but this isn't what I expected. I expected the economic recovery to last for several years, a period of slow but steady gains for industrial stocks and eventually rising interest rates. But there's no point in fretting over the fact that the markets didn't follow the usual scenario. That's what makes investing interesting and a challenge. The question now is how to react to these recent moves, and take advantage of them.
For now, I'm putting my bets on the likelihood of a continuing economic recovery. Economic data may be imperfect, but it's objective, unaffected by the emotions of the moment. The markets, by contrast, strike me as highly emotional, given that they are a mirror of investor sentiment. All the anecdotal evidence I hear suggests that investors are deeply disturbed by corporate scandals, allegations of insider trading, fears of war in the Middle East and the Indian Subcontinent, and anxiety about further terrorist attacks. These are legitimate concerns, but so far, they aren't showing up in the economic statistics.
Something has to give, and my prediction is that interest rates will again begin to slowly rise, and stocks will gain, as the strength of the broad economy persists and the markets realign themselves with economic reality. I'd be neutral or take some profits on fixed-income positions, and wouldn't be a buyer again until interest rates rise. And I'd continue to move cash into the stock market, especially economically sensitive cyclical stocks like DuPont or General Electric (GE), which I recently purchased. My next buying target is 1400 on the Nasdaq, but if you're raising cash or have excess cash right now, you don't have to wait. At levels of around 1450, there are plenty of stocks that look to me like bargains. |
