January 2, 2004
THE BOUNCEBACK YEAR
Energized by the Economy, Small Stocks Lead the Way to Big Gains
By FLOYD NORRIS
T was the year that almost every stock went up and volatility plunged. Small stocks had their best year ever and some stars of the bubble era made impressive comebacks. But can such good fortune continue?
The rise of the stock market began well before most economic forecasters saw any sign of an end to the business doldrums that had depressed both spirits and economic growth since the bubble burst in the spring of 2000.
Last year's sharpest gains came in the second and fourth quarters, starting a few months before the economy suddenly accelerated, growing at an 8.2 percent annual rate and suddenly silencing - or at least embarrassing - the seers who had forecast that a long period of economic torpor would follow the bursting of this country's stock market bubble, as had happened in Japan a decade earlier. Then prices accelerated again as the year ended.
So powerful was the market's advance that many stocks - including most of those in the Standard & Poor's index of 500 stocks, the leading barometer of large companies' stock performance, and most in the Russell 2000, a leading indicator of the performance of smaller companies' stocks - are now higher than they were when those indexes peaked in 2000.
For the year, the Dow Jones industrial average was up 25 percent and the S.& P. 500 gained 26 percent, while the Nasdaq composite rose 50 percent, and the Russell 2000 picked up 45 percent for the best year in its 25-year history.
To get the economy going required a prolonged dose of easy monetary policy, driving short-term interest rates to their lowest levels in more than four decades and then keeping them there, combined with a huge dose of easy fiscal policy, in which a combination of tax cuts and spending increases ended the Clinton-era budget surpluses and produced deficits that may yet challenge the record levels run up in the Reagan administration.
The final step on the accelerator was the government's mailing of more than 24 million checks totaling $14 billion for child-care tax credits to parents in the summer. It should not have been a surprise that the back-to-school shopping season that followed the arrival of those checks turned out to be a good one. But some did not see it coming, and the high sales led to newfound retailer optimism as the holiday shopping season approached.
That optimism may have been a little overdone. The preliminary reading on the shopping results indicates that luxury stores did quite well, thank you, but that stores catering to those lower on the economic ladder found sales a little harder to ring up. Since Thanksgiving, the S.& P. 500 has risen 5 percent. But the average of department store retailers within the index was down 6 percent.
If the season turns out even worse than Wall Street now believes - and the decline in retailer share prices represents less of a belief that it was a bad Christmas than that it was not as good as expected - that could be an indication the economic stimulus provided by tax cuts is starting to wear off.
At worst, it might begin to appear that the heavy foot on the accelerator caused the economy to lurch forward but did not get it into gear in a way that will produce the continuing movement investors now expect. Many economists, however, think that business spending will grow enough to offset any slowdown in consumer spending.
There was no denying the power of the stock market's advance in 2003. Of the 499 stocks in the S.& P. 500 that were traded for the entire year, 92 percent went up. In the 24 years that S.& P. has been keeping track of that statistic, that is the best performance ever, exceeding the old record of 86 percent set in 1995.
"We did not have that in the last round," said Howard Silverblatt, an equity market analyst at Standard & Poor's, noting that market breadth, as that statistic is called, was nowhere nearly so good in what turned out to be the final run of the bull market that ended in the spring of 2000. In 1999, in fact, more stocks went down than up in the S.& P. 500, despite the index rising almost 20 percent that year. "The question is," he added, "can it be sustained?"
There are some signs that it can be, or at least that the broad market is not about to turn lower. This is the fifth time since Standard & Poor's began keeping the statistic in 1980 that at least 400 stocks in the index have risen; the other years were 1985, 1991, 1995 and 1997. In each case, the index rose the following year, although by less than the previous year, and more stocks went up than went down, although the number of increases declined to fewer than 400.
"It's typical of the first thrust of a cyclical bull market," said Steven C. Leuthold, the chairman of Leuthold Weeden Capital Management in Minneapolis. "But in the second year, the rate of ascent does slow down." He said the market was likely to rise around 10 percent in 2004 and could peak in midsummer.
The 2003 performance seems to have done wonders for investor confidence. Even as scandals swirled through the mutual fund industry, billions of dollars were invested in equity funds. Investors who stayed with the stocks that did best in the bubble years - largely those in technology and telecommunications but also including some big blue chips - are nowhere close to breaking even. But those who held a more diversified portfolio in those years may now be richer than they ever were.
Measured in the normal way, the S.& P. 500 ended 2003 with a 26.4 percent gain, but it was still 27 percent below its peak set in 2000, as long-term investors in mutual funds that track the index are painfully aware. That performance, however, reflects the fact that the index is capitalization-weighted - that is, the most valuable companies in the index dominate its performance. And those companies are less likely to have bounced all the way back than smaller companies. General Electric and Microsoft are down more than 40 percent since the index topped out. Between them, they have more impact on the S.& P. 500 than the 169 smallest companies in the index.
There is another way to measure the S.& P., by treating it as an unweighted index, giving every company in it an equal impact. Measured that way, an investor in those 500 companies has managed to make up all of the decline since the S.& P.'s top. Just this week the index moved to a record high. For 2003, the unweighted index was up 38.7 percent, its best showing since S.& P. began computing the unweighted movement in 1990. The old record was a gain of 31.7 percent in 1991.
Perhaps even more remarkable, even as the market chalked up those gains, volatility declined. It is still higher than in the early 1990's, to be sure, but the decline of volatility also means fewer headlines about big market movements - and therefore, perhaps, in investor anxiety.
In the final quarter of the year, there were only 10 days - or 16 percent of the total sessions - when the S.& P. 500 closed up or down at least 1 percent from the previous day. That was the lowest volatility for any quarter since 1996. At the peak of volatility, in the third quarter of 2002, two days of every three had moves that big. Then the market was sliding into what became the lows in stock prices for the cycle, which were reached on Oct. 9, 2002.
If it was a great year for most stocks, it is also true that high quality was not rewarded as well as lower quality. S.& P. rates more than 3,000 stocks, from A to D, based on the solidity of their financial position; the ratings are not intended to forecast performance. In 2003, A-rated stocks rose 30 percent on average. But B stocks gained 57 percent, and C stocks - a category that includes companies in dubious financial condition, although it excludes those that have actually defaulted on their obligations - rose 118 percent. Stocks rated D for default rose 44 percent, or more than the top-quality names.
Last year was the year that taxes were slashed on dividends, which market seers confidently forecast would lead more companies to pay dividends. There is some evidence that did happen, but little indication that investors cared very much. Within the S.& P. 500, reports Mr. Silverblatt, stocks that paid dividends rose, on average, about half as much as those that did not.
Value-oriented investors - the kind who treasure dividends and strong balance sheets - felt vindicated in 2001 and 2002 but lost out last year. Speculation got a bad name after the bubble burst, but it came back strong in 2003.
TECHNOLOGY stocks once again became market leaders in 2003. Yahoo, Intel and Cisco all gained more than 80 percent. But each of them is still worth less than half its peak value.
As with any year, it was possible for a stock to go from very valuable to virtually worthless in one year - if it turned out that there was massive fraud. The good news for American investors was that after Enron in 2001 and WorldCom in 2002, last year's example was not listed on an American stock market. The leading fraud of 2003 was Italy's Parmalat, a diary company that persuaded its auditors that it had billions in a nonexistent bank account.
The one group of pre-2000-peak favorites that failed to make a significant bounce was telecommunications stocks. While suppliers for the industry did show gains - Lucent Technologies more than doubled - operating companies continued to suffer from the problems of falling prices and increasing competition. Among the stocks that fell in 2003 were Qwest, SBC and Verizon.
The saga of Lucent and its offspring shows just how little last year's gains mean to someone who got in at the peak. The investor who bought Lucent at its top price in 1999 and held on now has stock in Agere Systems and Avaya, two Lucent spinoffs, as well as in the parent. Each of those three stocks more than doubled in 2003, and Avaya was the best-performing stock in the S.& P. 500 for the year, with a rise of 428 percent. Even with that rise, Avaya is worth less than half its peak price around the time it was spun off by Lucent in 2000. All told, the package of stocks owned by a longtime Lucent investor is down 94 percent from the peak.
Among the 10 economic sectors in the S.& P. 500, all showed gains in 2003, a year after all 10 fell. The best performer over the last two years is the materials index, which is up 24 percent. It is dominated by such heavy-industry stocks as DuPont, Dow Chemical and Alcoa.
One reason to expect the next year to be strong is the presidential election cycle. Weak economies and weak stock markets may never be welcome, but they are less damaging politically if they happen early in a presidential term. Whether by coincidence or not, strong stock markets have been more likely as an election nears.
Over all, since 1897, the Dow Jones industrial average has shown its best performance in the third year of the cycle, rising an average of 12.8 percent, falling to a still respectable 9.2 percent in the fourth year.
But under Republican presidents, the pattern is reversed. On average, the best years under Republicans have been the fourth years, when the Dow gained an average of 13.7 percent, just in time for the vote. If that trend continues, this could be a very good year for stocks.
nytimes.com |
