‘93/’94 Year-End Review and Outlook : Riding the Recovery
If only Wall Street could learn to follow a script, here’s how the Oscar winner would read for 1994:
We’re in an economic recovery, and people finally learn to enjoy it. Interest rates rise, though slowly. U.S. growth is moderate, but healthy enough to cause corporate profits to boom. Europe’s economy revives. The dollar is strong, but not too strong. Third World stock markets are red-hot again.
A year from now, the typical stock investor walks away with a return in the low double-digits. The typical bond investor earns about 6%--still better than 3% money market yields. Everyone goes to Spago to celebrate.
Too good to be true? Maybe. Yet many Wall Street optimists offer the above as the logical scenario for ‘94--continuing economic growth and markets that aren’t bearish, but aren’t wildly bullish, either.
If 1993 taught us anything, however, it was that logic’s use in forecasting investment winners and losers can be limited.
A year ago, for example, it was reasonable to assume that gold couldn’t rise in a low-inflation economy--yet it jumped 17% in 1993; that recession-bound European stock markets would lag the U.S. market--yet just the opposite occurred; that President Clinton, a Democrat, would be bad for interest rates--instead, long-term rates plunged to 20-year lows.
For traditional buy-and-hold investors who sat quietly, it turned out to be a decent year, as the economy improved at a steady pace without unleashing inflation.
Major U.S. stock indexes posted total returns between 10% and 20%, and U.S. bonds offered returns of 6% to 12%--the longer term the better, because such bonds appreciated in value as interest rates tumbled.
But how long can sitting quietly work as an investment strategy? Even the optimists concede that with the U.S. stock bull market 38 months old and with interest rates near 20- to 30-year lows, the risk of a reversal this year in financial markets--at least a temporary one--is substantial.
Peter Anderson, strategist at investment giant IDS Financial Corp. in Minneapolis, describes himself as modestly bullish on stocks.
But with the market up three years in a row and stock prices historically high relative to companies’ underlying earnings per share, any number of possible disasters could quickly change the outlook, he allows: “A political crisis in China, a shooting war in Korea, the extremists take control in Russia . . . .” And that’s not even counting any missteps by the White House, Congress or the Federal Reserve.
Moreover, because the wave of novice mutual fund investors who jumped into stocks and bonds in 1993 was unprecedented, the potential is huge for many of them to bail if trouble hits the markets.
Investors large and small profess to be in the market for the long-term, notes David Shulman, strategist at Salomon Bros. in New York. But just how many trigger fingers are out there is not known, because they have yet to be tested by a major crisis. “I think everybody is complacent now about the markets-- too complacent,” he warns.
Yet he also agrees that such concern must be weighed against the increasingly bright outlook for the U.S. economy. Growth is good, hiring is picking up, inflation is still low--and so are interest rates.
One of Wall Street’s most respected investment strategists, Greg Smith of Prudential Securities, recently put it this way in a memo to clients: “We don’t want to tempt fate, but neither do we want to become too carried away with the notion that some really bad things are about to happen.”
Maybe, Smith, suggests, Wall Street can learn to be happy with good times again. There is recent precedent, after all: Stocks and the economy advanced together for the five years between 1982 to 1987. So far, this recovery and bull market have lasted three years.
In short, many pros say the smart investor in 1994 will reject overt bearishness, but will also allow for the unexpected--the surprises that logic wouldn’t dictate.
How best to invest new money or rearrange your portfolio this year? Some experts advise letting two basic laws of nature guide you:
* Over time, everything returns to normal. In market parlance, this is known as “regression to the mean”--simply, that an investment’s performance cannot exceed or undershoot its historical average for too long before reversing, perhaps violently.
John Bogle, head of the Vanguard Group of mutual funds, calls the mean “a powerful magnet that pulls financial market returns toward it.”
For U.S. blue chip stocks--those represented in the Standard & Poor’s 500 index--the average annual total return over the past eight decades has been about 10%.
Because average stock returns in the 1980s were so much greater than that--17.5% a year--Wall Street pros believe that there is substantial likelihood of average returns under 10% in this decade, to keep the historical mean intact.
Regression was clearly underway in 1992, when the S&P;’s total return (appreciation plus dividends) was just 7.6%. In 1993, the S&P; just slightly exceeded its long-term average, with a total return of about 10.1%--a 7.1% price gain plus a 3% dividend yield.
Even with the best possible economic backdrop this year, the pull of the mean is likely to be felt again in stocks, many experts say.
The upshot is that “average” stock performance will probably grow increasingly unexciting. And that, in turn, will accelerate a profound shift in investors’ thinking--a shift, indeed, that already has begun, Wall Streeters say:
To beat a shrinking average return on U.S. stocks, you’ll have to move some money into other, higher-risk investments.
In 1993, the search for higher returns drove investors into foreign stock markets, small-company U.S. stocks and gold. And, in fact, each of those higher-risk categories paid off with returns that topped the S&P; last year.
Some on Wall Street decry investors’ reach for higher returns as a speculative binge. What the critics are forgetting is that this process also encourages diversification. In the long run, having a well-diversified portfolio--which any investor now can build with ease using mutual funds--is likely to be a blessing rather than a curse.
* Chaos begets opportunity. Many investors are terrified that a bear market is coming in stocks and bonds. And someday, maybe soon, the bear certainly will growl.
Rather than be frozen into inaction by that prospect, however, it’s worth remembering that only in bear markets is truly big money made--by people prepared to buy at market lows instead of highs.
Consider: A year ago, nobody wanted to own gold, which was as good a sign as any that the price was ready to explode.
Similarly, foreign stock returns had lagged U.S. returns for four years prior to 1993. In retrospect, every investor knows what he or she should have been doing in those years--systematically buying into foreign markets, betting on an eventual turnaround.
The key in 1994 is not to be a total contrarian on the markets, buying only what is unloved. Instead, recognize that you should always search for the markets with the greatest potential. And those, by definition, usually are markets that recently have been out of favor or just begun to rebound.
Today, that could describe gold and other commodities, real estate, small energy stocks and Japanese stocks, among other sectors.
Jim Crabbe, money manager at the Crabbe Huson mutual funds in Portland, Ore., says “out-of-favor” also describes many individual U.S. stocks--even though the market overall is at record highs.
Because the nature of Wall Street is to overreact to the slightest bit of bad news from individual companies, Crabbe says there is no shortage of overly punished stocks lying around for patient investors.
Think of it this way, he says: There’s a bigger crowd buying stocks today--probably the biggest ever--and therefore a bigger crowd that rushes for the exits when things temporarily go wrong.
“That just makes it all the better for someone who wants to go against the crowds,” Crabbe says.
In the end, Wall Street’s chronic inability to follow a script, or to act logically, is the savvy investor’s greatest advantage.
1993 Investment Score Card
Which investment categories performed best, overall, in 1993? Here’s a look at average performance of indexes measuring popular stock, bond, “cash” and commodity investments. For example, “small company mutual funds” measures the average gain of stock funds specializing in small stocks. Also shown are 1992 and 1991 returns for each category, to put 1993 numbers in perspective. Finally, the estimated inflation rate is included, to show which investments beat inflation. All returns are “total returns,” which includes the investment’s price change plus any dividends or interest earned.
STOCKS (Total investment return)
1993 1992 1991 Gold oriented mutual funds +80.9% -14.6% -4.5% International mutual funds +39.2% -5.1% +12.4% Science/technology mutual funds +23.8% +13.5% +45.4% Small company mutual funds +16.0% +12.6% +51.6% Growth mutual funds +10.4% +7.8% +36.0% Blue chips (S&P; 500 index) +10.1% +7.6% +30.5%
BONDS (Total investment return)
1993 1992 1991 High yield “junk” corporates +17.2% +18.2% +34.6% Long-term Treasuries +17.2% +7.9% +18.4% Mortgage-backed (GNMA) +14.9% +7.4% +15.8% Long-term high-quality corporates +13.9% +9.3% +19.6% Long-term tax-free munis +12.4% +10.3% +13.4% Intermediate-term high-qual. corps. +11.0% +7.6% +15.8% Intermediate-term Treasuries +8.2% +6.9% +17.5%
CDs/MONEY FUNDS (Total investment return)
1993 1992 1991 Five-year CD, annual average yield +5.0% +5.8% +7.7% One-year CD, annual average yield +3.2% +3.8% +7.4% Money market mutual funds +2.7% +3.4% +5.7% Money market bank accounts +2.5% +3.3% +5.3%
COMMODITIES (Total investment return)
1993 1992 1991 Silver futures +38.7% -5.4% -7.4% Gold futures +17.3% -6.0% -10.2% Platinum futures +11.5% +4.5% -17.4%
INFLATION
1993 1992 1991 (Consumer Price Index) +2.8% +2.9% +3.1%
Sources: Lipper Analytical Services (mutual fund returns); Merrill Lynch (bond index returns); Bank Rate Monitor and IBC/Donoghue’s (CD and money fund returns); Commodity Exchange and New York Merc (commodity returns)
