It's been quite a year, hasn't it? With hindsight we know that, in November of last year, we began the final blow-off stage of the great tech-sector stock market rally. Remember one analysts recommendation that "Qualcomm should see $250 per share next year" (split adjusted) and actually reaching $200 that last week of 1999 before falling to $56 in July? The New-Millennium-induced euphoria of 1999's final week has left many investors and their portfolios with a hangover.
Year to date the NASDAQ is down 25.6% as of November 10. Has anybody noticed that the Standard & Poor's Utility index is up 44% this year and 36% for the past 52 weeks, more than doubling the next best sector index for this year and almost doubling the next best index for the past 52 weeks? And, this does not include the generous dividends that utilities pay! My guess is that not too many have noticed this.
Since the technology sector peak during the first quarter, a lot of last year's excesses have been corrected. This is not to say that we are out of the woods yet. Nonetheless, during the current skittishness in the equity markets, investors need to take time to re-evaluate their portfolios.
We have to ask ourselves: Is my portfolio properly diversified? Is my portfolio too aggressive or conservative? Do the stocks and mutual funds I own still make sense for the long term? Do I own a sufficient number of conservative dividend growth stocks to counter balance those volatile technology and telecommunications shares? And, finally, with the macro-economic variables beginning to weaken, what might happen to my portfolio if we have a recession? A recession does not in fact appear imminent, and the purpose here is not to sound an alarm, either. Nevertheless, it is useful to reflect upon historical experience and see just how the markets have reacted during periods of stronger than expected business slowdowns. It is also useful to examine which industries and market sectors have provided investors a relative safe-haven during these times.
Most of us are aware that rising interest rates are the bane of bull markets. This is particularly true when, as now, the Federal Reserve has raised rates three or more times in succession. Another aspect that is cause for concern is something known as the "inverted yield curve." This simply means that short-term rates are higher than long-term rates. The Fed Funds rate, or the rate for overnight inter-bank borrowings, is 6.5%, 90-day Treasury bills yield 6.3%, 10-year Treasury bonds yield 5.7%, and the 30-year Treasury bond yield is at 5.8%. More commonly, the yield curve is upward sloping. This inversion has occurred during the past year as the Federal Reserve has pushed up interest rates. Inverted yield curves often presage stock market corrections and recessions.
The Yield Curve and Recessions
Periods with Inverted Yield Curves
(Fed Funds rate vs. 30-year T-Bond yield)
|March, 1966 - March 1967||Dec. 1969 - Nov. 1970|
|April, 1969 - July, 1970||Nov., 1973 - Mar., 1975|
|Feb., 1973 - Jan., 1975||Jan., 1980 - July, 1980|
|Aug., 1978 - Jun., 1980||July, 1981 - Nov., 1982|
|Oct., 1980 - Nov., 1981||July, 1990 - Mar., 1991|
|Feb., 1982 - June, 1982|
|Jan., 1989 - Dec., 1989|
|Sep., 1998 - Oct., 1998|
Source: A. Gary Shilling and Co.
While still in the midst of the longest up-cycle in U.S. history, perhaps it is easy to lose sight of the fact that economic and invariably stock market corrections will occur still. Since World War II, there have been nine recessions lasting an average of eleven months. From two to thirteen months after the beginning of these recessions, the Standard & Poor's 500 index hit a low.
Investors whose portfolios are properly diversified and balanced among stocks, bonds and money market funds need not be overly concerned about recessions. After each post-World War II stock market correction brought on by a recession, stocks have reached new highs.
Although the current growth phase dates from March, 1991, the longest ever, few economists are predicting a recession for 2001. The current consensus calls for year 2000 Gross Domestic Product (GDP) growth of approximately 5% and for 2001 growth of approximately 3%. Whenever a recession does materialize, however, stock prices will surely turn down.
From the start of the nine post-war recessions, the S&P 500 index fell between 6% (1953) and 42% (1973) with the average being 18%. Six months after the end of the recessions, the S&P 500 ranged between down 20% (1975) from the onset of the recession and up 31% (1954) from the onset with the average being a 12% gain.
From the onset of a recession until twelve months after its end, only the 1973-1975 recession failed to produce a net gain (-7%). The average such gain over these time periods was 19%.
There have been six recessions since 1960. The worst performing industries have been trucks and parts, machinery, airlines, automobile manufacturers, apparel, major regional banks and life and health insurers. These industries have fallen between 4% (financials) and 16% (airlines). On a positive note, consumer staples gained 6% on average while health care and utilities gained 2% and 1% respectively. Consumer staples include food processors, beverages, household products and retail grocery chains. Health care includes the major pharmaceutical manufacturers and medical supply companies. Gold and precious metals mining has been the most recession resistant industry, gaining an average of 25% over the last six recessions. We would caution however that this is a highly cyclical and volatile industry.
We tend to avoid recommending most of these poor performing industries simply because of poor fundamentals such as financial leverage, low return on equity, erratic revenue and earnings history, and poor dividend growth. We do, however, tend to recommend many stocks in the better performing industries for these same reasons. In the 1999's technology led market, these stocks did not perform as well as anticipated but the reverse is true this year as technology stocks are faltering
It bears repeating that dividends provide much of the long-term total returns from stocks. From the mid 1920s until today, nominal gross domestic product grew at an annual rate of 6.4%. Over the same period, the returns on stocks due to price appreciation alone, not including dividends, has been 6.0%. In other words, stock prices tracked earnings very closely over the long term. Investors benefited from the 4.6% average annual return from dividends. This represents 43% of the long-term total return from common stocks. With the dividend yield on the S&P 500 at 1.2% today and slower forecasted growth for GDP, investors would do well to focus on stocks of high-quality companies and pay a bit more attention to dividends.
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright, 2003 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.