LFM&P
Linnard
Financial Management & Planning, Inc.
Registered Investment Advisor
October
1, 2006
Outlook & Trends
Outlook & Trends often comments upon financial
issues that are being written about in the financial and general media, trying
to help you see the larger picture by looking at the issue from a different
perspective. One such story may be about to appear, as the Dow Jones Industrial
average is poised to reach a new all-time high, surpassing the last peak posted
in January 2000. In addition to our
review of the current economic environment, this issue of Outlook &
Trends discusses why this milestone can be considered both important and
irrelevant to your financial health at the same time, depending on your
perspective. We will also present another topic that you are not likely to read
about in the newspapers, the Presidential Election Cycle, which could be
significant right now.
On October 25, David will be presenting a class through the Concord-Carlisle Community Education entitled “Understanding & Using Exchange-Traded Funds”. If you would like to find out more about what ETFs are, and how you can use this low-cost, tax-efficient investment innovation, please join us. You can get registration information at http://ace.colonial.net or call (978) 318-1540.
Economy
The economy
continues to grow, although at a slower pace than before. The deceleration
prompted the Federal Reserve to put its interest rate-raising program on hold,
because inflationary pressures have diminished. That is not to say that
inflation has gone away. The Consumer Price Index has risen 3.8% over the last
year, much of it due to increases in energy prices. The cost of gasoline, which
spiked during the summer, put more of a damper on people’s attitudes than
actually hurting the economy. Coincident with the normalization of gasoline
prices, consumer confidence has also improved recently. Interestingly, while
retail sales recently grew at about a 4% rate, in line with inflation, sales by
gas stations increased at an annual rate of almost 20%!
The
slowdown in the housing market is old news, but no change in the downtrend is
visible yet. Existing home prices have dropped about 2% since last year, and
pressure on sellers continues to grow, evidenced by the increasing inventory of
homes for sale, which has reached 7.5 months worth of sales, a 57% increase
since last year.
On the other hand, stock market investors will be glad to know that corporate profits, a prime determinant of stock prices, are up 20% since last year. In fact, profits have grown between 9.7% and 25.4% every quarter since 2002. This growth is the reason why the Dow Industrial Average is nearing a new high.
Financial
Markets
The market rose 5% during the
3rd quarter! Or did it? Well, the Dow Jones Industrial Average and
other large cap stocks were up 5%, but what about the rest? The Russell 2000
small-cap index was up only ˝%. Middle and small capitalization stocks, which
have doubled the gain in the Dow Industrials for the last three years, took a
breather. Likewise, broadly diversified portfolios under-performed during the
quarter. They have been outperforming the standard allocation recommendation
that emphasizes large-caps for several years now. Smaller stocks have become
over-valued versus the large-caps. It will be important to watch to see if this
shift to big company stocks continues.
There was also a big change in the bond market. High quality bond prices have been under pressure since 2003 as the Fed raised interest rates. Bonds rallied with the recent Fed rate pause. In fact, it is probable that the change in rate policy was the force that lifted the large cap stocks, since stock valuations rise as interest rates fall and earnings rise. This performance was significant, because it occurred during the weakest period of the year for stock prices.
Thoughts
on a New Market High
The Dow Jones Industrial Average began as a simple
average of the prices of 30 industrial stocks in 1896. Of course at that time
there were no computers, so the calculations of the average had to be done by
hand. It can be argued that the Dow Industrials do not represent the market as
well as other, more sophisticated, measures available today. While this is true,
a new high in the Dow is still important for three reasons:
1)
Most people think that the Dow is the stock market, and a
new high is likely to cause at least some amount of additional buying, lest an
investor miss the boat.
2)
A market that is moving up will set new highs. Setting new highs is
indisputably the most bullish thing the market can do. The Dow Theory says that
when the Dow Industrials and Dow Transports both reach new highs, a bull market
is in force. The transports did their part by setting a new high almost two
years ago.
3)
A new Dow Industrials high says the bear market that started in 2000 is
over, and implies that the markets and economy are mended.
For other than psychological reasons, however, the Dow is largely irrelevant. If you consider the dividends that have been paid, the Dow’s new high was set two years ago. Beyond that, the Dow Industrials is really only a good representation of large-cap value stocks. Divergence of performance, during both the last several years and last several months, between the DJIA and other stocks, shows the venerable measure does not represent the rest of the market very well. If you have a well-diversified portfolio, it will not represent your personal experience either.
The Presidential Election Cycle
There are historical patterns in the market that tend to repeat themselves. The
period from November to May is usually stronger than the rest of the year.
September is often the weakest month. Likewise, there is a repeating pattern
that follows the Presidential Election Cycle, since presidents like to get their
recessions over with early in the term and have a robust economy near election
time. I have plotted the following graph using data back to 1950. You can see
that mid-way through the term is usually the farthest away from the average
growth trend and is often the beginning of the strongest period.
It is important to note that this is historical data,
not a prediction of the future. Just as the Dow Theory suggests, but does not
guarantee a bull market, the four year cycle does not guarantee higher prices.
Having said that, however, I find it impressive that the large cap stocks
performed so well last month, during a period that is historically a drag on the
market
To learn more about LFM&P investment
management and financial planning services, our client goal-centered financial
philosophy, and to better understand the value we can bring to your financial
life, we encourage you to contact us or look at our website, www.linnardfinancial.com.