It is safe, though, to disregard the historical argument that stocks can’t fall again in 2002 because the stock market hasn’t fallen for three straight years since the Great Depression. (Stocks fell for four straight years, 1929 to 1932.) The problem with this historical argument is that the market isn’t about history. It’s about the future. Or, more accurately, about the market’s view of the future. A company’s value today depends on its future profits and cash dividends and assets. It doesn’t depend on a company’s past numbers, because we can’t revisit the past.
Even if the economy turns around next year, which is a distinct possibility, stocks may not do well. How can this be? Because today’s stock prices relative to companies’ dividends and projected profits are high by historical standards, and have already taken a better economy into account. In late December, the Standard & Poor’s 500, the Dow and the Nasdaq were up 21, 18 and 35 percent, respectively, from their post-9-11 lows. Meanwhile, the economy has weakened enough for the National Bureau of Economic Research to declare that the economy had peaked in March and a recession had started in April. The point? Selling stocks because you thought that September 11 trauma would tank the economy made you an economic seer, but a blindsided investor.
The bond market offers another example of how investing by looking at the rearview mirror instead of the windshield can cost you big bucks. Through October, this had been a great year for bonds and a terrible year for stocks. Bonds soared on Oct. 31, when the Treasury announced it would stop selling new 30-year Treasury issues. Lots of people dumped stocks, which were unpopular, to buy bonds, which were hot. Guess what? The S&P 500 rose about 9 percent in November, according to Aronson + Partners, a Philadelphia financial firm, while long-term Treasuries fell about 5 percent. So switching out of stocks into long bonds left you 14 percent below where you would have been had you stayed still.
Yes, the Federal Reserve Board has cut short-term interest rates–but long-term rates have been rising steadily since October. As of late December, yields on 10- and 30-year Treasuries were higher than they were before Alan Greenspan started cutting short-term rates on Jan. 3. This despite the fact that Greenspan has cut short rates 4.75 points during the period. “The minute the Fed starts cutting rates, the bond market starts worrying about inflation,” says bondmeister Joseph Rosenberg, chief investment office of Loews Corp. He says the bond market is predicting an economic recovery in 2002.
Long-term rates are more important to the economy than short rates, especially these days. A major reason: mortgages. Mortgage rates are influenced far more by long rates than by short rates–and homeowners’ refinancing mortgages has helped keep consumer spending going. If the refinancing boom falters, it will hurt consumer spending. And long-term rates have a higher impact on business investment–a weak point in the economy–than short-term rates do. That’s because no one in his or her right mind will use short-term money to finance factories or other long-term assets.
But don’t despair about being unable to foresee the future. You have plenty of company. If we knew what the market would do, investing wouldn’t be any fun, would it?
