AAMG - Past Market Views - What's Ahead for 2001

What's Ahead???

Who knows the answer to that question? No one does. In fact this is one of the most confusing markets this writer has seen in the last forty some odd years. One thing is for sure; we are in the middle of a bear market, one that has been going on for nearly two years. So how much longer will it last? Again, who can tell? The Dow Jones Industrial Averages are selling close to 25 times earnings and yielding 1.69%, while the S&P 500 is at 26.65 times earnings with a 1.29% yield. Historically these numbers denote tops in the market, not bottoms.

Looking back over the past two years (the chart below shows) the market has moved in a very defined trading range. A high was established in January of 2000 at 11,722.98 and a low in March of 2001 of 9,389.48. This 15-month top to bottom correction, lopping off 25% of the Dow Averages, may have established a trading range that could last for several years.

A similar period can be found in stock market history. As can be seen below, from 1966 through 1974, the market traced a pattern of average annual 25% top to bottom corrections.

	High	Low	% Correction
1966	955.15	744.32	33.7
1967	943.08	849.57	11.1
1968	985.21	825.13	19.4
1969	968.85	769.93	25.8
1970	842.00	631.16	33.4
1971	950.82	797.97	19.2
1972	1036.27	889.15	16.5
1973	1056.70	788.31	34.1
1974	891.66	577.60	35.2

This was a very interesting period to live through because the market went from extreme over valuations to extreme under valuations. At the market bottom in 1974, stocks paying dividends of 6% or better were commonplace. Will this happen again? Maybe, but we may see the market establish a new high above the 11,722.98 before it is over as was seen in both 1972 and 1973 before sinking to the low of 1974.

Can money be made in this confusing market? Yes it can, but first we have to examine the avenue we need to travel to make money in a "cranky" market. A review of where one is currently positioning their money is in order before determining where one should re-position for future growth under changing economic conditions. There is an old saying traders use, which goes like this, "the trend is your friend." In other words, to make money you have to follow the direction of the market, up or down.

If you are a contributor to a 401K, IRA or other voluntary plan, then you are properly making monthly investments in a family of mutual funds. A diversification program may be in place where you contribute to several funds, each with a separate investment objective. For the last four or five years this has worked well for most people. The funds invested your money and you paid them the appropriate fees. Most funds did well in the bull market and showed an annual 10% or better total rate of return to the investor. Now comes the bear. No longer can the funds rely on capital appreciation for their returns. For the majority of funds, the dividends they received from the companies they invested in were used for management fees and other fund expenses. Nothing was left over to pay to the funds' shareholders… No net income, no fund dividends. If the market is going to stay in a narrow trading range for the next couple of years, the chances are great that these funds will show very little, if anything, in the way of total return. Your money is dead in the water.

This may sound funny, but cash is king. If you change directions and direct all of your monthly contribution to your family of fund's money market fund you may well end up on the plus side. If you are adding $100 a month to a fund that is paying a 4% annual distribution, compounded monthly, you will have $2,501.55 at the end on the second year. You may say "not great" but it is on the plus side and a better return than "dead money."

How sure are we of the 1966 - 74 scenarios? No one can foretell the future. All we can do is look to the past for clues to what the market will do. A close look at the chart on page one will show that the narrow trading range is either a base building formation or the distribution of stock out of strong hands into weaker ones. Given the state of the economy, the amount of debt, both public and private, plus the lack of savings on the part of the public, leads us to believe the latter. Time will tell.

So what should the 401K and IRA investor do? Our research staff is well along its way in developing a methodology that will assist us in detecting the direction of the market and various sectors within the market. We call it our STAR WATCH program. We plan to use this program to assist us in directing assets in and out of various funds within a clients' 401K or IRA plan. No system is fool proof, but it is a research tool, which may well improve overall performance in a confusing market.

If you are in one of many that are concerned about the market and are not sure where to direct your investment dollars, why not investigate our program. E-mail us at gordon@aamg.com for more information and how to subscribing to our STAR WATCH program.

Gordon B. Lamb
July 26, 2001

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