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On the 2004 Horizon
Can the US Stock Market Sustain Pace?
By Russell Investment Group
Global Leaders in Multi-Manager Investing
December 10, 2003
This article has been provided by our parent company and any references to rates or returns are based in $US and specifically related to US markets
Strong gains for the US stock market in 2003 have renewed confidence for many investors, but those who expect similar returns in 2004 could have expectations dashed, even if the market moves upward. That's the problem posed by looking backward rather than forward given a market that continually changes.
Russell portfolio manager Dennis Trittin oversees independent investment managers who pick stocks for Russell's multi-manager large-cap products. Insights gained from the conversations between Trittin and Russell's money managers place a valuable perspective on both the past 12 months and the year ahead.
The Roots of Market Recovery
Trittin cites five major catalysts for stock price growth in 2003:
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- Reduction of uncertainty regarding Saddam Hussein's power, the Former Iraqi president was eventually captured late in the year.
- Dramatic improvement in corporate profits in North America, leading to more reasonable valuations.
- Low bond yields making equities more attractive.
- The US Federal Reserve Board's support for a sustainable economic recovery with ample liquidity and interest rates and inflation kept under control.
- Changes in US federal tax policy raising after-tax returns. The long-term capital gains tax declined from 20% to 15%. The dividend rate plunged from ordinary income tax rates down to 15%.
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Why Losers Became Winners
While increasing profits generally spur stock price growth, the 2003 recovery has been unusual according to Trittin. "Some companies decimated in the bear market of 2000-2002 outperformed the market in the past year," he said. "In many cases, companies with losses actually did better than companies with profits."
In fact, the stock prices of many large, stable US companies haven't budged much. "They're simply not seen as exciting," Trittin said. Rather, leadership has shifted from defensive companies where profits are being taken into more cyclical, aggressive companies.
"The US bond market played a role in all of this as well," Trittin explains. "Yields of the highest-risk bonds fell as companies restored their financial strength. With this, money flowed into stocks of highly leveraged companies."
Sustained Profits are Key
Russell money managers generally believe that in 2004, earnings growth may continue to elevate stock prices. They expect corporate profit growth to sustain returns in the 8—12% range. That's significantly lower than 2003's market gains but certainly a sound return from a long-term perspective.
In Trittin's opinion, the key to success in 2004 may be "profit sustainability." Thus, successes may arise from a set of companies investors essentially overlooked in 2003.
Where Might 2004 Take Us?
Trittin has no crystal ball but offers investors several factors to consider.
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- The Fed is widely expected to raise interest rates. No one knows how soon and how far. Investors will undoubtedly be unsettled over the impact of this regime change.
- Earnings growth comparisons may suffer in the second half. Corporations showed approximately 20% growth in the third quarter of 2003 compared to Q3 2002. Growth is likely to continue, but the rate is likely to decelerate as the year progresses. Growth seen in absolute terms may appear mediocre in relative terms. "This may cause a leadership change from cyclical stocks to more stable companies whose stocks didn't benefit as much in 2003," Trittin said.
- Business costs may go up beyond rising interest rates. With inventories depleted, companies are likely to hire more employees. That may increase consumer spending power but may cut into profits — just as layoffs helped build profits in 2003. Shipping costs are rising, too.
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Protecting Against the Unknown
While near-term expectations remain positive, the key to avoiding unpleasant surprises, says Trittin, is diversifying and rebalancing your portfolio at least yearly.
"You have to be forward looking and plan for different market scenarios when developing your investment strategy," Trittin advises, "and not be overly influenced by prior trends. Otherwise, you're doomed to a 'buy high/sell low' approach which costs wealth."
A well-diversified portfolio may help investors take advantage of change.
Copyright© Frank Russell Company 2003. All rights reserved. See Legal Information. Date of first use: December 19, 2003.
This is a publication of our parent, Frank Russell Company. It should not be construed as investment, legal, or tax advice. The contents are intended for general information purposes only, and you are urged to consult your own investment, legal, or tax advisor concerning your own situation and any specific investment questions you may have. For further information about these contents, please contact Russell Investments Canada Limited.
Russell Investment Group is a registered trade name of Frank Russell Company, a Washington USA corporation, which operates through subsidiaries worldwide. Frank Russell Company is a subsidiary of The Northwestern Mutual Life Insurance Company.
Russell Investments Canada Limited is a subsidiary of Frank Russell Company.
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