|
|
|
|
 |
|
How to Cope with a Cloudy Investment Forecast
Russell Portfolio Managers Discuss Strategies to Deal With the Unexpected
Weather-related imagery has always helped to define the language of finance. You should "make hay while the sun shines" in order to set money aside for a "rainy day." But now, investors are hearing a new term that defines an economy so uncertain that it stumps the forecasters: Cloudy visibility.
What economic and market conditions create "cloudy visibility?" How could a period of uncertainty impact your planning? Two of Russell's US equity portfolio managers, Dennis Trittin and Erik Ogard, recently fielded these questions in explaining how they factor cloudy visibility into their strategies. To decipher cloudy visibility, start with the fact that financial professionals rely upon proven analytical tools in an effort to forecast trends. But at times, these tools become more difficult to interpret and less reliable indicators of economic and market behavior. The first quarter of 2001 was such a time. Specifically, many companies announced shortfalls in sales and profits (earnings) compared to projections. Also, these companies and the analysts who track them were unable to say, in many cases, when earnings would rebound. The murky outlook contributed to weakness in US and international stocks. During the first quarter, the most vulnerable stocks were those that had been bid to high prices based on earlier estimates of continued earnings growth.
Why Clouds Formed Over the Economy
Why did the financial skies cloud over in the first quarter? The Russell managers offered these answers:
| |
- The US economy declined at an unusually rapid rate in the fourth quarter of 2000. The annualized increase in Gross Domestic Product (GDP) fell from a 5-6% rate earlier in the year to about 1% in the fourth quarter. "The magnitude of the decline was so abrupt that it caught everyone by surprise," said Trittin, a Russell large-cap manager. The economic slowdown was triggered by a series of six interest rate increases by the Federal Reserve in late 1999 and early 2000. But instead of cooling economic growth gradually, the cuts produced a "delayed reaction" impact that hit all at once. "The Fed engineered a far faster slowdown than even they fathomed," Trittin said.
- The technology sector of the market went into a tailspin. This trend began in the first half of 2000 with mounting problems among Internet stocks. By the fourth quarter, it had spread to major large-cap technology companies, with many experiencing a swift slowdown in sales of equipment and services. "As dot.coms went out of business, some of the equipment they owned came back onto the resale market. This further depressed technology equipment sales," Trittin said. Technology is a notoriously cyclical sector, and it has become a larger component of the US economy in recent years, so the impact of a tech "down cycle" was greater.
- The new Regulation FD (fair disclosure) reduced the ability of companies to discuss earnings forecasts with securities analysts. "When regulation FD went into effect, companies clammed up more," said Ogard, a Russell small-cap manager. Since this regulation prevented companies from releasing data selectively to analysts (instead of the public at large), companies were not able to offer nuances about how they are coping with the slowdown. Instead, many companies issued terse "earnings guidance" of a numerical nature. Ogard observed that in the first quarter of 2001, "90% of companies were coaching their earnings downward." The new regulation may have added to clouds hovering over a variety of industries.
- Concern that a recession may develop slower and last longer than in the past. Since World War II, the U. S. economy has produced nine recessions that have lasted an average of 11 months. About halfway through a typical recession, economists usually can see "a rebound at the end of the tunnel." But recently the stock market has reflected worries that this may not be a typical slowdown. Instead, it could be what Trittin calls "a slow domino" produced by a chain reaction of unfavorable developments. According to Ogard: "There has been very little visibility into how businesses are improving. In the first quarter, consumer spending held steady. But economists were worried that a slowdown in consumer spending and weakness in Europe could push a recovery further into the future." A more fundamental concern, he added, is that the Fed's usual medicine for a slowdown, interest rate cuts, may not produce quick results in an economy experiencing a major capital spending slowdown.
|
How to Plan for a Cloudy Day
In a nutshell, cloudy visibility means uncertainty about the timing of a recovery — in the economy, markets, and individual sectors and companies. Trittin and Ogard believe this creates opportunities for long-term investors. Even if the economy takes time to revive, some sectors can perform well in the interim. They caution that technology stocks can be risky in times of cloudy visibility, except for special companies that look attractive long-term and are undervalued currently. "Tech spending eventually should pick up, because modern companies need technology to be competitive," says Ogard. He believes that periods of cloudy visibility create opportunities to invest selectively. "We are not aggressive yet, but we are not in a defensive position either." Both Russell managers suggest that more cloudy intervals may occur in the future. Therefore, learning to cope with these periods by staying on course with your long-term strategy, and using active managers who have proven ability to make hay on cloudy days, may be beneficial.
Date of first use: 05/11/01.
Past performance is not a guarantee of future performance.
This is a publication of Russell Investments Canada Limited. 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.
|
|
|
| |
RELATED Topics |
|
|
|
Products and services described on these websites are intended for Canadian residents only. Information on these sites should not be considered a solicitation to buy or an offer to sell a security to any person. Persons outside Canada may find more information about products and services available within their jurisdictions by going to Russell's worldwide site, http://www.russell.com.
Legal Information Privacy Policy
Required Sales Disclosure
© Russell Investments Canada Limited 2009. All Rights Reserved.
|
