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Investors Ignore Economic Up-tick in Favor of Fear
Positive Indicators Can be Seen Through the Market Fog
By Jean Carter
Director, Equities
Russell Investment Group
August 1, 2002
Ah, the power of investor fear.
It's so strong right now that it is brushing aside all indications that economic recovery is at hand. Investors don't seem to believe the signs. Perhaps they just don't care. Or perhaps they are just flat-out scared of what could still lie ahead in corporate America.
The result: Although the economy is looking healthier than it was in 2001, the equity markets are looking downright sickly.
Yet we should not be completely surprised. Investors have ignored economic signals and resorted to emotional reactions in the past. In 1998 the equity markets plunged when investors lost confidence because of the financial flu that spread through Russia and Asia and led to the collapse of Long Term Capital Management (which lost US$3.8 billion in bad hedge-fund investments). The events of September 11, 2001 shook investor confidence and stocks fell sharply. Now the likes of Enron and Tyco and the fear of further terrorist attacks once again are causing investors to lose confidence in equities.
On the Horizon
Investors are reacting not so much to the scandals themselves, but to the fear that more might lie ahead. They don't want to face the prospect of being invested in a company when its track record is suddenly brought into question and the stock plummets within minutes. The more companies are brought into question, the more the fear grows of which could be next.
The question troubling investors is whether the scandals that have emerged so far are a few rotten apples or indicators of a sick tree. If only a few are involved, most people would like to see the perpetrators punished, enabling Wall Street to move beyond the scandals.
But right now investors just aren't sure. The result is that many are sitting on the sidelines or moving to what they perceive as safe havens.
The Bright Spots
If there is a silver lining to be found in all of this, it is that valuation risk is lower than it has been for years. Price-to-book ratios of the world's stocks, as measured by MSCI World Index, stands at 2.4, below the 10-year average of 2.8 and nearly half the 10-year high of 4.2. Price-to-earnings ratios stand at 30.1, still above the 10-year average of 25.7, but closer to it than the 10-year high of 35.7 was.
Investors should continue at this time to do what they always should be doing. They should recommit to their asset-allocation strategy and ask themselves whether their investments are where they need to be. They should rebalance their portfolios to ensure they retain their diversification goals - and they should believe that balance will return to the market.
After all, the relationship between risk and return still holds true, although the perspective has changed. Three years ago we had to make the case that risk remained in the market. Today we have to make the case that return still is there - even though it might be hidden behind a fog of fear.
Copyright© Frank Russell Company 2002. All rights reserved. See Legal Information. Date of first use: August 1, 2002.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
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