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Jubak's Journal
Recent articles:
• 10 stocks the big money is buying, 12/5/2003
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| | Jubak's Journal
Turn 2003's lessons into 2004's profits
A year that dramatically demonstrated the ways stocks, the economy and our paychecks react to outside forces provides a handy guide to the year ahead.
By Jim Jubak
Its about this time of the year that investors start looking for lessons from the past year that can help them pick profitable stocks in 2004. My advice is to forget about backward-looking conclusions and try these three forward-looking lessons from 2003:
- The stock market anticipates the economy.
- The financial markets are stable until they tip, much like a pile of sand.
- The stock market, the economy and your personal financial well-being can be amazingly out of sync for long periods of time.
Ok, now here are the details on those lessons and what they mean for 2004.
The stock market anticipates the economy
In 2003, economic growth seemed stubbornly stuck in low despite tax cuts, low interest rates and massive home mortgage refinancings. After showing 4% growth in the third quarter of 2002, gross domestic product (GDP) growth dropped to 1.4% in the fourth quarter of 2002 and stayed there for the first three months of 2003. It wasnt until the second quarter that the economy started to lift, with GDP growth of 3.3%. And everyone knows what happened in the third quarter: GDP growth popped to a revised 8.2%.
But the stock market didnt wait for that third quarter, or even Julys second quarter numbers, to act. The stock markets lows for 2003 came on March 11. By the time the U.S. Department of Commerce delivered the data on the second quarters 3.3% growth, the Nasdaq Composite index ($COMPX) was already up 36% and the Dow Jones Industrial Average ($INDU) had climbed 23%.
Convinced that the U.S. Federal Reserves interest rate policy and the Bush administrations tax cuts would jump-start the economy, investors drove up stock prices well in advance of any validating numbers.
In 2004, investors will be focused on potential interest-rate increases, not cuts. Thats not to say that investors wont be intensely interested in what the economy will do for an encore in 2004 -- will growth fall to 3.5% or surge ahead at something like 6%? But whatever growth the economy delivers will be viewed as evidence for or against an early Fed interest-rate hike.
Right now, interest-rate watchers are divided into two major camps:
- The early hikers, who believe that the first interest-rate increase will come in March.
- The late hikers, who believe that the Fed will hold off increasing rates until after the November elections.
In 2004, investors who are convinced that rate increases will slow the economy and dampen stock prices wont wait for the actual announcement before acting.
The economy and the markets are stable until they tip
Why did it take so long for the rate cuts, the huge stimulus from home mortgage refinancings, and the final push from the Bush administrations tax cuts to get the economy surging? After all, by December 2001, the Fed had lowered the fed funds rate to 1.75% from the 6.5% level at the end of 2000. So why was the economy still growing at less than 1.5% annually at the end of 2002?
And why, when the growth came, did the economy go so quickly from standing still to racing down the track? The economy quickly accelerated from anemic growth of less than 1.5% at the beginning of 2003 to something better than 8% just six months later.
That behavior is a real puzzle to anyone who thinks of the economy -- or the financial markets for that matter -- as analogous to a car. Step on the gas pedal, and the acceleration is linear and gradual. The harder you press, the faster you go.
But press the economy's gas pedal and nothing seems to happen, at least not initially. Keep sending more and more fuel to the engine and the economic car stubbornly refuses to go any faster. And then, suddenly, the engine revs to life and the car is doing 60 in an instant.
Scientists who study the behavior of complex systems -- and, believe you me, the economy certainly qualifies -- call this tipping behavior. Youve experienced tipping behavior if youve ever piled gains of sand onto a growing sand hill. Add one grain and the pile grows minutely larger. A second grain has the same effect. And so on for grain after grain, until suddenly with the addition of grain X, the pile becomes unstable and collapses in a sand avalanche.
So in 2003, grains of financial stimulus piled up with no discernable effect on the economy until one quarter, wham-mo, 8% growth.
In 2004, look for interest rates and inflation to exhibit similar economic tipping behavior. So far, even though an increasing number of investors believe that interest rates will go up in 2004, the actual increase in interest rates has been very subdued. A year ago, the yield on a 10-year Treasury note was 4.2%; today, its around 4.4%. It is possible, of course, that once the Fed actually raises short-term interest rates that long-term rates, which are set by the bond market, will climb gradually. But its much more likely that the bond market will react with tipping behavior that suddenly sends interest rates speeding upward.
Id make the same case for inflation. Right now, overall inflation is running at an annual rate of just 2% (as measured by the overall Consumer Price Index) and the less volatile core inflation rate is an even lower 1.3%. Inflation isnt in these numbers, and its certainly not on most investors minds.
But the inflationary fuel is present even if the economic car isnt showing any signs of an inflationary speed-up. You can see it, if you want to look, in commodity prices. Moodys index of scrap metal prices, for example, is up 27% over the last year. The price of silver is up 23%. Soybeans are up 31%. A broad gauge of commodity prices such as Rogers International Commodity Index is up 29%.
Investors who say that inflationary pressures dont exist because they cant see the evidence in the final CPI or Producer Price Index misunderstand how the economic reacts to fuel.
In 2004, I expect that inflationary commodity pressures will pass a tipping point and suddenly put inflation on investors radar screens. (And thats even though I expect that global overcapacity in manufacturing will keep the prices of manufactured goods falling.)
Stocks, the economy and your wallet are out of sync
For much of 2003, investors joyfully watched the stock market go up. In recent months theyve seen -- hurrah, hooray -- evidence of a better-than-solid economic recovery.
And yet many of my readers dont feel good about their personal financial well-beings. If theyve kept their jobs through the downturn, theyre working harder in many cases for the same or even less pay and paying more for benefits such as health insurance. If they arent working, they despair at finding a job at the same salary and with equivalent benefits, or even worse worry that they wont be able to find any job at all.
Thats led many readers who e-mail me to question the accuracy of those government numbers that show the economy roaring ahead and to believe that the current stock market rally is built on illusion.
But you can have a super-growth economy, a roaring bull market and tough times for individual balance sheets all at the same time. While the three systems are linked in the long run, in the short run, they have a high degree of freedom to go separate ways.
In 2003, for example, layoffs, givebacks and pay freezes have devastated individual income statements. But the same factors have done wonders -- in the short run, remember -- for corporate profits. With productivity growth running at an annualized rate of 9.4% in the third quarter, companies are getting a lot more products and services out the door with the same number of workers. No wonder earnings for the stocks in the Standard & Poors 500 are projected to grow by 16% in the third quarter of 2003 and 23% in the fourth quarter, according to First Call.
Its tough to ignore whatever your own personal financial well-being index is telling you. It is important as an investor, however, to realize that times that are tough on individuals can be great for stocks and for the economy. In the short run, the personal tough times and macroeconomic and stock-market good times are anything but mutually exclusive.
Your own personal experience, which may legitimately convince you that the world is going to hell in a handbasket, isn't necessarily the best guide to how to invest your money.
Thats an important lesson from 2003 to keep in mind as you plot your investment strategies for 2004. From all indications, workers are looking at another year of rising paycheck deductions for things like health insurance, and only modest improvements in wages and salaries. But that doesnt mean the economy -- measured by GDP -- wont keep growing or that the stock market cant go up.
But 2004 is likely to be a transitional year. If the economy keeps growing, and if the stock market doesnt plunge, in the normal course of things, workers could expect to see some of that big-picture improvement filter into their own paychecks.
The degree to which that improvement happens in 2004 will be a measure of how much the new rules of the global economy have changed the dynamics of the U.S. economy and the personal financial well-being of us all.
And knowledge of the nature of that change is likely to be among the most important lessons of 2004.
My next column will be devoted to the long-delayed reader solutions to The job-is-worth-less recovery that I described in my Oct. 24 column.
Changes to Jubak's Picks
Sell State Street
Shares of State Street (STT, news, msgs) climbed to $52 and change last week before fading. Thats not quite the level of my target price of $54, but, with this market looking a little tuckered and risk levels climbing, Im going to take my profits here. The shares are up 40% since I added them to Jubaks Picks on May 9, 2003.
New developments on past columns
Bull market in metals is just beginning
The work to improve the balance sheet at Freeport-McMoRan Copper & Gold (FCX, news, msgs), the worlds low-cost copper producer, goes on. On Dec. 8, the company announced it would pay a cash bonus of $20 a share plus interest (per $1,000 in principal amount) to investors converting its senior 8.25% debt to shares of common stock by Jan. 6. The offer, if fully accepted, would add about 30 million shares to the companys share count but reduce debt by almost $300 million. Thats important for a company such as Freeport-McMoRan that shows a debt-to-equity ratio of 2.8. On the same date, the company announced that its Grasberg mine in Indonesia would return to normal operations after an October landslide that killed four employees. The Grasberg mine, on the western half of the island of New Guinea, has the worlds largest gold reserves and the third-largest copper reserves. As of Dec. 8, Im raising my March price target to $48 a share for Freeport-McMoRan. (Full disclosure: I own shares of Freeport-McMoRan Copper & Gold.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Freeport-McMoRan Copper & Gold. He does not own short positions in any stock mentioned in this column.
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