Stock market likely to post loss for year

This may be of no great historical consequence, because the stock market has often recorded losing years. But a loss this year could be somewhat noteworthy if for no other reason than many investors won't remember the last time it happened.

It was about a decade ago.

Some novice investors may even feel cheated by this year's lethargic market. And they could be tempted to jump ship into the apparent safety of bonds or certificates of deposit. But that would be a mistake, says John Frankola, senior portfolio manager at Parker/Hunter Asset Management in Pittsburgh.

"If you are a long-term investor, you should not be looking at periods of negative returns as bad," Mr. Frankola said. "You should look at any period where the market is down as a buying opportunity. It should be a period of stock accumulation."

The Dow Jones industrial average and the much broader Standard & Poor's 500 index last recorded losses for the year back in 1990. The Dow's loss was 6 percent; the S&P 500, 3.1 percent. Even the much more volatile Nasdaq composite index hasn't posted a yearly loss since it dropped 3.2 percent in 1994.

Investors who stayed in the market during those down years didn't wait long for the payoff.

The very year after posting losses, the Dow gained 24.2 percent and the S&P soared 30.4 percent. The Nasdaq was up almost 40 percent in 1995 – the year after it posted its last loss.

"The 1970s was another down period for the stock market, but those who accumulated during that period reaped huge rewards," Mr. Frankola said.

Financial experts also said that it's important to remember that the stock indexes often don't tell the complete story. For example, last year, technology stocks accounted for 90 percent of the performance of the S&P 500, he said. And just 10 companies accounted for 70 percent of the performance. There were actually more stocks down than were up on the New York Stock Exchange.

"You take away those 10 stocks, and you have very little performance," Mr. Frankola said. "That's why we had what I call a stealth bear market last year."

This year with all the major indexes in negative territory – the Dow closed at 10,847.37 Friday and the Nasdaq ended at 3,803.76 – most people would assume stock investors are getting hammered.

But they aren't.

Just as a handful of stocks propelled the Nasdaq and the S&P higher last year, a handful of companies are bringing the averages down this year – much like Intel Corp. did Friday.

The truth is that the majority of stocks traded on the New York Stock Exchange is actually up substantially this year. So far this year, 2,076 stocks are up on the NYSE and 1,418 are down. And the average gain for the winners is 28.5 percent.

In the parlance of Wall Street, this means that the market has broadened and is not so narrowly focused on technology as it was last year.

This should be a nice surprise for mutual fund investors when they open their quarterly and year-end statements. The average U.S. stock fund is up about 5 percent so far in the third quarter and up about 8 percent year-to-date, according to Lipper Inc., a mutual fund tracking service.

That's not to say that the stock market doesn't face some formidable headwinds for the remainder of this year.

It does. And those positive gains could quickly turn negative.

Gail Dudack, chief market strategist at Warburg Dillon Read in New York, is forecasting that the Dow will end the year at 10,000, which means it would have to drop more than 800 points, or about an additional 8 percent.

She's forecasting that the Nasdaq could drop from its current 3,800 level to about 3,200, or about an additional 16 percent. The market will struggle against higher crude oil prices, a weakened euro and a slowdown in corporate earnings, Ms. Dudack said. Oil prices have risen from $10.50 a barrel in February 1999 to about $37 a barrel last week, and that raises the specter of higher inflation and interest rates.

"Higher fuel prices are like a tax on consumers, and they tend to slow the economy and ultimately corporate earnings," Ms. Dudack said. "When bonds and cash outperform stocks, the stock market is trying to tell us that there is an earnings problem on the horizon."

The weak euro also affects U.S. corporate earnings because companies' overseas profits decline when converted into dollars. Shares in Colgate dropped 15 percent last week after several analysts warned that the weak euro would hurt earnings. And McDonald's has also warned that the currency translation will cut into this year's earnings.

The euro rallied more than 5 percent Friday when the European Central Bank, the U.S. Federal Reserve and the Bank of Japan teamed up to support the ailing currency. But it lost most of the gains later in the day as traders remained skeptical about the lasting impact of the intervention.

While these factors will weigh on the market, long-term investors should be looking beyond the current problems, said Bob Cordiak, senior vice president for investments at Dain Rauscher Inc. in Dallas. There are several very positive long-term trends, which ultimately will pump some life into the market this year and next.

While the earnings of some companies are being hurt in the short run, the earnings outlook for the future "is spectacular," he said. For example, companies in the S&P 500 have annual earnings growth of 7 percent, historically speaking. For 2001, S&P earnings growth is expected to be 15 percent to 18 percent, according to First Call, which provides earnings estimates. This is a decline from the 23.6 percent growth rate of the first quarter, but still very respectable, Mr. Cordiak said.

Further, the alternatives to investing in stocks don't look all that attractive. The 30-year U.S. Treasury bond is currently yielding 5.9 percent, and the average certificate of deposit is yielding just over 6 percent.

"Who in the world would buy a 30-year Treasury bond?" asked Mr. Cordiak. "Nobody. Money will come back into the market at some point and when it does, it will bump up."

And there's certainly plenty of money "sitting on the sidelines" perhaps waiting to come back into stocks.

Currently, there is $1.77 trillion sitting in money market funds, up from $1.50 trillion for the same time a year ago, according to the Investment Company Institute, which tracks mutual fund flows.

"We've just got a ton of liquidity, more than at any other time in history," Mr. Cordiak said.

Investors should focus on these long-term prospects for good earnings, high liquidity and relatively low interest rates instead of the short-term "noise" that so often permeates Wall Street.

"The future is bright, and at some point the market will give us some relief," Mr. Cordiak said.