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Headlines from 2004
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December 31, 2001: 5:00 p.m. ET
The economic rebound, the big-cap recovery, the next bubble, resurgent inflation and signs of a coming slowdown.
By Michael Sivy
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NEW YORK (CNN/Money) - After 310 articles -- enough words to fill almost three thrillers -- this will be my last regular column for CNNMoney, although I'll be continuing to write for MONEY magazine. Times have changed a lot since I began writing these online columns more than two years ago. Back in 2000, the market was going through a great deal of rotation, and it was possible for value investors to scoop up unreasonably cheap stocks on dips and see a rebound within six months.
But as the bear market worsened and the recession began -- in March 2001 as we now know -- almost all stocks got caught in the downward vortex. As a result, a certain amount of conventional wisdom has been inescapable. Investors should be diversified as broadly as possible in a bear market to protect against unpredictable disasters. They should maintain unusually large cash balances and use the money to buy big-cap stocks with first-rate franchises when share prices are deeply depressed.
The one good thing about such truisms is that they are, after all, true. But for my last column in this space, I'd like to jump forward a few years and imagine what the investing headlines might look like in early 2004.
Economy stronger than expected
Preliminary data released yesterday by the U.S. Commerce Department shows that real growth in the gross domestic product averaged more than 4.5 percent for 2003 as a whole. "After all the Fed's interest rate cuts in 2001, it was inevitable that we'd see at least a temporary boom," one economist noted. "The real question, though, is whether growth will slow to sustainable levels on its own, or whether the Fed is going to have to keep raising interest rates the way it did last year."
Big growth stocks again lead the market
"After all the talk about value investing and small-cap stocks, it's the same big growth stocks leading the market," said one top-performing money manager. "People who got started investing in the 1980s and 1990s forgot about the recession as soon as they could and went back into the best-known growth stocks. Forget about value -- this crowd wants to own the same top names everybody else does."
Market analysts note, however, that not all of the big names of the 1990s have rebounded with equal energy. The aftershocks of the telecom bust are still holding back stocks like Cisco and Corning. By contrast, top drugmakers have been outperforming tech stocks ever since leading biotechs began cranking out new products that could be marketed through joint ventures with giants like Merck and Pfizer.
Biotech is the new Internet
Drug design has advanced far faster than anyone expected thanks to discoveries stemming from the human genome project -- and the stock market has taken notice. Biotech stocks have nearly tripled over the past three years -- and the most-aggressive mutual funds, such as the Bio Bio Fund, have returned more than 500 percent over the same period.
Industry analysts now question whether the sector has become seriously overvalued. "It's true that the industry's revenues will grow more than 30 percent a year for the foreseeable future," said one industry insider. "But the capital requirements are enormous and a disturbing number of new drugs are failing in clinical trials. Investors scrambling to get in on the next billion-dollar drug should remember that 90 percent of these companies don't make any money and could be bankrupted by one flop."
Inflation is B-A-A-ACK
Investors were stunned when inflation topped 5 percent last June, even though economists noted that the core rate was still only 3.2 percent. "That blip was largely the result of the sudden runup in oil prices after the Saudis refused to increase production to make up for wells destroyed in the failed Iraqi uprising against Saddam Hussein," one energy analyst explained. "The oil price probably won't stay above $34 a barrel for long, but it's hard to see the price dropping below $26 anytime soon."
The high cost of energy will help fuel inflation, but the real danger is a continued rise in unit labor costs that began after the Fed pumped so much money into the banking system to end the 2001 recession. "On top of that, there's the Euro," one economist added. "The currency is still unproven. But after people started using it on a daily basis, the Euro appreciated from 88 cents to $1.09. That has helped U.S. growth, by making our exports cheaper. But the relative weakness of the dollar has also raised the prices of imports and fueled domestic inflation."
Debt clouds economic outlook
The remarkably strong rebound of the past two years could be cut short by the debt overhang among both businesses and consumers, according to a growing number of economists. "Lower interest rates during the last recession helped consumers by allowing widespread mortgage refinancings. And the recovery that followed bailed out enough bad loans to take the pressure off banks. But little has really been done to bring down the overall levels of debt that were built up in the 1990s," said one economist.
Since bad inflation numbers in early 2003 encouraged the Fed to start raising interest rates last fall, some market forecasters warn that a new bear market could be just over the horizon. "Some slower-growing companies that have a lot of exposure to raw materials prices are suffering a margin squeeze. We won't know the extent of it until first-quarter results are reported."
The long-term outlook for health care, entertainment, tech and even telecommunications remains strong. But some market forecasters fear that rising inflation and interest rates could still trigger a bear market within the next year.
"The breakdown we've been seeing in defensive stocks could easily be the start of a rotation that hits growth companies much harder," said one technical analyst. "Investors have to recognize that the boom of the 1980s and 1990s was exceptional and occurred because everything came together just right. Even though the U.S. economy is basically in good shape, we're likely to see a lot more cyclical ups and downs. The key to earning money is going to be staying defensive enough to hold your losses in downturns to only 10 to 15 percent, and then positioning yourself in advance to cash in on the upturns." 
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FROM THE SIVY ARCHIVE
