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Portfolio strategy update
David Gottstein
Editor’s Note: The following portfolio update is from David Gottstein’s monthly Dynamic Research Group’s newsletter. It was compiled in early October. INTEREST RATE & Y2K JITTERS
Many investors feel they’ve already suffered through a correction, since most stocks are 20 percent off their highs — and we haven’t yet reached any Y2K selling hysteria.
The dollar has fallen dramatically against the Japanese yen due to record trade imbalances. This caused some concern that the Federal Reserve would raise interest rates on Oct. 5 to help support the dollar. Money supply growth has faltered, mutual fund flows have abated and the price of oil is up.
Is the sky about to fall? First of all, the good news is the economy is very healthy and earnings are still growing very nicely, thank you. October was earnings reporting month, so we should have learned a lot about the future then.
Secondly, Federal Reserve chairman Alan Greenspan would like to see our balance of trade deficit versus Japan fall. A pricier yen makes our products more competitive. The market goes to excesses, both up and down, stock by stock, and the market overall.
Interest rates won’t be raised to stem further rises in the price of oil, and other inflationary signs are still tame. Wage increases have been won by labor in some instances, but usually in line with inflation expectations. All in all, we still have a formula for the continuation of the bull market: solid double-digit earnings growth expectations and a stable interest rate environment.
Within trading range We would not be surprised to see the market stay within a trading range through the end of the year and potential Y2K issues. There will be associated dislocations, both domestically and abroad as a result of computer breakdowns.
In the U.S., where technology is more a part of everyday life and thus more vulnerable, we have gone further to prepare ourselves for the pending millennium. Other, less dependent, countries are less prepared. All in all, every country is at risk to a minor level of disturbances, and there will be individual catastrophic failures on a limited basis.
However, the bulk of our capacities will likely ride through the New Year just fine.
The bigger problem, especially for investors in the short run, might be fear-based selling leading to a major sell-off. We think the possibility of that is somewhat low, but should be mentioned. However, the risks are very low that a rebound, relief rally wouldn’t occur soon thereafter. So the investment question is: do you want to market-time the possibility of a short-term Y2K market cycle?
BUY LOW We believe that the economy is strong enough to average a 10 percent growth rate in earnings over the next three to five years. This is a dramatic decrease over the last several years, but more in line with historic norms.
For this growth rate, we think the market will pay about a 22 price/earnings multiple for those earnings. With the recent set-back in stock prices, that should result in returns of approximately 13 percent, including dividends, before taxes. That is quite a premium over current long-term bond rates of about 6 percent.
The market will likely ride out these storms and continue its trek along a bullish path. The strength in the economy, combined with recent suppressions in stock prices has generated enough fundamental value to cause us to raise our asset allocation once again to 92.5 percent invested, 7.5 percent cash.
Good luck this month!
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