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Portfolio strategy update
David Gottstien
Editor’s Note: The following portfolio update is from David Gottstein’s monthly Dynamic Research Group’s newsletter. It was compiled Dec. 30. CURRENT MARKET NEWS
We can all relax now and let the post-Y2K festivities begin.
There’s a lot of cash swishing around in defensive pockets, and it’s ready to be invested. Mutual funds have continued to see steady inflows. Companies have held back on capital spending due to competing Y2K issues. The economy keeps barreling ahead at a healthy clip.
Unemployment remains at all-time lows with only a scant amount of wage pressure. Inflation continues to stay low, except for oil, which has likely peaked in price. Even so, it is a much lower percentage of GDP than it was 20 years ago, before the technology revolution. Europe and Asia see signs of life in their economies. Productivity continues to rise, and profits move steadily higher.
We expect that the stock market will be buffeted by all this good news in the short run.
Interest rate jitters However, now that the Federal Reserve is also past the start of the new millennium, it will be less fearful of the potential effects of further interest rate hikes.
We believe the Fed won’t hesitate to raise them once or twice this year to keep growth in check, and they may go as high as 7 percent on the long bond. High stock prices and high growth will give them ample ammunition to do so.
However, if growth and profits abate, a raise may be avoidable. This would add a further moderating influence on stock prices as we move forward in the intermediate term.
Long-term buffeting In the Nov. 22 issue of Fortune Magazine, investor Warren Buffett foresees an average return potential for stocks in the foreseeable future. He reminds us that the last 17 years of predominately bull markets were led by a dramatic reduction in interest rates during that time and a corresponding dramatic rise in corporate profits. This rise in profits was not only in absolute terms, but also in relation to GDP — now at about 6 percent.
Since we are at the high end of a normal range, future gains will be difficult due to natural competitive forces. Since interest rates won’t be working with us, don’t expect real corporate profits to rise much faster than real GDP growth.
In a previous 17-year period, profits more than tripled and stock prices remained flat because of interest-rate increases. Higher stock prices do not necessarily generate more corporate profits. They just lower ultimate returns. Beware of the bubble! We are maintaining a 10 percent cash reserve at this time for asset-allocation purposes.
Good luck this month!
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