Eileen P. Gunn
03/01/2005
Liz McMillan of Long Island, N.Y., boasts of the money she made from the hysteria surrounding Y2K. The mother of three bet her water- and cash-hoarding friends that nothing out of the ordinary would happen when the world’s computer calendars rolled over to the year 2000. “That event made us realize how vulnerable we are if something goes wrong with technology,” she says. But while many panicked at this possibility, she ignored it—and won her bets.
 |
Not all news these days is bad: Oil prices occasionally dip; consumer confidence nudges upward. Inflation, which often goes hand-in-hand with war, remains, so far, in check. The problem, as McMillan and many like her see it, is that such glimmers of hope do not quite offset the fact that oil prices remain near record highs, the conflict in Iraq grows bloodier every day and the twin U.S. deficits—trade and budget—have ballooned to historic levels.
Mixed signals such as these have forced many investors to take a wait-and-see approach to their portfolios. “People stop listening to their gut instincts at times like this,” McMillan says. Although still actively investing, McMillan admits she is more reticent, and because she spends more time on research and due diligence, she comes to decisions more slowly. She is now considering defensive tactics—investing in funds that hedge against the dollar, for example—and, for the first time, is sending her money overseas to places such as Australia, where the currency remains strong, interest rates higher and economic trends more clearly defined.
Even before oil prices shot up in early 2004, U.S. investors had endured a series of morale-dampening trials. The Internet bubble, followed closely by massive layoffs, corporate scandals and dismal market performance, led many to question the wisdom of investing in corporate America.
Richard Grafer, also of Long Island, retired from Arthur Andersen in 1998. Since then, these broader trends have affected him on a very personal level. “I lost most of my retirement nest egg as a result of Andersen’s demise, which is attributable to Enron, et al, and the economy,” Grafer explains. “I was certainly angry for a while. But as shocking as it was personally, it was also shocking that 84,000 people around the globe could become unemployed overnight.”
Moreover, as a retiree, Grafer had dabbled in angel investing, backing several socially responsible start-up companies. After the stock market fell and the economy tumbled, about half the companies he invested in went out of business, and the other half are barely hanging on, he says.
Unlike several former Andersen colleagues, Grafer had enough money stashed elsewhere that he did not feel he had to return to work. Still, he had to learn to accept his new reality and move on. “There’s no way to rebuild that retirement fund; it’s forever lost,” he laments. While Grafer still shuffles his investments to gain a bit more income here or there, most of the time, he, like many investors, seems to be stuck in neutral.
Passive Hoarders
“When things are up, people believe the rules have been rewritten so that they will always be up, and they will take risks and be more generous,” says Rosabeth Moss Kanter, a Harvard Business School professor who recently authored Confidence: How Winning Streaks and Losing Streaks Begin and End. “When things are going down, people become depressed and risk-averse. Again they say all the rules have been rewritten so things will never turn around, and they become passive and hoard what they have.”
Today ambivalence reigns. In November 2004, the Bureau of Labor Statistics counted 1.5 million people who were “marginally attached to the workforce” (the same number counted 12 months earlier). They wanted to work and were available, but had not looked for work during that month. Among these were 392,000 “discouraged workers” (also about the same number as a year earlier) who had halted their job searches “specifically because they believe no jobs are available for them.”
TOP VIEW |
Corporate America has become even more cautious. “The companies in the S&P 500 are sitting on a ton of cash,” notes Howard Silverblatt, a market equity analyst for Standard & Poor’s in New York. Not including the financial services firms, this group was holding onto a collective $622 billion at the end of November 2004, compared with $260 billion at the end of 1999. “I don’t know if you can connect the dots directly back to terrorism, but I think if you asked a CEO over cocktails, he would tell you that’s somewhere in the back of his mind,” says Dean Dordevic, a portfolio manager at Ferguson Wellman, an investment advisory business in Portland, Ore. “They have accumulated all this cash and are being conservative in case something goes wrong.”
Simultaneously, Kanter points out, “We don’t have a hot new technology or industry that will lead a recovery.” During World War II, Korea and Vietnam, an increased demand for goods and services revved the economy (see “Of War and Wealth,” below). According to Wayne Hummer Investments in Chicago, the GDP grew by 112 percent between 1940 and 1945. Similarly, it swelled by 28 percent during the Korean War. By comparison, today we are not seeing new orders that are going to make or break the quarter, says Tobias Levkovich, chief U.S. equities strategist at Smith Barney in New York.
Stormy Bellwethers
With the economy remaining slack, the U.S. government has not been able to collect taxes on higher incomes to compensate for lower tax rates. Consequently, the mounting costs of the war against terrorism and of homeland security have contributed to an alarming budget deficit. “Higher spending and lower taxes are things that happen quite often in wartime, but this has a different feel than a wartime economy,” explains Benjamin Pace, chief investment officer at Deutsche Bank’s Private Wealth Management Group in New York. “Our economy is relatively weak. And the clear consequence of high deficits is usually higher interest rates, which would slow the economy down more.”
A weakening dollar makes this scenario all the more likely. Creditors, especially those overseas, have been willing to lend money to the United States cheaply for years because of the dollar’s stability and strength. If the dollar falls further, these investors—like McMillan—might go looking for better returns and more stable environments elsewhere. This might spark a sell-off in bonds that could further weaken the dollar, igniting inflation and a stock market sell-off.
Meanwhile, to continue to make U.S. bonds an attractive and worthwhile investment, the government may have to raise interest rates. But this would make credit—including consumer credit—more expensive, and could tip the country into a recession.
Uncertainty and indecision cast a long shadow over the markets in 2004. “Earnings growth was at 20 percent and the GDP was hitting 5 percent, and the market wasn’t responding,” Pace says. He notes that lately the stock market has offered greater risk and lower return, a trend that might continue for some time. This situation puts investors such as McMillan and Grafer on the defensive, and they are hunting for better opportunities. “The standard wisdom used to be 50 percent stocks, 40 percent bonds and 10 percent cash in your portfolio,” McMillan says. “But now I’m hearing from even conservative money managers that you need to have at least 20 percent in alternative investments.”
In addition to hedging against the dollar and buying bonds in Australia and New Zealand, she is looking into funds that short U.S. Treasury bonds, and into equity opportunities in China. The term “alternative investments” has been used to describe opportunities such as venture capital and hedge funds, where greater risk was tempered by potentially greater rewards. But McMillan says that what she has been doing lately “isn’t about going out on the edge. It’s about looking at how people have managed to make money lately, and diversifying.”
The Dollar Dilemma
David Baird is an entrepreneur in Ottawa, Ontario, who in 2002 sold the security technology company he founded, and invested a portion of the proceeds in a portfolio of U.S. stocks. “They have done well in and of themselves, and if I spend that money in the United States, there’s no problem,” he says. But if he converts his gains back to Canadian dollars, they will be worth far less than they would have been a short time ago because of the weakening U.S. dollar.
Baird has been watching the dollar for any inkling of a further slide, out of concern over the same herd mentality that worries McMillan. “There are a lot of people like me around the world who lose money when they bring their returns back home. If they see the dollar sinking further, they’ll all pull out of the market together, and that could have an effect on the market,” he says. “I’d rather be ahead of that crowd than behind it.”
Yet, hope springs eternal on Wall Street. While the stock market in 2004 showed a tendency to revert to an uninspired mean, a rally in December allowed investors to boast of at least a small gain for the year. Dordevic and others believe this could be a signal that, even if the economic outlook is not becoming clearer, perhaps investors are learning to take a certain amount of uncertainty in stride. “There’s always a worry about something,” Dordevic says. In 2004, investors worried about terrorism during the political conventions and the Olympic Games. Then “people were delaying things and blaming the contentious election. Now it’s the dollar,” he adds. “But you can only hold your breath for so long. At some point, you just have to move on.”
Grafer agrees, saying he could give in to his fear that the conservative portfolio that protected him in the downturn will not keep pace if inflation picks up. With this in mind, he tinkered with his hedge funds to nudge his returns a bit higher, and he has decided, for the time being, that simply has to be enough. “You can easily become paranoid about your finances in this environment,” he says. “But you have to learn to let go and focus on what’s really important and move on with your life.”
Eileen P. Gunn is a Brooklyn-based journalist who writes about personal finance, careers & real estate. epgunn@hotmail.com
Illustrations by Viktor Koen.
Additional Information
Of War and WealthA Slippery Slope