Happiness Train - stock market analysis - Brief Article

Kiplinger's Personal Finance Magazine, May, 2000 by Steven T. Goldberg

STOCKS | If market upheavals prove anything, it's that DIVERSIFICATION works.

IN THE OPENING scene of Woody Allen's Stardust Memories, Allen sits aboard a train full of sullen, grim-faced people. Passing by is another train, this one occupied by happy, attractive, celebrating passengers. Until mid March, that could have been a metaphor for the stock market. The happy people were those riding the tech-and-telecom express. Everyone else was on the wrong train.

But in one tumultuous week the roles seemed to reverse, as industrial, financial and consumer-product stocks staged a gigantic rally. It was enough to make you wonder: Who's aboard the Happiness Train now?

Until the Dow Jones industrial average's 499-point rally on March 16 (on the heels of a 320-point gain the previous day), the stock market suffered an awesome case of double vision. From the time the Federal Reserve Board began boosting interest rates last June 30 until March 13, technology stocks in Standard & Poor's 500-stock index of large companies soared 57%. But the overall in dex rose just 2%, and every other sector in the S&P 500 was in the red.

The trend among small companies was just as polarized. After bottoming last October, the Russell 2000 index of small-company stocks rose 45% to March 13, but growth stocks in that index soared 77%.

On the wrong train. At the same time, the average stock listed on the New York Stock Exchange was way down in price, and had been dropping for two years. So-called value funds that invest in beaten-down stocks fared worst. Edwin Walczak's Vontobel U.S. Value fund lost 14% in 1999 and fell another 20% through March 14. Said an unhappy Walczak: "It's the worst experience I've had since I got into the business in 1982--a huge cloud over my head."

Then in those two blowout days, March 15 and 16, Walczak's fortunes--and those of every other value-oriented investor--seemed to take a new, happier turn. Vontobel U.S. Value made up far more than half of its deficit for this year as some of his favorite stocks shot upward. For example, Fannie Mae (symbol FNM, New York Stock Exchange, recent price $61) gained 21% from March 13 through March 16, Freddie Mac (FRE, NYSE, $48) gained 26%, and Berkshire Hathaway Class B (BRKb, NYSE, $1,702)gained 25%. Rejoiced Walczak: "If this was a blip, I sure enjoyed it--we were up 8% one day and 7% the other. But the Fannies and Freddies and Berkshires in my portfolio are still pretty cheap."

More or less the same story was repeated up and down Wall Street. Skyline Special Equities fund, which invests in small, undervalued companies, fell 13% last year, and manager William Dutton could count himself lucky to be only 5% in the hole for this year. But when trading ended March 16, Skyline was 1% to the good for 2000. Still, Dutton was disappointed that smaller companies hadn't shared more of the action. "In the short run," he says, "this may not amount to much, but it's a preview. Our stocks remain extraordinarily cheap." Dutton's two favorite stocks, O'Charley's (CHUX, Nasdaq, $12) and CSK Auto (CAO, NYSE, $12), didn't budge during the March madness, but Dutton says both "could easily double" within the next year.

Happy now? Don't cry for those tech investors. Yes, they gave back some of their gains in mid March--the growth portion of the Russell 2000 index of small companies fell 7.6% in four days--but the Nasdaq composite index then shot upward from its retreat.

So what's going on? Is money flowing from technology, telecom and biotech stocks to the neglected financial, industrial and transportation sectors? Or was that 499-point rally by the Dow industrials a fakeout?

Most strategists remain unconvinced that much more than bottom fishing is occurring. "Last year at this time, we saw the same thing happen, but nothing came of it," says Sam Stovall, senior investment strategist at Standard & Poor's. "I would treat it as a blip right now."

Abby Joseph Cohen, investment strategist for Goldman Sachs, has been bullish on technology stocks for a decade. Now Cohen calls them fairly valued, due to their price run-ups. But while she currently favors financial over tech stocks, she does not expect technology issues to tank suddenly.

What to do now. The only safe way to play today's volatile market is to diversify. Any other course of action risks missing that Happiness Train. So don't ignore the tech stocks. Edward Yardeni, chief global economist for Deutsche Bank Securities, says old-economy companies aren't growing rapidly anymore and cannot raise prices. He calls their products commodities. It's also a good time to pluck some of what Vontobel's Walczak terms "the low-hanging fruit" by owning either the cheap stocks he and Dutton recommend or their funds.

Now you can sit back and enjoy the ride. No matter which portion of the stock market makes its move next, you'll be on the happy track.