Halftime report

If anyone were to ask me at the beginning of this year if markets would post strong negative returns in 2002, I would have leaned on the side of no. Well, if the first 6 months is any indication of markets to come for the rest of the year, we are in for big concern.

According to the MSCI statistics, Austria was the only national index (out of 23) posting a positive 6-month return of 7.08%. All the other indexes as measured by the MSCI were in the red. The biggest loss came out of Finland with a 38.9% loss in the first 6 months of the year. After that was Sweden with a 28.23% loss.

Other notable market indices were:

  • MSCI World – 12.8%
  • Europe – 13.6%
  • Far East – 2.0%
  • Canada – 7.9%
  • Japan – 1.5%
  • US – 14.7%

Back to back negative years

As everyone already knows, 2001 was a tough year for markets all around the world. The problem is that for many world markets they started having market problems that stemmed back to 2000. Last year, over half of the national indexes experienced back to back negative years. In other words, 12 countries had markets that experience negative returns in both 2000 and 2001.

Statistically, there is a low probability that countries will experience back to back negative years. Going back to 1954, the occurrence of back to back negative years has happened 3 times in the US (1969/70, 1973/74 and 2000/2001).

A possibility of three consecutive years?

Is it possible to have three consecutive years of negative returns? Yes. Is it probable? No.

2002 has started the year with some significant losses. In order to finish the year positively, we are going to need a strong rally in the second half just to break even. I went back and tried to find any markets where there were three consecutive years of negative returns and I found only two examples Belgium and Japan. According to Morningstar, the Japanese market lost 3.8% in 1995, 16.6% in 1996 and in 1997 Japan continued with a 25.2% loss. Belgium lost money in 1999, 2000 and 2001.

While statistics tell us that it is highly improbable that there will be another year of loss in 2002, the short-term results are less hopeful.

What’s causing all the problems?

Many financial gurus will attest to the fact that fundamentals really are not that bad. The economy is growing, interest rates are low, inflation is in check, corporate earnings are improving, valuations are much lower, and statistics are on our side. Unfortunately, the short-term movements in the markets are not moved on fundamentals. Rather, they are often moved on emotion. And today, emotions and sentiment are the key drivers in the market.

Today, investors lack confidence in accounting and accountability with huge disruptions like Enron and now Worldcom. Investors are losing patience having gone through one of the most painful bear markets in history. Add in the fear of war and terrorism you have one of the most negative sentiments in history.

Where do we go from here?

The advice is really boring. Hang tight and stay invested. With every continued downturn in the market, your patience threshold will continue to get tested. I’m not saying that it is easy or fun. The reality is that markets have to turn around and the key fundamentals say that it should happen sooner than later.

The problem is that investors have no real alternative. Fixed income is just not an attractive option at this point with low-interest rates and some suggestion that rates are going up, not down. The future returns will come from equities but the challenge for any investor is the patience and discipline to stay invested. As we saw in the last quarter of 2001, markets can move up just as fast as they went down. Those who try to time the markets will probably miss the returns as they happen too quickly.

While I acknowledge that times are tough and times are strange, I think we are still in the bottom end of the market cycle and to sell now means you may miss out on one of the biggest opportunities in history to make money in the next bull market.

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