Economic Principles Remain Intact as Markets Confound Investors

 

During the past three years, the investor’s state of mind has swung from fear to greed, then back to fear again. Despite these changing moods, three core tenets of our economy remain constant:

A Shrinking World

Globalization continues to expand the reach of companies into additional markets and manufacturing bases. When managed properly, this wider reach can be used to boost efficiencies and reduce costs. Data networks are making physical location less of an issue for multinational companies.

Low Rates and Easy Money

We may all debate the wisdom of the Federal Reserve System’s rate hikes of 2000 and the subsequent rate cuts in 2001. Regardless, the boom of late 1999 and early 2000 is a perfect illustration of the effects of easy money fueled by low interest rates.

Investors can probably expect the Fed to continue this low rate trend because its fear of recession outweighs its fear of inflation. Due to this low rate policy, businesses should continue to invest and expand.

History is a helpful tool when projecting market trends. During the last 30 years, the Fed lowered rates six or more times on four different occasions. On average, the 12 months following these final Fed actions resulted in 24 percent gains in the Standard & Poor’s 500 index. In addition, the NASDAQ composite index averaged 29 percent gains after the cuts.

Advancing Technology

Despite the technology sector “bust,” no other sector has changed the business world as dramatically over the last decade. Many technologies, especially in the field of data communications, are now more reliable than ever before.

Technology is now being recognized as a tool that will increase productivity rather than just an advance with no real-world application. Investors should focus on companies that effectively use these new technologies, and less on the companies that develop the technology.

One technology stock example is Nokia, which is gaining considerable market share due, in part, to the financial troubles of its competitors. Nokia’s strength is its ability to increase the productivity of its customers.

A long-term perspective leads investors to two tactics for identifying attractive investment opportunities.

First, consumer spending continues to remain strong. Although there have been increased layoffs, there also has been steady job creation and continuing low rates of unemployment. Subsequently, favoring companies that benefit from steady consumer spending, such as AOL Time Warner, Wal-Mart, Home Depot and Target, may be wise.

Second, as we come through the economic slow-down, investors should focus on the importance of a strong balance sheet, basically asking themselves, “Does this company have enough cash to survive and win?”

In general, smaller inventories, lower tax rates, and the Fed’s interest-rate cuts all lead to a more positive outlook for the second half of 2001.

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