Don't run off the road

July 1, 2002
A weak economy in 2001 and a stock market decline for the second year in a row have combined to frustrate many investors.

A weak economy in 2001 and a stock market decline for the second year in a row have combined to frustrate many investors. Are you one of them? While no one can predict how the economy will act in the future, here are some thoughts from two experts at Waddell & Reed Investment Management Co. about what we may expect in 2002. Diane Dercher, chief economist and vice president, and Hank Herrmann, chief investment officer, shed some light on the future and what you need to focus on.

Just as the car in your driveway is not your father's Oldsmobile, near-term growth won't resemble the economic recoveries he experienced, says Diane Dercher. "In past recoveries that followed recessions, most had a fairly strong bounce early on, somewhere in the 6 percent growth range. I don't see that happening this time."

Dercher says she believes a 2.5 percent growth in real gross domestic product (GDP) is more likely and that a stronger second half of the year could very well lead to an improved 2003. (Real GDP is the market value of goods and services produced, adjusted for inflation.) "I think that consumer spending, which accounts for two-thirds of the economy, will improve, but not enough to produce the 3.6 percent growth that many economists are predicting for late this year," she says.

The Value Line Investment Survey for 2002 predicts a 14 percent increase in corporate earnings and virtually flat interest rates. Dercher agrees with the forecast for flat rates, adding they should remain low for the remainder of the year. But she takes issue with the double-digit earnings prognosis.

"I see earnings growing at a slower pace, probably in the upper single digits. Remember, the rapidly growing company profits and soaring stock prices of 1995 are over. Now more than ever, your performance expectations need to be down-to-earth," Dercher says.

Spread your investments around

Hank Herrmann points out that one of the keys to coping with these uncertain times is portfolio diversification. It is very important that you spread your assets among large-, mid- and small-cap stocks, bonds, cash equivalents, and international securities. Your exposure to each depends on your own situation, age, risk tolerance, and financial objectives, according to Herrmann. If you are still working, continue participating in your employer-sponsored retirement plan and even try to increase your contributions for greater tax-deferred growth.

A depressed market is actually a good time to invest on a regular basis because you are buying more shares when prices are down and fewer shares when prices are high. (However, keep in mind that this type of purchase plan does not ensure a profit and does not protect against loss in a declining market.)

"Consistent investing, maintaining a long-term horizon, and staying with the program are critical to your financial success in all market environments," Herrmann says.

Additional numbers to watch

As for other economic indicators you should keep an eye on this year, Dercher underscores the following:

  • Federal funds rate - Many forecasters see the rate charged by banks to other banks for overnight loans going up by 100 basis points to 200 basis points (1 percent to 2 percent). But Dercher expects the Federal Reserve will hold rates low for the rest of the year: "I don't anticipate the type of growth necessary for the Fed to justify hiking rates. The economy is just too fragile."
  • Unemployment - The jobless rate was 5.6 percent in January 2002. "I believe it may still go up by mid-2002," Dercher says. "Regardless, companies will do what they must to reduce costs. Weakness on the job front translates into slower consumer spending."
  • Capital spending - Dercher isn't counting on any sizable increase in the amount companies spend on facilities and equipment (roughly 14 percent of the economy). "Businesses must turn profits around before they boost capital spending," she says.
  • Consumer confidence - The Conference Board's Consumer Confidence Index jumped from 94.6 in December to 97.3 in January. That is close to the board's benchmark index of 100 in 1985. "However, the latest number, although encouraging, is still far below the triple-digit confidence indexes of 1998 to early 2000," Dercher says. "Fixed expenses such as gasoline, natural gas and heating oil are down, but consumers are not quite ready to do some serious spending."
  • Consumer borrowing - This category rose by $19.8 billion in November, the biggest monthly increase since the Federal Reserve began keeping records in 1943, according to a Jan. 13 The New York Times report. "I believe that consumers will be reluctant to take on a lot more debt relative to income, so they will likely keep spending growth within a limited range," says Dercher.
  • In Inventory levels - According to a report in The Wall Street Journal on Jan. 4, companies cut their inventories at a $50 billion annual clip in 2001. That's a 4 percent decline, one of the largest in history. "This is what companies need to do to push supply back in line with demand," Dercher obsere."However, if consumer and capital spending can't be sustained, lower inventory levels don't have much of an impact."
  • Manufacturing sentiment - The Institute for Supply Management Purchasing Managers Index increased to 48.2 in December from 44.5 in November and 39.8 in October. (A reading above 50 represents growth.) "This is somewhat encouraging. At least it shows we're headed in the right direction," says Dercher.Both Dercher and Herrmann say they believe the economy and stock market will recover, offering significant opportunities for investors. They advocate you should stay the course, diversify your assets, and maintain realistic performance expectations.

Kathleen Adams, RDH, BS, is a financial adviser with Waddell and Reed ( She is currently trying to initiate money-management workshops for hygiene students and specializes in working with dental professionals. She can be reached at (800) 210-1357.