In anticipation of the Federal Reserve’s actions on interest rates in late August, market watchers’ theme could have very well been the old Rufus song, “Tell Me Something Good.” In fact, investors were initially keen on Fed Chairman Alan Greenspan’s policy that inflation containment would require another rate hike-as long as there wasn’t going to be an encore. But after the Fed acted, it seemed as if the market changed its tune to the Graham Central Station classic, “Stomped, Beat-Up and Whooped.”
Check out our market indicators. On August 23, the day before the Fed raised two key short-term interest rates, including the federal funds rate-the rate charged to banks for overnight loans -to 5.25%, the Dow Jones industrial average showed a gain of 199.15 points, or 1.8%, driving the index to 11299.76 and shattering previous records. The Standard & Poor’s 500 and the tech-heavy Nasdaq Composite index also produced healthy gains of 23.61 and 71.24 points to reach near-record levels of 1360.22 and 2719.57, respectively. But what a difference a few days make. Bedeviled by profit-taking, renewed inflation worries and a weakened dollar, the Dow lost roughly 500 points over a four-day period. The S&P 500 and Nasdaq indices were walloped as well. As for the bond market, prices plummeted further as the yield for 30-year Treasuries jumped to 6.07%.
Over the past few months, the Fed’s posture has turned a number of cautious optimists into wallflowers as far as pricey large-cap growth stocks are concerned. Some like Northern Trust Bank’s Chief Investment Strategist Bob LaFleur favors smaller issues. In the bank’s newsletter, Market Signals, he commented that “mid-caps sell at nearly a 25% discount to large-cap stocks and a 35% discount to the 100 largest companies. I think that we are in the very early stages of a multi-year outperformance by mid-cap and, eventually, small-cap stocks.”
Out-and-out contrarians like Charles Allmon, the editor of the 35-year-old Growth Stock Outlook newsletter, view the market as “being at its most dangerous. I’m not a bull or a bear. I’m a chicken.” In fact, he only has 15% of his clients’ assets invested in stocks of any kind. The remainder of his portfolio is in cash. Performance for the past decade: 12.78%. “It is my belief that the market is going to drop 40% to 60% over the next few months,” says Allmon, who selects the few equities that he does hold by reviewing a company’s sales, balance sheet and earnings, placing them last on his list of priorities. “I don’t see dips as buying opportunities. I would start to buy companies once they produce dividend [yields] of 6%.” So what does he like? Companies that have shown consistency in sales, profits and dividends like Clayton Homes (NYSE: CMH), Genuine Parts (NYSE: GPC), and Franco-Nevada Mining (Toronto Exchange: FN).
Don’t panic and rush to look for new dance partners just yet. Make a clear-eyed assessment of your portfolio and continue to develop a long-term investment plan. Work with your advisor to identify a solid