What did I learn in 2000? The only way to find out is to go back to what I wrote.
At the beginning of the year, in the issue of January 10, 2000, I concluded my "Dag's Commentary" by saying: "It looks like 2000 will be a difficult year for investors due to lack of crises on the horizon, a strong economy, and rising short-term interest rates."
Later in the same issue I added "…, the economy will downshift toward the end of the year."
I also mentioned several times that we were going to experience a market environment more suited for traders than for long-term investors. The main reason for my cautiousness was slower growth in liquidity and rising short-term interest rates.
Since early 1999 the growth of the money supply helped me in predicting correctly stock market trends, the growth of the economy, and the direction of interest rates. The growth of the money supply peaked in early 1999 and, after the typical 18 months to 2 years, the economy began to slow down.
The lesson is that the growth of the money supply does matter and is the main force driving the economy which eventually impacts short-term interest rates and commodities.
Through 2000 I believed short-term interest rates would rise at least 2 percentage points from the low reached in 1998, when they bottomed close to 4.3%. They peaked early in November at 6.20% (rate on 13-week Treasury bills). I was expecting at least 6.7%.
Why did I miss? I did not consider the impact of high real short-term interest rates. However, because of their high level, I correctly predicted that commodities would not rise much in spite of the strong economy. On the other hand, in 1994 they jumped 40% because of low real short-term interest rates.
Inflation too remained low because of high real short-term interest rates. This subject is discussed in detail in my book "Profiting in Bull or Bear Markets" to be published by McGraw-Hill in February. The lesson is that real short-term interest rates do matter and have a major impact on commodities, inflation, and bond yields.
I expected bond yields to rise. Instead bond yields declined throughout the year and therefore bonds would have been a great investment. However, in March I correctly noticed that real bond yields were unusually high and were at levels associated with a top in yields. The lesson is that real bond yields do impact, together with inflation trends, the level of bond yields (more on this later).
I was also guilty of greed as I played the momentum strategy, by buying high growth, high PE technology companies and not selling them soon enough. I paid the price, but I learned a great lesson. It is fine to be aggressive when the stock market is in a strong upswing. This happens when the growth of the money supply is rising.
However, the investment strategy has to change when the financial cycle is in a downturn and the growth of the money supply is declining. During such times emphasis should be place on value, that is companies with a steady stream of earnings and cash flow, with PE lower than the market, and strong management performance.
(This
Observations was published in the 12/28/2000 issue of
The Peter Dag Portfolio).
George Dagnino, PhD
Editor,
The Peter Dag Portfolio. Since 1977
Ranked second best gold timer by
Timer Digest
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