December 31, 2000

T'is the season to be jolly? As I write this, the industrial average is down 9.2% for the year, its biggest drop since the same percentage fall for all of 1981. The S&P 500 index has fallen 10.7%, its biggest drop since 1977's 11.5% decline. And the tech-heavy NASDAQ is down 34.8%, just shy of its worst-ever fall of 35.1% in 1974. What happened? The U.S. economy is slowing at a rapid pace. The U.S. has been operating at a really high level of productivity but the rest of the world is still underachieving. Commodity and energy prices are up, corporate sales and earnings are slowing, consumer inflation is higher. It is looking like the risks of recession are exceeding the risk of inflation. There is speculation that the Federal Reserve will lower interest rates, and of course, a tax cut would help also.

What to do? Diversification never appears that smart, because investors always have at least some exposure to the market's most lackluster sectors, but over the long haul, it is a much surer way to build wealth. Even in a grim year like 2000, a diversified portfolio will usually include at least one sector that does well. Just as folks took on too much risk during the good times, I fear investors are now shedding investments at the worst possible moment. The consumer is the ultimate winner in a global slowdown, as long as they benefit by getting lower prices and lower taxes and not by losing their jobs. Homebuyers also will benefit from a lower interest rate, which is currently at 7.54% for a 30 year fixed mortgage.

Non-U.S. funds can usually boost the returns of portfolios while reducing the risk. Not this year. Since September 1^st, the average international fund has fallen 14.11% versus the average domestic fund 11.43%. Why the disappointment? First, the U.S. economy has grown faster than most foreign countries and the sinking value of the euro has hurt the returns of all foreign funds. Another problem is that big mutual funds have invested abroad in big global companies, which tumble with the U.S. market. I look for foreign funds that focus on small and midsize companies, which tend to rise and fall with their local economies rather than with their global industry. Over the past three years, international small cap funds have returned an annualized 14.77% according to Lipper, beating the 5.92% return for large-cap foreign funds, and even beating U.S. diversified stock funds, which returned 11.73%.

What tends to be forgotten in all the hysteria of a declining stock market are two things. First, these down drafts tend to be brief in duration. Second, volatility is greater on the following upswing than on the actual decline. There have been 12 bull markets and 12 bear markets since World War II. On average, bull markets go up 105% on an index basis over a period of three years and four months and bear markets decline 26% over 14 months. The past three bear markets (1987,1990, and 1998) have lasted only three months or less. A bull market goes up 42% faster than a bear market goes down. Moreover, the rebound coming off a market bottom is very substantial in the first three to four months following the bottom. A correction is a market decline of at least 10%, while a bear market is a market decline of at least 20%. The average recovery for all down cycles has been 20% over the first three and one-half months coming off the bottom. From bear market lows, the average gain was 26% for six bear markets over three and one-half months. Once again, it can be seen that volatility is much greater on the upside than on the downside.

It is no fun to lose money in the stock market; however, it is important to keep stock market declines in perspective by recognizing that the stock market moves faster on the way up than on the way down. This should not be a time to panic, but one to put more money to work. The stock market has always recovered and gone on to higher highs after every correction or bear market.

My office move is complete but not without some snags. My email server was down for a week and our telephone lines are finally working after some difficulties. My apologies for the confusion; I always respond promptly to emails and mail, so if you have sent something and have not received a reply, please email or send to me again. My new address is 30 S. El Camino Real Suite 203, San Mateo, CA 94401-3839. My telephone is the same at 650-579-7969. My new fax number is 650-579-7566, and my new email address is fern@afdadvisors.com.

My business has grown mainly from the referrals you have given me and I can't thank you enough for that. I feel very blessed to work with such wonderful people. I wish you and your families a wonderful Holiday Season and a very prosperous New Year!