The stock market has begun the new millennium with more ups and downs than an elevator on the Empire State Building. Unfortunately, this will probably be the norm rather than the exception this year. Even with this volatility there is still good reason for optimism. The U.S. is enjoying the benefits of the technology-led economic expansion as we shift from the industrial age to the information age. The increased productivity that companies and individuals have seen in the past few years is truly amazing and will continue.
However, some sectors of our stock market are becoming increasingly overextended. Despite the many signs of investor mania for technology stocks, it is not accurate to label the overall market as too high given that a majority of stocks have actually declined over the past two years (see chart on page two for more details). Technology stocks are creating a classic investment “bubble” and the Internet sector is in a class of its own with prices soaring without any evidence that earnings will ever materialize.
All bubbles eventually burst and this one will be no different. What will trigger the burst? Our concern is whether the end of this technology bubble will cause a major decline in the rest of the stock market. Higher interest rates, foreign markets, and political developments all contain the ingredients to pop the bubble. The good news is that since a majority of stocks have languished in the past two years their valuations are reasonable and they should hold up well.
1999 was the worst year for bonds since before World War II with even the safest of U.S. Government bond funds losing money in 1999. In fact, anyone who owned a 30 Year Treasury bond in 1999 lost around 11%. Going into 1999, bonds were overvalued with interest rates under 5%. Now, bonds seem undervalued with yields over 6.5%. Although the FOMC has raised short-term rates by 75 basis points in the past five months, the domestic economy continues to grow faster than Fed Chairman Greenspan would like. Therefore, the FOMC will raise rates this year. The big question is how many times and by how much