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Are Your Investment Coffers Half Full or Half Empty?

By Marc Davis, Managing Editor
June, 2002

In 2001, the U.S. Federal Reserve cut interest rates a total of 11 times to historic 40-year lows in order to kickstart the sputtering economy. And now it looks like such efforts are beginning to pay off, setting the stage for robust economic growth in the second half of 2002.

With no inflationary fears hanging over the economy, the Feds and the Bank of Canada still have the luxury of keeping short-term borrowing costs at multi-decade lows - an enviable scenario in the year following a recessionary squeeze. This situation bodes well for investors, many of who still see stocks as a more attractive source of returns for 2002 than the bond market.

Investors are right to be optimistic that the stage is set for a cyclical rebound in share prices later this year. For instance, corporate earnings are likely to continue to improve as businesses have emerged from the recession leaner and fitter than before. They have stripped away surplus spending in the form of excess inventories, factories and offices, and of course, workers. Thus, businesses find that it will take fewer revenues in 2002 to bolster profits. In turn, this scenario eventually translates into improved share values.

On the consumer spending side of the equation, the scenario is also encouraging. Unlike most of the last 10 recessions since World War Two, consumers have not been too shaken up this time around. In fact, the last two quarters of 2001 saw an actual upswing in retail spending. Such bold behavior has been precipitated by a number of key factors such as lower interest rates, lower taxes, lower energy costs and a sustained and anomalous downward trend in unemployment figures. Consumer confidence, aided by historically low interest rates, has even translated into increased housing sales in the U.S. and Canada. Even automobile sales, spurred on by 0% financing, have been holding up nicely.

More encouraging news is also on the horizon for consumers and investors, alike. They should take heart in the fact that history (as measured by somewhat predictable cycles of economic expansion and contraction) is on their side. Indeed, the recession that officially began in March of last year, and was exacerbated by the events of September 11, may soon be over. Officially, a recession is triggered by two straight quarters of shrinking Gross Domestic Product. Conversely, its demise is heralded by two back-to-back quarters of continuous robust growth in GDP.

Many market analysts say that such a turnaround already began to shape up in the last quarter of 2001, fueled by the Fed's economic stimulus package. The GDP figure for that quarter was a relatively weak 1.7%. However, the U.S. Commerce Department recently announced that the 2002 first quarter GDP figure came in at an impressive 5.8%. A similar figure for the second quarter of 2002 will assuredly put to rest any debate as the whether the recession is still casting a long shadow over the markets. Regardless, most economists predict that on aggregate the economy will experience a modest turnaround this year with about 4% growth.

What does this all mean to the average investor? It suggests that as early as the summer investors may be returning in numbers to the stock market to capitalize on the improved corporate earnings of undervalued stocks. This will prove particularly timely in the case of small cap and emerging growth stocks that have more blue-sky earnings potential than more unwieldy, often debt-heavy large cap equities.

So, now is a time for investors to start 'cherry picking' seriously undervalued stocks that have strong fundamentals supporting their business models. I cannot stress this point enough. Forget for the time being about the lure of tomorrow's futuristic economy. The Brave New World promised by the Dot Coms, wireless companies and other self-proclaimed high tech sensations is based on consumer demand expectations that are anyone's guess. After all, who remembers the Internet phenomenon of cyber shopping malls? It was going to revolutionize shopping by putting brick and mortar malls out of business. Imagine buying an expensive suit or new shoes off the Internet. Enough said on that note. So again, stick with the bottom-line companies that have proven track records for products or services that are of tangible value in today's rebounding economy.