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A Painful Year

Published Sep. 28, 2005

From the demise of many dot-com darlings to a slip for some blue-chips, the stock market picture for 2000 wasn't pretty. But will 2001 be much better?

Shell-shocked investors probably are relieved to bid farewell to 2000, which turned out to be the worst year for stocks since 1981 - or even longer by some measuring sticks. But a lot of gloomy talk about 2001 isn't making them feel much cheerier.

"I'm in dismay," said Kenneth Weise, a New Port Richey postal worker. "I'm very, very heavily invested in telephone stocks that came down through the family and have been very good to me through the years. Now they're disintegrating."

Stock collapses were depressingly common this year, from Amazon.com to Xerox Corp., both down 80 percent. The Dow Jones Industrial Average, the best-known market indicator, fell 6 percent, while the broader Standard & Poor's 500 Index dropped 10 percent. It was the worst finish for the Dow since a 9 percent decline 1981 and the worst for the S&P since an 12 percent drop in 1977. And the technology-heavy Nasdaq wiped out most of the 86 percent gain from 1999, finishing with a 39 percent loss, its worst ever.

Only a few sectors proved rewarding for investors, including utilities, financials and health care. Others were disappointing to disastrous.

After a meteoric rise, the dot-com darlings came crashing to Earth. For months, investors bid up technology stocks to dizzying heights, ignoring that many of them were burning through millions of dollars with no prospects for profitability. The tech-heavy Nasdaq Composite Index soared above 5,000 in March.

But then the savviest of investors began bailing out. Since then, investors have decided earnings do matter. The Nasdaq index has been cut in half as value stocks enjoyed a resurgence. But many Internet stocks are down more than 50 percent. Yahoo Inc., which traded at a split-adjusted price of more than $432 a year ago, closed Friday at at $30.06. Ask Jeeves Inc. is down 98 percent this year, and Priceline.com has lost 97 percent of its value.

While Internet stocks were expected to be volatile, who could have predicted what happened to Weise's shares in venerable AT&T Corp.? Selling for more than $60 a share in March, the faded blue-chip stock now trades in the teens and just cut its dividend 83 percent. AT&T's glamorous high-tech spinoff, Lucent Technologies, which Weise also owns, has fared worse. A year ago, you might have paid as much as $78 for a share. Last week you could pick up a share for less than $14.

Weise, 66, is reconsidering his plan to retire next year and has given up trying to manage his investments himself. He said he will see a financial planner this month.

"I need some help," he said.

But even for investment professionals, 2001 presents huge challenges, ranging from the faltering economy to the collapse of the Internet bubble.

"There's just a lot working against the economy, " said Alan Levenson, chief economist for T. Rowe Price Associates, a Baltimore mutual fund company that has an office in Tampa.

What sort of things? "Energy prices are up. Debt levels are higher. Loan quality has deteriorated, and banks are pulling back. It all starts to feed on itself. Then job growth slows. Income growth slows and that leads to further cuts in demand."

What investors fear is that it all adds up to slower growth in corporate earnings, and, ultimately, to stagnant stock prices.

We've gotten used to the economy growing at a better than 4 percent annual clip the past few years. But that kind of growth created a tight labor market and sparked fears of inflation. The Federal Reserve Board reacted by raising short-term interest rates six times in the past year-and-a-half in a deliberate attempt to cool things down. The plan worked, but maybe a little too well.

Investors have been hoping for a soft landing, with growth slowing to about 3 percent to 3.5 percent, enough to bring inflation under control without widespread job losses or other undesirable side effects.

Now some economists, including Levenson, are lowering their forecasts and predicting a hard landing, with growth closer to 2 percent. That could feel like a recession even though it would not meet the textbook definition of a decline in economic output lasting at least two quarters.

A few people, including Vice President-elect Dick Cheney, are even using the "R" word openly as they talk about prospects for a more serious pullback.

"We've gotten spoiled because the last three to four years have been just phenomenal," said Scott Brown, chief economist at Raymond James & Associates Inc. in St. Petersburg. "It's a tough transition at this point. The hardest thing to gauge is the psychology of investors, consumers and businesses. We've had unbridled optimism for quite some time, and it can quickly turn the other direction and become overly pessimistic."

But there is a silver lining to the clouds of economic gloom. The slowdown has forced the Fed to change its stance from raising interest rates to preparing to lower them.

The first of what investors expect will be several rate cuts could come within the next two weeks. Falling rates not only help corporate profits, they also make stocks more attractive relative to bonds. The slowdown also improves the odds that Congress will approve some kind of tax cut, which would give people more money to spend.

Together, lower interest rates and tax cuts could be the essential ingredients in a rebound of both the stock market and the economy. If you accept that premise, the big question is: when?

Money managers and market analysts don't see eye-to-eye on whether investors should be jumping in with both feet or holding back waiting for a more convincing sign a rally is ready to begin.

"You have to be optimistic about next year," said Gerald Perritt, who publishes the investment newsletter Mutual Fund Letter in Largo. "The problem is how low does it go before things get turned around?"

Because that question can be answered only with the benefit of hindsight, he recommends investing now to be ready for the rally.

"The best time to buy stocks is the first month of a recession," Perritt said.

Clearwater money manager Gloria Blackburn at Premier Investment Management also is optimistic. She suggests wading into battered technology stocks with up to a fourth of your investment resources.

"Technology has taken such a hit here, it's sad," she said. "That's really the place you need to be for long-term future growth, and it's really an excellent value at this point."

Clearwater market timer William I. Ferree Jr. also says this is a good time to buy. He says the new money that floods into the market in January from retirement savers brings with it the potential for "an upside explosion."

"Ignore the pessimism from the next president on down," he said. Ferree said his timing model is soaring to levels that forecast "a move of bull market proportions."

But others see no reason to rush into the market just yet.

"Earnings are going to be disappointing in the weaker economic environment," predicts Ann F. Cody, vice president and research director at the Louisville, Ky., brokerage firm Hilliard Lyons. First-quarter earnings face particularly tough comparisons with a very strong first quarter last year.

"We are getting back into a phase where value does matter," she said. Her recommendation for the first half of the year is to look for good stocks in areas such as health care, regional banking and real estate investment trusts. Although she says there are some "bargain basement prices" in technology, she doesn't think those stocks are ready to rally.

"The second half of the year people may realize that we're still using and applying all kinds of technology," she said.

St. Petersburg money manager Timothy J. McIntosh at Strategic Investment Partners also is cautious but said history gives him some confidence. The stock market has not had back-to-back losing years since the 1970s.

"Economic conditions currently are a lot different from then," he said. He sees 2000 as most similar to 1994. That year the Dow eked out a 2.14 percent gain before taking off on a run of five consecutive years of double-digit gains. The key to the reversal: cuts in interest rates.

"I don't think earnings will be the story of 2001; it has to be dramatic interest rate cuts," he said. "The best value right now is the premier technology companies, but investors need to be extremely selective."

Investors are going to take some convincing.

Many are still sitting on their hands. Among them is Joseph Bausano, a retired police officer who lives in Palm Harbor.

"I think it's going to be a very difficult year," he said. "You have to be ultraconservative and ultracautious. I'm going to stay with what I have, but I don't see anything out there that I want to buy right now."

To some market watchers, negative sentiments like that are a good sign that a bottom could be near if it hasn't already been reached.

"We think this is just a full-blown correction and the worst is behind us," said New Port Richey investment adviser Steve Athanassie at Trademark Capital Management.

Weise and many other investors certainly hope he is right.