This sure has been a great year for the stock market, so much so that it feels like we’re almost back to pre-crash levels. But are we? True, this has been a terrific year for the stock market by almost any measure. Year to date, the S&P 500 is up almost 20% and the NASDAQ up a head turning 45%. Based on those numbers it seems that we’ve recovered most of what we lost in the last few years. Unfortunately, the actual numbers tell a different story.

As of the end of October the S&P 500 and NASDAQ indices stood at about 1,050 and 1,950 respectively. How does this compare to the market peaks in March 2000? They’re lower, a lot lower. The S&P topped out on March 27, 2000 at 1,527.46 and the NASDAQ on March 10, 2000 at 5,048.62. So even after our great run in the market this year the S&P is still only about two-thirds of its peak level and the NASDAQ only slightly better than a third of it’s peak. Does this mean that the market is still too cheap? Not necessarily. There is no question but what the markets in early 2000 were way over valued so it’s not a good idea to use those peaks as a litmus test for correct value. Also, it’s unlikely that investors will return to the days of blind faith in markets that seem to always go up, so any long term price improvements in the markets are more likely going to need actual good earnings performance to support it.

More importantly, this market performance data underscores some of the basic lessons of investing.

Volatility is usually best avoided. An investor that had all his/her portfolio in the NASDAQ since March 2000 is still down by two-thirds in real dollars, in spite of this year’s almost 50% gain! The investor who stayed in the decidedly less sexy S&P 500 stocks has done relatively much better, in spite of it’s much lower 2003 return. The volatility of the NASDAQ versus the S&P can really penalize your real returns. (For more detail on how volatility and the math of returns can work against you read my December 2002 newsletter.)

Diversity and rebalancing works. As much an opportunity cost as it may have seemed at the time, owning bonds in 2000 ultimately paid you handsomely over the following three years. If you rebalanced annually you are likely showing a positive return today because you "forced yourself" to invest fresh dollars in the market at the end of 2002 and enjoyed the full benefit of this year’s strong returns.

Stick to your plan. By any measure 2002 was a terrible year to be invested in stocks. At the end of the year who amongst us didn’t dread the thought of contributing more hard earned dollars to our savings and retirement accounts in fear of seeing them evaporate in the market. Failing to make those planned investments, however, would have been a mistake as we’d have missed the rally and now be even more reluctant to invest at these "higher" levels.

Don’t chase the crowd. In 2000 most armchair investors thought you were stupid if you owned bonds. In 2003 most of those same people thought you’d be even more foolish to rebalance and sell bonds to put more money in stocks. The consensus view was wrong both times. Clearly, following the minds and pocketbooks of the general investing public will not lead to higher returns.

Don’t get greedy. Perhaps the most important lesson here is to learn to quell your greed instinct. Those who pursued lower but less volatile returns were clearly the winners over the last three years. Avoid listening to your neighbor who has regained confidence in his investment prowess because of the big bounce in tech stocks that has made him a "fortune" this year. The reality is he’s only recovered part of the even larger fortune he’s lost since March 2000. Slow and steady wins the race.

Fortunately, 2003 has been a great year so far but we can not predict the future and sticking to your basic investment plan and avoiding emotional investment decisions is the best thing you can do to keep your portfolios on track.

As always, please feel free to call if you have any questions.

Randy Gridley

November, 2003