Across My Desk

With the first quarter behind us, and the average stock fund off nearly 2.7 percent, a mid-March Schwab newsletter has some info in it that's worth remembering.

What follows are sections of a piece written by Liz Ann Sonders, chief investment strategist at Charles Schwab:

"WE'RE (NOT) GONNA PARTY LIKE IT'S 1999

One of the most significant, but least realized, results of the massive market correction we saw five years ago was that the stock market paused in its function as a leading indicator of the economy. In fact, in a complete role reversal, during the past three-and-a-half years, we've watched the performance of the stock market actually lag that of the economy.

Here we are, 38 months into an economic recovery (The recession ended in November, 2001.), and the stock market is ......well below the median of 20 percent normally seen this far into an economic recovery. Here's my take on what happened and why.

NOT YOUR CLASSIC BEAR MARKET

First, it was a particularly tough bear market, certainly in terms of profits, and tough bear markets tend to stay in investors' psyches for a long time. Not only did the Internet bubble burst, but it was accompanied by a series of other events that made a bad situation worse. There's little doubt that the terrorist attacks of 9/11, corporate malfeasance, Wall Street scandals, and accounting fraud had an enormous impact on investor confidence. Investors went into a "prove it to me mode," lost trust in the system, and were no longer willing to bet on the future growth of the economy. Ultimately, the market is a discounting mechanism for the future, but that mechanism broke during the bear market.

Not only that, the situation was exaggerated because people had unprecedented amounts invested when the bear market began. The late 1990s' market surge and investor reaction to that, put increasing pressure on companies to continue churning out earnings growth and exceed analysts' forecasts. The situation spun on itself until it went out of control, resulting in the historic bear market we experienced through the spring of 2003.

In hindsight, we look at this boom-to-bust period for stocks as a two-year exception to the rule, particularly from a valuation perspective. What's odd, however, is that most economists and market-watchers don't apply that same reasoning to certain economic trends as well.

UNACKNOWLEDGED ECONOMIC BUBBLE SKEWS PEOPLE'S VIEWS TODAY

Dour predictions and/or analysis about our economy today are partially due to a failure to consider the fact that in the late 1990s, the ENTIRE ECONOMY experienced a bubble. Using the economics of the last cycle, which included the late 1990s, as the sole basis for comparison today is faulty. It's hard for anything to look good relative to the late 1990s...

THE MARKET IS SLOWLY REGAINING ITS STATUS AS A LEADING INDICATOR

While the market's recovery is still sub-par relative to the timeframe of the economic recovery, the gap is beginning to close. This is evidenced by a return to focusing on more market-oriented fundamentals like earnings and valuation, and other traditional economic measures like trends in inflation and interest rates."