Market Outlook for April 2002

The month of March has been kind to most investors. Returns have not been all that high, but the breadth of the recent market rally means that new money is coming into the market and finding a home among many sectors. The vague but increasingly real promise of a swift economic recovery appears to be the underlying theme of the current rally.

While the notion of a continuing economic recovery has become a given, the character of the recovery is far from clear. Semiconductors have rallied sharply, yet computer and telecommunication stocks have lagged behind, failing as yet to confirm the chip rally. Regional banks and financial services have rallied on schedule, yet brokers and large banks have floundered on fears of weak trading revenue and exposure to bad loans.

Leisure, multimedia, and retailing stocks all have risen in the last month, continuing the theme of the strong consumer-oriented entertainment and shopping. Even biotechnology and internet stocks have mounted strong advances. There are strange bedfellows, too, among recent winners. Amid all the gains, the contrary play of buying gold in anticipation of inflation is panning out well.

High-dividend stocks in real estate and utilities have attracted new money, as have small cap stocks in both growth and value styles. Small is better right now as blue-chip stocks, with their higher relative price-to-earnings ratios, continue to muddle along as their smaller competitors rise. The best way to invest in small-cap companies may be through mutual funds, iShares, and other basket-style equities, which allow for risk to be spread among many small companies.

Losing stocks are just as hard to judge, this time because there are so few. Many sectors are holding steady, but only pharmaceuticals have taken a wrong turn in the last month. Interestingly, market volatility is also down, nearing its 52-week low. Typically, this suggests that prices are unsustainable and will fall dramatically some days or weeks, perhaps even months, from now.

Optimism in the recovery is riding increasingly positive economic reports and companies' outlooks for earnings growth. Alan Greenspan and the rest of the Federal Reserve have put a bit of a lid on big current gains, when they announced last week that the risks to the economy are balanced and that no Fed rate change is imminent. Many analysts expect rates to increase gradually soon, as the Fed removes what were essentially "emergency" rate cuts enacted after the 9/11 terrorist attacks.

On top of these concerns is the approach of the light summer trading season. Prices will tend to be more volatile in the summer. Whether recent strength continues will depend on continued support from company earnings and economic reports, as well as investor confidence in the viability of the unfolding recovery. The old standards of a diversified and balanced portfolio make sense more than ever in the coming months.