Bell Financial Management Corporation

The first month of the new millennium was the worst performance for the stock market since 1990. Ironically, the U.S. economy entered February with a new record, 107 months of expansion, the longest recession-free period in U.S. history.

Most major stock market indexes however, finished January trending upward, albeit never recovering their earlier losses in January.

Long-term bond yields started declining in January, after rising throughout 1999. In mid January a rare phenomenon occurred, the inversion of the “Treasury Yield Curve“.

An inverted yield curve means that short-term interest rates are higher than long-term interest rates. Often an inverted yield curve presages a recession, but in this case it is the reduction in the size and frequency of the auctions for the Thirty Year Treasury Bond facilitated by the U.S. Treasury recently, that is bolstering the price and reducing the yield of the Thirty Year Treasury Bond. The Treasury and the Federal Reserve (Fed) have been at odds recently, as the Fed is continuing to nudge up interest rates while the Treasury is trying to bring them down.

One of the biggest fears that investors had at the end of January was the posture of the Fed at their next meeting on February 2.

Most economists and investors were predicting a fourth increase of interest rates since June of 1999.

The Fed did in fact raise interest rates 1/4% on February 2. They raised the Federal Funds Rate to 5.75%, and the discount rate to 5.25%.

Most major banks followed the Feds lead and raised the prime rate 1/4% to 8.75%.

The stock market had a muted reaction to the Fed raising interest rates. Most major indexes finished up for the day, albeit off their intra-day highs.

The Fed is trying to cool off the torrid pace of the U.S. economic expansion. They continue to fear the resurgence of inflation in the U.S. economy.

Home building has however, slowed a bit as a result of mortgage rates escalating significantly in the last year.

Unfortunately, for the Fed policymakers , the economy is becoming more resistant to the Feds actions. Many borrowers can escape the higher borrowing costs by utilizing an adjustable mortgage as a vehicle to finance their home purchase. They are hoping that as the economy cools, they can refinance their homes with a fixed rate that is more attractive when interest rates decline.

I don’t believe in the Feds stance that the robust economic growth in the U.S. presages a inflationary spiral building in the future, as productivity gains from U.S. corporations should continue to offset any pricing pressures building for the U.S. economy.

The Dow Jones Industrial Average (DJIA) and the SP-500

Index continued their slide during February. The Nasdaq Composite Index (NASDAQ) however, regained its upward momentum in February and continued to power ahead.

This divergence of the DJIA representing the “old economy” stocks and the NASDAQ representing the “new economy” stocks, actually makes a lot of sense. The “old economy” stocks represented by the DJIA are more dependent on the cost of money, which is dictated by the level of interest rates. The Fed has been raising interest rates since last summer and since then, the NASDAQ has certainly been the undisputed leader in the stock market.

The Russell 2000 index, representing small capitalization stocks, has kept pace with the NASDAQ this year, as a result of investors embracing small capitalization stocks for the first time in many years. This broadening of the investors appetite for Russell 2000 stocks, is very healthy for the stock market.

The DJIA continued to slide in March, while the SP-500 Index traded in a narrow range, going nowhere. A big catalyst in the decline of the “old economy” stocks was the announcement by Proctor and Gamble (P&G) on March 7, that its fiscal third-quarter growth rate would fall well below Wall Street expectations. Investors ran for cover, selling shares in P&G at a breathtaking pace. Shares of P&G dropped a whopping 31% on that day, slicing an astounding 35.1 billion dollars from the stock market value of P&G.

Eventually, investors may not pay as much attention to the DJIA, as it represents 30 arbitrary stocks, most of them from the “old economy“. Investors are learning that owning the “blue chips of the DJIA” does not necessarily enhance the safety of their stock portfolio.

The NASDAQ continued to climb in early March, breaching the 5000 mark for the first time in its history on March 9. What is more amazing is that the NASDAQ reached the 3000 milestone just a few short months ago on November 3, and by the end of December broke through 4000 as well.

Investors appetite for technology stocks seems insatiable at this time.

The NASDAQ did succumb to a 10% correction in mid March. However, this correction was short-lived, lasting just a few days. At the same time, the DJIA and the SP-500 gathered upward momentum, as the divergence of the “old” and “new” economy stocks, changed directions.

On March 16, all of the stock market sectors had one of the most bullish days in stock market history. The catalyst for investors renewed appetite for stocks is illusive. On that day a neutral Producer Price Index (PPI) report was released. It disclosed that the PPI rose 1% in February. The core rate was up .3%. These numbers were in line with the expectations of investors, and as such, should have had little affect on the stock market.

The volatile biotech sector was one of the big winners of the first quarter.

The inverted yield curve prevailed for the bond market at the end of the first quarter. The Thirty Year Treasury closed the quarter yielding 5.831% , the Two Year Treasury yielded 6.466%.

The global markets had a mixed performance in the first quarter, with no major economic calamities. However, the Euro closed the first quarter at 95 cents to the dollar, at its lowest level.

What is ahead for the stock market in 2000 is, as always, unpredictable. What is likely, and healthy for the financial markets, is that some of the “froth” of the “internet mania” is replaced with “financial sanity” for the majority of investors.