Isn’t any investment safe anymore? Sure, everybody knows those white-hot dot-coms have got to be risky. But the big blue-chip stocks, the companies that dominate the Dow Jones industrial average and Standard & Poor’s 500 index, are the pillars of American industry.
Surely, an investor could count on companies such as Coca-Cola Co., DuPont Co., J.P. Morgan & Co. and Procter & Gamble Co. And then there are all those other classic havens, such as utility stocks, stocks with high dividends and low P/E stocks, which are companies trading at prices that are low compared with their earnings.
If this sounds like your line of thinking, maybe it’s time to wake up and smell the coffee. Investing in the stock market involves risks, and these days the big risks aren’t limited to small, little-known stocks. The shares of big, established household-name companies, the ones you were told were safe, are increasingly gyrating up and down with gut-wrenching intensity.
“The theory says, and the evidence supports it, that in the long term, if you take risk, you can expect to be better off,” says Nobel laureate William F. Sharpe. “But there is a risk return tradeoff, still.”
Procter & Gamble’s 31 percent plunge last month was only the latest stunning dive by one of the market’s biggest, seemingly safest stocks. Many of the market’s most seasoned stocks have traded recently at prices significantly below their 52-week highs: Alcoa, Coke, DuPont, IBM, Philip Morris and P&G.
True, the bull market has meant bigger profits for more investors in a shorter time than anyone would have ever dreamed. But when prices of big and small stocks alike are falling–in some cases, sharply–the desire for some sheltered port in the storm is understandable. A plaintive posting on an Internet message board last month summed up the quandary felt by many investors: “Is there such a thing as a safe stock anymore? It doesn’t pay to play it safe in this market.”
Indeed, that is a lesson that many investors have taken. In an environment where “safe” stocks have plummeted while “risky” stocks have soared, logic has been turned on its head.
What is an investor to do?
Diversify, and think long term, but don’t turn your back on technology, which seems certain to be an even more important driver of the national and world economies in the years ahead.
“The argument against tech stocks is one-dimensional,” says Thomas Galvin, investment strategist at Donaldson, Lufkin & Jenrette. “It’s all about valuation.” He recently boosted his target weighting for technology stocks to 40 percent, or as much as 50 percent if you add telecommunications stocks to the mix.
Technology alone, however, isn’t apt to give investors a comfortable ride. “If you made a fortune in some technology or biotech stock, you should take some of that money and buy the DuPonts and the P&Gs of the world,” says Harold Evensky, a financial planner in Coral Gables, Fla.
Moreover, focusing too heavily on what has worked well recently can leave investors blindsided by the next market-transforming development. Richard Bernstein, chief quantitative analyst at Merrill Lynch & Co., says that investors’ best chance for taking part of “the next tech sector” is to shift their focus and diversify broadly. “If you’re looking very short term, the Old Economy is incredibly risky. It looks as if it’s going out of business,” Bernstein says. “But we know that’s not true.”
Concentrate on fundamentals, he says, which “are improving most demonstratively in energy and basic industries.”
Leah Modigliani, U.S. stock strategist at Morgan Stanley Dean Witter & Co., suggests looking for Old Economy companies taking on New Economy strategies. Ford, for example, “is starting a process of acquiring materials via the Web, so they’re able to get exactly what they need at the best price,” Modigliani says.
Richard Cripps, chief market strategist for Legg Mason Wood Walker Inc., suggests dividing a portfolio based on three key themes. He would put about 36 percent of one’s assets in global companies such as America Online Inc. and General Motors Corp., 22 percent in Nasdaq 100 companies such as Cisco Systems Inc. and Intel Corp. and the remaining 42 percent in “traditional” companies, such as filter maker Pall Corp. and food-and-drug retailer Safeway Inc. The weightings are based on how each theme is reflected in the Wilshire 5000 Index.
Companies in each sector must be analyzed on different terms, Cripps adds. The Nasdaq 100 companies, for example, should be viewed on a “very forward-looking basis,” with a focus on the company’s projected business model and whether it is first in its segment. Traditional companies, by contrast, should be viewed with an eye to the past. Investors want to look at where the stock is “trading relative to where it has traded in the past, relative to earnings and to book value,” he says.
Traditionally, investors could mimic the sector allocations of the S&P 500 index to consider their portfolio moderately aggressive. But these days, even the S&P may appear risky to some folks. Technology stocks currently account for 35 percent of the S&P index’s market value. The percentage has climbed steadily from below 20 percent last year. “Ten years ago it was closer to 10 percent,” says Sam Stovall, S&P’s senior investment strategist.
The rise of technology stocks has made the market riskier, says Jeremy Siegel, a professor of finance at the University of Pennsylvania’s Wharton School of Business. “Tech stocks are more volatile than traditional stocks,” he says. Moreover, the technology stocks themselves have gotten riskier as more and more momentum players enter the market, betting that stocks that are going up in price will continue to do so as more and more investors jump on the bandwagon.
“The expectations built into these tech stocks are getting higher and higher,” he says.
But dividing your portfolio between tech stocks and the S&P 500 isn’t a good way to control risk, Siegel says. “If you think technology is overblown and you want to get away, then you have to go to some of those value-based funds, those that have done badly,” he says.
For people afraid of being left out if the tech boom does, in fact, continue at its recent blistering pace, Evensky suggests putting 10 or 15 percent in technology, “if they can afford to lose a good portion of that.” Because the list of winners is short and constantly changing, Evensky suggests that investors buy an index like the Nasdaq 100 or a mutual fund, rather than individual stocks.
Steven Enright, an investment adviser in River Vale, N.J., says it is important for investors to re-evaluate their mutual funds to make sure they still like them. Many funds have gotten so big so quickly that they aren’t the same fund they were a year or two ago. “Many are no longer as nimble or flexible as you might think,” Enright says.
Keep in mind that although the Internet’s influence is pervasive and growing, it doesn’t eliminate investment risk. “The quality of information, the timeliness of information, the breadth and depth of information is there as never before,” says John Markese, president of the American Association of Individual Investors. “But it doesn’t allow you to predict the future.”
