Equity release mortgage

DOES ANYONE REMENBER WHAT A MARKET RALLY FEELS LIKE? The first half of 2003 certainly felt like one: stocks on the Dow Jones industrial average up some 13% and Nasdaq issues climbing a hearty 30% as of mid-August. We haven't seen such a steady rise in the financial markets in almost three years. With uncertainty hanging in the air from a tepid economy, international upheaval, and ongoing terrorist threats, how can we be sure if the markets are ready to rebound or whether investors will be hurt by a severe market relapse?

We assembled four high-powered money managers to try to answer that question by evaluating the current economic picture and telling us what we can expect in the fourth quarter of 2003 and beyond. Members of our roundtable are Mary Pugh, CEO of Pugh Capital Management (No. 15 on the BE ASSET MANAGEKS list with $609 million under management), a Seattle-based firm specializing in fixed-income portfolio management; Isaac Green. president and chief investment, officer or Piedmont Investment Advisors, a Durham, North Carolina-based firm focusing on core investing--a portfolio-building strategy identifying quality stocks from each segment of the market; Randall Eley, president of The Edgar Lomax Co. (No. 9 on the BE ASSET MANAGERS list with $1.48 billion under management), a Springfield, Virginia-based mutual fund company that embraces value investing; and Raymond Stewart, president and chief investment officer of Rasara Strategies, a Briarcliff Manor, New York-based money management firm that, focuses on value investing within the banking sector.

BLACK ENTERPRISE: Give us your assessment of the economy and market forecast for the second half of 2003 and into 2004.

RAYMOND STEWART: I'd characterize the economy as lethargic, at best. You've got unemployment at 6.4% versus 5.8%. You've got rising budget deficits. Even it' the nation's policy makers are successful, I do not see more than a 5% to 10% increase in year-end stock prices. Next year, I'd expect perhaps another 5% to 10% gain. I would really have to see a strong pick up in corporate earnings for me to become a little more sanguine about the outlook for the stock market.

MARY PUGH: Our outlook says we are going to see a W type of recovery, which means we'll have some growth and then we'll have a slow down in that growth. We won't go back into a recession, but we will not experience substantial growth either. Our forecast for 2004 would be about 3% GDP [gross domestic product] growth, with interest rates of about 3.75% to 4.5% for the 10-year treasury [bonds].

ISAAC GREEN: Our outlook on the markets for the second half of this year and into next year is ... that there is a lot of room for things to get better.

I think it's possible that the market may correct in the third quarter of this year, based on spiking interest rates: but we don't think the spiking rates are sustainable or merited. We think stocks are slightly undervalued right now. based on depressed earnings, and that there is meaningful room for the earnings of corporate America to appreciate, from their cyclical lows. So, if you consider that earnings can recover very strongly over the next few years, you could expect the market to start rallying over the second half of this year [and] first half of next year as it becomes clear that the economy is recovering. Then that rally can be sustained by the fact that as profits go up, optimism will go up.

B.E.: How much of a factor will psychology play in any recovery in the near future?

GREEN: In the short term, the stock market is nothing but psychology. It reflects the balance between greed and fear [and] optimism and pessimism. Psychology determines what the discount rate of the market is [or] how much of a risk premium do investors have to earn relative to risk-free investments in order to have an incentive to go into stocks. The more optimistic folks are, the less of a premium they require and, therefore, the higher valuation they are willing to pay for the market.

PUGH: Psychology works a little differently from the corporate bond standpoint, with respect to the equity side. If you step back to last year, psychology was a tremendous driver of the market and there were a couple of really significant events, We bad Enron followed by Worldcom, Qwest, and Global Crossing. All these major corporations with accounting fraud issues really challenged investors in terms of whether or not they could believe their Financial statements. That was significant.

Another major event last year was the July sign-off period in which CFOs and CEOs had to sign on the dotted line, [verifying] their financial statements. That actually was a point when both the equity market and the corporate bond market rallied for a short period because people were saying, "Okay, I can start to believe a little bit more."

Also, the leadership of major corporations got the message that they really needed to focus on paying down debt, and that is a trend that started to gain traction, All of those things came together, initially because of the problems, to create a horrible market. But then, as a result of the realization that a lot of it was being dealt with--not necessarily overnight, but overtime--we started to see the psychology change. From October to November of last year everything crystallized to its worst point and then started to rebound, both in the equity market and in the bond markets.

ELEY: However long this current stock market rally goes, whatever economic growth we see over the next year or two. it is not likely to be nearly as strong as in past recoveries because you are not going to get increased capital spending or substantially increased employment.

I expect this year and next year [for] the market to perform in a milder manner than we saw ill 2001 and 2002. However, I think that's because of the political machinations that are going on--the lowering of interest rates and fiscal spending--but somewhere the federal government will stop doing that and then we'll all have to pay the piper ... maybe into 2004, maybe 2005 before the old bear market resumes.

B.E.: Given the likelihood of a return of a hear market, what should investors do?

GREEN: I think investors have to make long-term decisions about what parts of the market they are going to have their money invested in, what their personal asset allocation is based upon their individual return objectives and risk tolerances. With those determinations made, investors are well served to stick to that asset allocation and only make minor adjustments in response to any wild gyrations of the stock market in the short term. If you are going to be active about, it at all, be active in a contrarian fashion.

ELEY: My suggestion, which is a relatively safe strategy that can get you some of the higher returns through stocks over time, is to hold some thing in the area of a 40% to 45% position in stocks, but make sure they are stocks you believe are relatively low risk, with the remainder being in fixed-income [vehicles].

STEWART: With the caveat that I'm a specialist, just looking at the banking sector, I think diversification among different asset classes is the key, say about 40% to 50% domestic equity. Then you've got other asset classes that you might want to consider, such as real estate or real estate investment trusts. You might want to also look at non-U.S. equity investments, and if you think inflation is coming back, diversify into gold and precious metals.

PUGH: As we talk about asset allocation, we have to think about earning lower than average returns and what that means for you in terms of being able to meet your needs. That would influence your asset allocation process. If you have a higher need for higher returns, you're going to do a different type of diversification than you would if you were more comfortable that that 5% to 7% type of returns were going to meet your needs over the longer term.

Just one other thing: I think the type of environment that we are in, and will be in, is most suited to active managers, whether they are on the fixed [income] side or the equity side. I think that there is the ability to differentiate and incrementally add returns through that active process.

B.E.: Is there anything else investors can do to increase their returns?

STEWART: I tend to look for companies that have fairly strong cash flows and fairly good dividend pay outs. I look toward things that I had a degree of familiarity with and things that I tend to utilize quite a bit. I am sure an investor can look to the [utility] company where he is paying the bill and if it's publicly traded, I'm sure he'll see a 3%, 4%, or 5% yield. Compare that to say keeping your money in a money market fund [yielding 1%].