INSIDE THE
TRACK RECORD
Maximizing Gains in Up Markets,
Preserving Capital in Down Markets
Editor Stephen Quickel explains
how USIR’s model portfolios
out gained the averages in up markets
and protected gains in down markets
consistently for the past 17 years
Fact: For sixteen years the USIR Growth Portfolios have consistently outperformed the greatest bull market in history and one of the worst bear markets.
Conclusion: Investors who follow the USIR Portfolios stand to profit more than others as the market recovers—and keep more of their gains.
Skeptical?
Of course you are. Investors these days take such grand claims with a grain of salt. So we are opening up our record for your inspection, going all the way back to Jan. 1987 when we started our portfolios. Perhaps we can overcome some of your doubts.
Below, for starters, you will find all of the numbers—our complete quarter-by-quarter track record since 1987, showing how each USIR portfolio has done vs. the major averages.
Then, to make the numbers come alive for you, I have also written a 17-year running commentary. It tells you how, at each important juncture, we tried to spot the best growth opportunities and keep USIR’s subscribers armed with profitable choices.
I’ve opened up the record in such detail to give you a good idea of how I will manage our portfolios going forward. You can see for yourself, year by year, how we have built our portfolio track record since January 1987.
Past performance is no guarantee of the future. We might suddenly lose our grip. We might stop picking good stocks and fail to spot shifting market conditions. We might stop doing what we’ve done successfully for 17 years. But, as you will see below, the record suggests otherwise.
First,
a Look at USIR’s Performance Numbers
Our
Track Record at a Glance
These charts summarize the compounded annual returns of the three USIR Growth Portfolios vs. the market averages over different time spans. The returns include the bear market of the past three years. Thus our ten-year returns, encompassing seven bull market years, are higher than the five-year returns that include three down years.
Our two longest-running portfolios—the Conservative Growth and Growth Leaders portfolios—were begun in Jan. 1987, before the crash. The Emerging Growth Portfolio was added in July 1995.
Point to note: USIR’s portfolios have gained far more than the averages in rising markets and declined much less in declining periods. The 17-year bottom line:
Out-performance in up markets
Gain-protection in down markets
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Legend
CGP: Conservative Growth Portfolio
GLP: Growth Leaders Portfolio
EGP: Emerging Growth Portfolio
Our
Detailed Track Record – The Quarterly Results since 1987
For a more detailed look at our performance, I invite you refer to the accompanying tabular presentation headlined “The USIR Growth Portfolios – 1987 to Present.” This table is a number-lover’s paradise. Quarter by quarter from 1987 through 2003, it shows you the performance of the three USIR portfolios vs. the Dow Industrials, S&P 500 and Nasdaq Composite.
I suggest you study these results along with my running commentary—in the pages following this one—entitled “How the USIR Track Record was Built.”
Click here for our
detailed 1987-2003 performance recap.
Are
these dramatic results accurate?
I can tell you this: Every buy and sell transaction for the USIR model portfolios is pre-announced in our issues and hotlines—so subscribers can follow our moves in the same time frame. It recorded at prevailing market prices and reported for everyone to see in our next issue. Also, all stop-loss limits are triggered at the prices specified in each issue of USIR. We strive for real-time transparency in presenting and tracking our portfolios.
I can
also tell you this: We’ve done something else
It was a tough audit. The firm reviewed every portfolio transaction we made during those five years To insure that our model portfolio returns replicated real-market results, they laid down strict assumed conditions and record-keeping procedures, which we continue to follow today in disclosing our results. When they were done reviewing our records, the auditors verified a 34% compounded annual return for the 1990-94 time period, before commissions—almost exactly the five-year performance we had reported to readers.
Since that audit, we have continued to account for the USIR Portfolios according to the rigorous methodology the auditors used. All stop-loss sales to be exercised at precisely the price limits published in our issues. Announced purchases and sales are recorded at the average price on the first trading day after publication of the issue in which they were announced—giving subscriber time to digest our intended moves. Employing strict bookkeeping methods, with transactions fully disclosed every issue, the USIR Growth Leaders Portfolio has grown at an annualized rate of 35.6% during the last ten years, from 1994 through 2003. The USIR Emerging Growth Portfolio, started in 1995, is today’s star performer with a 28.6% annualized growth rate for the past five years, including the 2000-02 bear market and the 2003 recovery.
What those numbers meant for USIR Subscribers
· Investing $100,000 at the Jan. 1987 startup of our Conservative Growth and Growth Leaders Portfolios, in equal dollar amounts, and following their moves religiously, paid off pretty well—to put it mildly. The initial $100,000 grew to $20,105,000 seventeen years later.
From Jan. 1987 through 2003
$100,000 invested grew to over $143,000
· Investing $100,000 at the Oct. 1990 Gulf War lows equally in the Conservative Growth and Growth Leaders Portfolios, and following every move announced in our issues thereafter, turned the initial $100,000 into $4,421,000 million at the end of 2003.
From the 1990 Gulf War Low through 2003
$100,000 invested grew to nearly $4,421,000
· Investing $100,000 in threee USIR portfolios in 1995, when we added our Emerging Growth Portfolio, the original sum grew to $4,773,000 in eight years—including the 2000-02 bear market—including $1,310,000 gained during the 2003 recovery.
From 1995 through the bear market and 2003 recovery
$100,000 invested grew to $4,773,000
Doubters used to say that USIR just rode the bull market. How could we miss? But they stopped dismissing our results as it became clear, year after year, that we consistently out-gained the market averages, usually by a wide margin.
There are no guarantees that we can repeat this record. But there is certainly the suggestion that we know our business. There’s also the suggestion that our stock picking technique and portfolio strategy have stood the test of time—a long time!
Want to know more?
Read on. The following article recaps, in some detail, key moves made by the USIR Growth Portfolios since Jan. 1987. As founding editor, I have overseen the portfolios every step of the way. This chronological look back gives you a peek inside my head. It tells you what I was thinking, which stocks I bought and sold, and the strategy refinements I made as the historic bull market rose for thirteen years, then turned into a three-year bear market.
How the USIR Track Record was Built
Editor Stephen Quickel looks back at decisions that enabled
USIR’s portfolios to consistently out-grow the bull market,
then successfully resist the recent bear market,
since creating them in January 1987.
My professional forte, from graduate business school through four decades of analyzing and writing about the investment markets, has been picking stocks.
In 1987, two years into publishing U.S. Investment Report, readers asked me to go one step further and start a model portfolio of my stocks. I did them one better. I started two portfolios—the USIR Conservative Growth Portfolio and, for more aggressive investors, the USIR Growth Leaders Portfolio. We added a third, the USIR Emerging Growth Portfolio, in mid-1995 as small capitalization stocks gained investor interest.
Some 400 issues of USIR later, I am glad we did so—and so are they. Subscribers who followed our portfolios closely have done well, whatever their entry date may have been—ten years ago, five years ago or even the last two or three bear-market years. We rolled up large gains in the long bull market through March 2000. And in the recent down-years we’ve preserved most of those gains—as our long-term performance figures show.
This article is a chronological recap of my thinking at important junctures as we built that long-term track record. My hope is that it will persuade you to join the many USIR subscribers who have profited from our portfolios over the years.
First, to set the stage before you dive in, a quick word about our portfolio strategy:
Our basic strategy is the same for all three USIR portfolios: The holdings of each are concentrated in a 10-15 competitive leaders in rapidly growing industry sectors. Concentration in a limited number of growth leaders helps us maximize gains and keep ahead of the averages. Yet we also have enough diversity with 10-15 holdings to limit risk without diluting our gains from good stock picking. What varies from portfolio to portfolio are the specific stocks each one holds in pursuit of its conservative, aggressive or emerging growth objectives.
Here, then, is a blow-by-blow recap of how we’ve made that simple, time-tested portfolio strategy pay off:
Oct.
1987 Crash: Surviving the collapse with profits to spare
The USIR Portfolios started out with a bang in 1987, but faced a crisis after just nine months—the Oct. 1987 Crash.
The stock market was red-hot through August, with the Dow up 43% from 1896 to 2722. By September both the Conservative Growth and Growth Leaders portfolios were fully invested in ten stocks and were up 50% and 64% respectively. We had doubles in four technology leaders of that era—Apple Computer, Amdahl, Digital Equipment and Motorola—and 50%-plus gains in Advanced Micro Devices, Hershey, Liz Claiborne, Merck, Seagate Technology and Wal-Mart. As October 1987 began, P/E ratios had become elevated, and bonds had hit 10%, but few foresaw the panic that would soon send the Dow below 1800.
The USIR Portfolios bore the full brunt of the Crash. We were fully invested and did not yet use stop-loss limits. Our portfolios were sitting ducks—except that both had already piled up huge gains and we refused to panic. Our portfolios lost 35% at the bottom, as did the market overall, but we sold almost nothing. Once the Dow had plunged 508 points on Blue Monday, Oct. 19, it seemed foolish to lock in the losses by selling. The economy was still strong and stocks were suddenly cheap again. And we had a cushion of pre-Crash gains. So even at the lowest point, our portfolios’ year-to-date performance never dipped below +20%. The strategy of narrow concentration in growth sector leaders not only allowed us to survive the crash, but ride it out with large profits. It was an important first test of a portfolio strategy some said was risky. It demonstrated that concentrating in the best stocks in the best sectors was the best strategy—providing the best gains to counter the worst of markets.
Dec.
1987 Snapback: Ready for the surprise rebound
The 1987 Crash ended more quickly than anyone expected—within just six weeks. The Dow bottomed on Dec. 4 and thereafter would rise with few major interruptions for the next 13 years, until March 2000. In late 1987 we did not share the grim view of the bears. “Depression” blared a Business Week headline, harking back to the aftermath of the 1929 Crash. But we viewed the drop in stock prices and P/E ratios as a bullish sign, not a harbinger of hard times. It was a huge correction, worsened by program trading and some flaws in market mechanics that were quickly being corrected. So while we were surprised by its quickness, we believed that a strong rebound in stocks was inevitable and were fully invested to take advantage of it.
Our
rationale: The 1982-2000 bull market was still young in 1987. Yes, the Dow had
tripled in five years, but from a severely depressed late 1970s base (when P/E
ratios averaged 7 times earnings) and from twin 1980-82 recessions induced by
the Fed to stop double-digit inflation. From the historic
Doing nothing is often the wisest course in an over-wrought stock market. We’ve frequently stood pat during bursts of trading madness—nearly always to our profit. By refusing to sell and remaining fully invested in leading growth stocks, the quick rebound in Dec. 1987 our Conservative Growth and Growth Leaders portfolios to handsome first-year gains of 42% and 32%, respectively.
1988-89 Post-Crash Era: Embracing the emerging tech superstars
The two years after the 1987 Crash were ideal for stock pickers like USIR. On the one hand, exchange-listed growth stocks with familiar household names attracted heavy buying by risk-averse investors—including technology issues like Motorola, IBM, Texas Instruments and Hewlett-Packard, as well as large caps like Merck, McDonald’s and Philip Morris with two-digit percentage growth rates. On the other hand, investors were also warming up to the frisky new personal computer, software and biotech stocks that were going public in those days—outfits with names like Microsoft, Cisco, Oracle, Sun Micro and Amgen. Nobody dreamt then what superstars those stocks would become, but they sure were rising rapidly and winning new respect among serious investors for the Nasdaq market.
With those twin streams of opportunity flowing, the major market averages advanced 10-15% in 1988 and 20-30% in 1989—nicely ahead of the average long-term growth rate for stocks of 9-10%. The record shows that USIR did even better: Our Conservative Growth Portfolio rose 25% in 1988 and 60% in 1989. Our Growth Leaders Portfolio, invested more aggressively in the new tech stocks, rose 46% and 70%.
Why did we outperform the averages again in 1988 and 1989—and almost always run ahead of rising markets thereafter? Two reasons:
n First, because we concentrate on the cream of the growth stocks. We stick to the competitive leaders in the fastest growing industries, with just enough diversification to cushion risk without diluting our gains selection.
n Second, because we make timely trades to keep our portfolios focused in the strongest growth sectors. For example, we took profits in many of the new tech stocks in early 1989 after their year-long run-up. Yes, we had bought them for their long-term growth potential, as with all of our portfolio stocks. But being long doesn’t mean being blind. And in early 1989, the hot new techs looked vulnerable. So we sold and bought them back later at lower prices.
While technology stocks did sell off in early 1989 as we suspected, the more familiar non-tech growth stocks remained strong. Accordingly, we focused the USIR portfolios on consumer leaders like Philip Morris, Pepsico, and Kimberley-Clark; on healthcare leaders like Abbott Labs and Merck; on media favorites like Disney and Capital Cities/ABC; on restructured industrials like GE and Harley Davidson; on financial growth stocks like American Express and American International Group; even on forward-thinking phone utilities like MCI Communications and Southwestern Bell. We also added a couple of promising new retailers called Home Depot and Toys R Us.
But the fast-growing techs were far from forgotten. Late in 1989, after a so-called “Mini Crash” briefly spooked the market just before Halloween, we were able to repurchase many of the best techs at greatly reduced prices. End result: In a year when the S&P 500 rose 30% and the Nasdaq 20%, our Conservative Growth and Growth Leaders portfolios jumped 60% and 70% respectively.
Aug. 1990 Gulf Crisis: Our stop-loss strategy passes a stiff test
Aug. 1990
brought a shocker. Our portfolios, both concentrated in technology and non-tech
growth leaders, were still on a roll in the first half of 1990—with the
Conservative Portfolio up 17% and the Growth Leaders Portfolio up 31%. In early
July Dow nudged above 3000 for the first time, pushing us still higher. Then
wham! As July ended,
Stops are controversial. Many investors don’t like being sold out automatically at a pre-set loss limit. Sometimes stocks do pop back up again, even on the same day. But we’ve found, more often than not, that stops set at 7% to 10% below the current market price can prevent much greater losses. In the Aug. 1990 Gulf Crisis they got us out with 7% to 8% losses while the Dow fell more than 20% to 2365. As the market grew more volatile in the 1990s, and more prone to sudden sell offs on quarterly earnings shortfalls and analyst rating downgrades, we’ve made it a practice to set stops on all portfolio stocks and enforce them religiously. Stops are a major factor in USIR’s successful long-term track record.
In late
Oct. 1990, convinced that Saddam would be push back into
Jan.
1991 Relief Rally: Riding quick Gulf victory to our best year ever
The best
was yet to come. Coalition forces swept to quick victory over
To generate such dramatic gains in 1991 we pursued a two-pronged course of action—concentrating on leaders in both technology sectors and non-tech growth sectors.
In techs, we favored the stocks spearheading the Nasdaq’s advance—Microsoft, Compaq, Dell Computer, Intel—and largely avoided weaker newcomers that were also making a splash but are now forgotten. It helped that we had good sources of information, a spillover from my days as a financial journalist, including well-placed consultants and well-informed analysts who knew the emerging technologies and the up-and-coming companies well. Our own decades of experience at sizing up public companies and analyzing their stocks was paying off too.
In non-techs, which were more vulnerable to growing recession worries, we took advantage of a mid-1991 sell off to buy some of the fastest-growing stocks at reduced prices. The Conservative Portfolio bought non-tech growth leaders such as Abbott Labs, Coca Cola, Liz Claiborne, Merck, Philip Morris and Wal-Mart—plus Microsoft, now well enough established to be included in this large cap portfolio. In the more aggressive Growth Leaders Portfolio, besides fast-rising PA and computer software leaders, we bought medical and healthcare stocks—including both the big drug stocks and those of rising new stars such as Cordis, Forest Labs, Medco and United Healthcare. Among the new non-tech names added in other sectors were Black & Decker, Home Depot, Illinois Tool Works, Nordstrom, Reebok and Wal-Mart. All were big factors in the portfolio’s stunning 119% gain for 1991.
Oct.
1992 Bottom: Full investment catches a deceptive liftoff
In 1992, with recession lingering and a presidential campaign in progress, stocks made only so-so gains. The Nasdaq, after a spectacular 1991, was down 2% for the first nine months and the Dow and S&P 500 were up barely 2-3%. Our portfolios were up 6-7%—pretty tame for us. But very quietly an important market bottom was forming in Oct. 1992, a turning point that hardly anyone appreciated at the time. Nothing dramatic had occurred, save the election of Bill Clinton a few weeks later. Market advances were steady but un-dramatic over the following two years, 1993 and 1994. Yet the market lows of Oct. 1992—at Dow 3137, S&P 403, and Nasdaq 571—would never be seen again, or even be approached.
USIR basic bullishness, however, kept our portfolios fully invested. Thus we caught the unheralded Oct. 1992 liftoff even though we didn’t see it coming. Except in headlong market declines, we prefer to be fully invested. We’d rather trust our stock picking ability than attempt the difficult task of market timing—hopping in and out in anticipation of market turns. We think we can find winners in almost every market, even weak ones. And so it was in late 1992. Stocks weren’t moving much, but they were cheap and had lots of upside potential in a recovering economy. With no obvious threats on the horizon, we stayed fully invested. The only change was an increasing tilt in our portfolio allocations toward the tech sectors. In the Growth Leaders Portfolio we upped tech holdings from 15-20% of total assets to 25-30%. Thus, when the Nasdaq market rallied in the final quarter of 1992, so did the GLP—ending the year with a 24% gain, twice the Nasdaq Composite’s 12% gain. We were concentrated in a dozen or so of the Nasdaq’s best techs.
The overall market had a good but unexciting year in 1993. The S&P 500 rose 10%, and the Dow and the Nasdaq were up 14% and 15%. Our search for growth stocks took us into technology sectors beyond PC and software stocks. We added Seagate Technology in disk drives, EMC Corp. in computer storage, Intel and Micron Technology in semiconductors, and DSC Communications and Scientific Atlanta in telecommunications. The Growth Leaders Portfolio’s aggressive focus on a handful of fast-growing stocks was the antidote to a dull market. It jumped 43% for the full year, with most of the gain coming in the second half. The Conservative Growth Portfolio, holding large caps like AT&T, Ford, GE and Monsanto, as well as market leaders like Intel, Merck and Microsoft, rose 12% for the full year 1993, about in line with the market.
Mar. 1994 Correction: A contrarian decision in a down-market
Stocks were clobbered in early 1994. The Dow dove almost 500 points from 4000 to just over 3500. Bears chortled that the 12-year-old bull market, then up 350% from its 1982 base twelve years earlier, was finally running out of gas. Yet the averages, even with a sharp correction, remained far above their Oct. 1992 liftoff levels.
The USIR portfolios countered the down market pretty dramatically. Both declined in the second quarter, but their first quarter gains and stops kept them positive for the first six months of 1994. Then, in late spring, when hardly anyone was buying stocks, we made one our best series of portfolio reinvestments ever—redeploying stop-loss sale proceeds in a dozen or so new stocks that gave us great gains in a losing year for the rest of the market.
Conventional wisdom as stocks fell in early 1994 was to diversify and spread risk. But to me, diversifying broadly at that point guaranteed replicating the market’s poor performance. Instead, we looked for heavily sold stocks whose fundamentals suggested sharply rising near-term sales and earnings—and thus had potential for rubber band-type snapbacks from their depressed prices. By May we felt that just such an opportunity was brewing all across the technology spectrum. An amazing number of established leaders were down sharply in price even though they seemed primed for strong earnings growth in the rest of 1994 and well beyond—particularly those with dominant market shares in the semiconductor, computer software and computer systems sectors.
So instead of diversifying defensively, and increasing the odds of matching the lousy market, we concentrated our Growth Leaders Portfolio in the oversold tech leaders. In May, with the market still declining, we repurchased Intel, LSI Logic, Oracle and Dell Computer. In June we repurchased EMC, 3Com and Seagate. Then we repurchased Cisco, Compaq, Microsoft, Silicon Graphics, Storage Technology and Texas Instruments. By summer, half of the GLP’s holdings were tech stocks—too much for a normal market, but just the ticket at a time when oversold techs were the only ray of hope in a depressed market. The downside risk was minimal, since they were already depressed. Result: as these companies reported rising sales and earnings we rode a summer rally in techs for a 22% third-quarter gain. By year-end 1994 the gain was up 40% vs. declines for the year in all three major averages. The Conservative Portfolio was up 12% in a down-year for the overall market.
Mar.
1995 Breakout: Suddenly it’s a whole new stock market
The market averages bottomed in Dec. 1994. Heavy buying continued into 1995, quickly recouping 1994’s losses. By March the Dow broke out above 4000 for good, headed for 5200 by year’s end. The Nasdaq hit 1000 and kept on rising. The S&P 500 topped 500, headed for 600-plus by the end of 1995. Suddenly, after a so-so 1993 and a dismal 1994, the market mood had turned super-bullish—and would remain so for five years.
Good things were happening for stocks. The economy was strong. Peace prevailed. Inflation was under control. Rates were attractive. Employment was high. Americans had lots of money to spend. The Baby Boomers had discovered stocks. Pension funds had tons of fresh money to put to work every month. The PC revolution was still in full thrust, and now the Internet revolution was coming on with a rush. Opportunities for business growth beckoned in a host of new areas—not only in information technology, telecommunications and biotechnology, but from innovations in specialty retailing, healthcare delivery and other fast-growing non-tech service sectors.
It was as though a whole new market mentality emerged—with both plusses and minuses. Nobody realized then just how different equity investing would become. Gap-down volatility, day trading speculation and dot-com IPOs were still to come. On the positive side was the fabulous portfolio performance that lay ahead—more than anyone imagined. Even the most rampant bulls did not dream that the Dow would rise from 4000 to 11000 in the next five years, the Nasdaq from 800 to 5000, the S&P 500 from 500 to 1500. At USIR, bullish as we’ve always been, we certainly did not foresee that our Growth Leaders Portfolio, already up from $100,000 to $3 million in its first eight years, was headed above $30 million at the March 2000 market peak.
But you did know in 1995 that the market mood had changed. The bulls had taken charge as technology companies grew and multiplied and their stocks soared. We of course kept the USIR portfolios fully invested, with a distinct bias toward technology issues. By mid-1995 the Dow and S&P 500 were both up 19% year-to-date and the Nasdaq was ahead 33%. Our Conservative and Growth Leaders portfolios were up 31% and 39% respectively through June, and were headed for full-year returns of more than above 40%.
July
1995: As the bull charges USIR adds an Emerging Growth Portfolio
By 1995, too, investors were more comfortable with small capitalization stocks—and with the Nasdaq electronic marketplace where most of them traded. They had seen how swiftly the small caps of the 1980s turned into the technology giants of 1990s. Maybe thinly traded emerging growth stocks weren’t so risky after all—given the rewards that were being reaped in the 1990s technology boom.
USIR readers were asking for more small cap ideas. Some we had already recommended—like AGCO in farm equipment in 1993, Adobe Systems in software and Sunglass Hut in eyewear retailing in 1994—had doubled and tripled. Little-known Qualcomm, which we recommended at 15 and a market cap of just $540 million in mid-1994, quickly jumped to 40. So in July 1995, we formed a third model portfolio to invest in small and mid-cap stocks—the USIR Emerging Growth Portfolio. It would use the same basic strategy as the two existing portfolios: That is, the EGP would concentrate its holdings in a limited number of market share leaders in rapid-growth industry sectors. We would also insist on positive earnings, or reasonable near-future prospects of profitability. Only the names and sizes of the companies would be different from our Conservative and Growth Leaders Portfolios.
We started the Emerging Growth Portfolio with initial capital of $1 million, to put it on a par with the size of the existing portfolios. In its first three months—the third quarter of 1995—the EGP jumped 13% vs. 4-5% gains in the major averages. A Sudden dumping of tech stocks by Fidelity Magellan, the biggest mutual fund, in the fall of 1995 hurt all three USIR funds during the fourth quarter. It was one of the rare times when being fully invested in top quality growth stocks hurt our second half performance. But thanks to big gains in the first half, before the EGP was started, our Conservative and Growth Leaders Portfolios ended 1995 with terrific gains of 42% and 48% respectively.
Dec.
1996: Is the Exuberance really Irrational?
The new Emerging Growth Portfolio became our star performer as the market continued to climb in 1996. The major averages, despite bouts of profit-taking during the first half, enjoyed a strong finish and posted a second super year in a row—with the Nasdaq up 30% and the Dow and S&P 500 each up about 25%. It was market made to order for USIR’s portfolio strategy and stock picking abilities. The Emerging Growth Portfolio rose 63% in its first full year of operation, edging out the 58% gain in our Growth Leaders Portfolio. Our Conservative Growth Portfolio was up 35%, also ahead of the averages.
Yet for all of the rejoicing over a second super year, 1996 ended on a sour note. In early December Federal Reserve Chairman Alan Greenspan publicly denounced the stock market’s “irrational exuberance”—triggering a sell off that persisted into the first quarter of 1997
Exuberance, yes, but irrationality? P/E valuations had certainly risen. Yet even red-hot Intel still traded at a modest 15 times year-ahead estimated earnings. Dell and EMC, two other technology favorites, also traded at mid-teens forward P/Es. True, other big movers were indeed edging up to rarified valuations: Cisco, Microsoft and Oracle now sported forward P/Es in the 25 to 32 range—but all were expected to grow their earnings at 25% to 35% a year. That put their PEG ratios—measuring P/Es against growth rates—very close to the one-to-one parity considered by analysts to be ideal. Among USIR's biotech and telecom stocks as 1996 ended, Biogen and Ascend Communications traded above 30 times forward earnings—but those P/Es were offset by projected earnings growth rates that kept their PEG ratios at the one-to-one level.
Valuations were up, for sure, but had not yet become irrational in our view. So when stop-loss sales hit the USIR Portfolios in the wake of Greenspan’s famous remark, we were quick to repurchase the likes of Oracle, Gateway and Biogen and return to a fully invested stance. And that proved to be the correct stance—not only in early 1997 but for the next three years.
Oct.
1997: Coping with day trading, volatility and whisper numbers
I wrote as 1997 began that I expected another big year for stocks—given the moderate, low-inflation growth of the economy and the broad strength in corporate earnings. The Greenspan remark still hung over the market in the first quarter, when it was reported that 40% of all stocks were down 20% or more from their highs. But the market roared back in the second quarter, helping the USIR portfolios to large year-to-date gains of 40% to 50% each through September.
Worries were cropping up, however. One was the big increase in daily price volatility, aggravated by the minute-to-minute speculation of day traders using Internet accounts. Rapid communications and rising P/Es brought another disturbing phenomenon—an unprecedented focus on quarterly earnings reports. Suddenly matching analyst estimates for the current quarter became more important for companies than meeting their long-term earnings targets for the next two or three years. This unhealthy near-sightedness led to the appearance of so-called “whisper numbers”—the quarterly earnings figures that analysts privately told favored clients to expect as opposed to those in their published reports. As whisper numbers were bandied over the Internet, daily price volatility became treacherous.
In an effort to combat the flood of divergent estimates, companies that previously avoided releasing earnings estimates began to provide so-called “earnings guidance” to analysts. This additional flow of information, which seemed laudable at first, magnified the focus on short-term quarterly results and thereby increased daily trading volatility. I will not forget the day late in 1997 when Oracle, one of USIR’s most successful stocks, opened “gap-down” from 32 the day before to 24 after reporting an earnings increase the previous evening—because at the same time it had also hinted that next quarter’s sales might fall short of analyst expectations. Huge gap-down openings on “earnings shortfalls,” which CNBC commentators jokingly began calling “disasters du jour,” became commonplace.
During the final quarter of 1997, when the Oracle gap-down was followed by a series of similar opening-bell disasters in leading growth stocks, our Growth Leaders Portfolio suffered a rare quarterly decline. As one wag noted, “They took the best stocks out back one by one and shot them.” The tumble became known as the “Tech Wreck.” Yet even with a fourth quarter loss, the GLP wound up 1997 ahead 41%, thanks to 22% gains in both the second and third quarters. It was the fifth straight year the GLP had returned 40% or more, and its market value was now close to $10 million—up 100-fold from its starting capital of $100,000 in Jan. 1987.
Again, however, the new Emerging Growth Portfolio stole the show, rising 57% on top of its 63% gain of 1996. Its performance included 50% to 100% gains in Atmel, BJ Services, BMC Software, Cambrex, Semtech, Tel-Sav Holdings and other small caps. From an initial $1 million it had already grown to $2.7 million and was now larger than our ten-year-old Conservative Growth Portfolio. The CGP, compared with the GLP, had risen a “mere” 39% in 1997 but had grown from $100,000 to $2.1 million since its 1987 startup.
Aug. 1998: The world turned upside-down
Three great years had pushed the Dow from 4000 to 8000, the S&P 500 from 500 to 1000, and the Nasdaq Composite from 800 to 1600. But while the Tech Wreck scars of late 1997 were fresh, stocks rebounded during the first part of 1998. Could a fourth super year in a row be in the making?
We were fully invested, with all three USIR portfolios allocated over 75% to information technology, telecom and biotech stocks. That was a disproportionate tech bias, but it did give us a great jump on the year. By the end of June the Growth Leaders Portfolio was up another 37% year to date. The Emerging Growth Portfolio, after some small cap profit-taking in the spring, was still up 19% through June—ahead of the mid-teens percentage gains in the major averages. Our Conservative portfolio at mid-1998 was up 23%. All systems did indeed seem be “go” for another great year.
But a
major sell off would interrupt the party for a few brief but scary months.
Economies from
At that point, the Fed made a crucial move—one with long-lasting repercussions. With the global financial crises unresolved and a possible recession looming at home, the Fed began lowering short-term interest rates. When the stock market sold even lower after the first stimulative rate cut, the Fed eased some more, and then more after that. A nervous stock market soon got the drift. Whoosh! Depressed stocks shot upward in the fourth quarter. The Nasdaq rose 42% in three months, giving it a 54% rise for the year. The Dow returned to 9200. Our own portfolios, quickly restored to fully invested levels after heavy stop outs during the summer, rode the resurgent market with their holdings of growth sector leaders. The Growth Leaders Portfolio bounced back 44% in the fourth quarter to an 86% gain for the year. The Emerging Growth Portfolio, with an even larger 58% fourth-quarter comeback, wound up the year ahead 74%. The Conservative Growth Portfolio, up 30% in the final quarter, gained 54% for the full year.
Oct.
1999: The Bull’s last charge
In USIR’s first issue of 1999 I made three points that turned out to be prophetic:
One, I cautioned against too much stimulation by the Fed, writing that “moderate inflation … is the stock market’s best friend,” but that over-stimulation was a serious mistake. Two, I suggested that subscribers “stay fully invested, but with stops in place in case debris from the bursting Internet bubble weighs down the whole market.” Three, I warned that “the most immediate threat [to stocks] are excessive valuations in certain sectors.”
Alas, the Fed did over-stimulate in 1999, as I feared, until it saw that excessive inflation developing. Whereupon it reversed direction so aggressively, raising rates six times in the following year, that it threw the economy into a prolonged recession. Alas, too, the bursting of the Internet IPO bubble did in fact spill over into the rest of the market with disastrous impact. And alas, thirdly, hyper-inflated P/E valuations did prove the undoing of the 18-year bull market in March 2000.
That same Jan. 1999 issue of USIR also reported that our portfolios were almost fully invested, despite fast-rising P/Es. Cisco was now at 52 times forward earnings, EMC at 45, Microsoft at 50—although Oracle’s 28 P/E and Qualcomm and Intel’s 21 P/Es still seemed reasonable. Beyond the tech sector P/Es Pfizer was at 50, Guidant at 39, GE and Safeway at 33. We rationalized owning such stocks because 1) they were still rising and 2) their projected earnings growth still seemed to justify high valuations. We did not yet know that the Fed would soon reverse direction and hit the brakes hard enough to trigger a recession and cripple earnings growth and stock prices for the next three years. As stocks continued upward in 1999, however, we did tighten our stop loss limits across the board—from 9-10% to a more defensive 7-8%.
Another new defensive wrinkle: With the Dow 10000 in March, then 11000 a month later, the bull market was looking over-extended. Besides tightening our stops, we also suspended our strategy of staying fully invested. We began allowing cash from stop-loss sales to accumulate instead of reinvesting it quickly. It was a form of market timing. We were more conscious than usual of the need to protect capital, to preserve the large gains we’d made over the years.
These defensive moves were evident in our performance in late 1999, when the bull market mounted its final charge. The Dow crested at 11479, its all-time high. The Nasdaq would shot up 57% for the year, from 2500 to 4000—though still short of the 5049 peak it would hit two months later. But USIR was more cautious now. We hung back during a period of mid-1999 market weakness, content to let cash from stop-outs accumulate. As a result, we were more lightly invested than usual when the bull market began its climactic rally in late 1999. We lagged far behind the Nasdaq’s 49% second-half gain. But we did reinvest enough to see the Growth Leaders Portfolio rise 33% for the second half and the Emerging Growth Portfolio rise 38%. Moving cautiously, all three portfolios were one-third in cash in mid-December, but they had fourth-quarter gains of 20% to 28%. It was mainly stock selection, always our strong suit, plus of course the market’s strong momentum, produced those gains. In the Emerging Growth Portfolio, for example, September reinvestments in Amazon, Citrix Systems and Cree Research were up 32%, 41% and 47% respectively by mid-December.
Mar.
2000: Ducking for cover at the top
From a tactical viewpoint, the first quarter of 2000 was one of our best. We didn’t score our biggest gains that quarter. But while the market averages stumbled at the start of 2000, then fell badly in March, we did manage to post increases of 13%, 22% and 31%, respectively, in the Conservative, Growth Leaders and Emerging Growth portfolios. More importantly, we also made two good tactical moves:
First, we went into year 2000 positioned in the stocks that were leading the market’s furious final advance. Our reinvested position in Cisco would rise from 69 to a peak of 102 before we sold it. EMC would rise from 74 to 106, Home Depot from 46 to 60, Oracle from 73 to 108, Citrix Systems from 65 to 122, and Cree Research from 50 to 77—to name our most successful reinvestments of late 1999. Thus, while the averages began slipping in February, our portfolios of market leaders were still rising even as the market averages peaked out.
Second, we bailed out early after the Nasdaq topped at 5049 on March 10 and the bug-cap averages topped out in April. We sold our high-P/E stocks with most of their gain intact, lifting cash back to the 35% to 50% level during March, while the market declines were still mild. In April we completed our retreat to cash, with more sales and stops minimizing our losses in the hardest-hit stocks. By mid-April, four weeks after the market top, we had just two stocks and 87% cash in the Conservative Growth Portfolio. We held four stocks and 83% cash in the Growth Leaders Portfolio. And we had four stocks with 71% cash in the Emerging Growth Portfolio. At that point the Nasdaq was back below 4000, where it began the year, on its way to 3100 by mid-summer.
We took some hits later on, but small ones. After the market fell we found ourselves in denial. I did not want to believe that the great bull market was over. So when the Nasdaq rallied back from 3100 to 4200 during the summer of 2000, we put some of our large cash reserves back to work. But the rally quickly failed, as did another in the fall. Two false rallies, plus growing signs of recession, made a believer of me. We rode out the rest of 2000 with cash reserves of 60 to 80%.
What had gone wrong? It’s easy to blame bloated P/Es and irrational exuberance. But those were merely symptoms. The main reason the market kept tumbling for the next three years was onset of a recession that suddenly came out of nowhere in 2000. The Fed, fearing inflation from its 1998-99 over-stimulation, was still raising rates to slow things down in June 2000—three months after the stocks peaked. That second Fed blunder in row set off a recession that grew deeper and deeper in 2001 and did not show signs of turning around even sluggishly until late 2002. The Fed’s ill-advised tightening in 1999-2000, in my opinion, turned a much-needed stock market correction into a three-year bear market.
Few saw recession coming at the March market top. But by the fall of 2000 corporate sales and earnings were starting to decline, particularly in technology sectors where booming capital spending suddenly dried up. Tech stocks, once considered immune to economic downturns because their products and services improved customer productivity, were no longer immune. Tech company sales and earnings hit the skids, and so did their stock prices. The big guys—Cisco, Sun Micro, Oracle and their ilk—fell 20%, then 40%, then 60% and more by early 2001, and stayed down. Cisco, once at 80, would remain mired in mid-teens three years later. Oracle, once at 46, was still bogged down in the low-teens in early 2003. Sun Micro was down from 128 to 3, EMC from 103 to less then 10, Qualcomm from 108 to the 20s, JDS Uniphase from 140 to 3. Those had been some of our best stocks. Under the circumstances, we were happy to emerge from year 2000, when the Nasdaq fell 30%, with only single-digit percentage losses for the full year in our model portfolios. Timely sales and strict stop-loss limits spared us the runaway losses suffered by so many others. From a peak market value of $31 million at the March peak, our Growth Leaders Portfolio had backed off to $26 million, down 16%, while the Nasdaq at 2773 was down 45% from its 5049 March 10 bull market high.
Apr.
2001: Hey, this Bear Market is for real!
For a long time I resisted calling it a bear market. That’s symptomatic of my bullish bias. I’ve always seen the glass as half full, not half empty. But I had to bow to reality as the recession and the market worsened month after month in 2001. The Nasdaq continued to tumble, below 2500, then below 2000, then below 1500 in the third quarter—down 73% to 1387 since March 2000. Large cap industrials fared better than the techs, but the Dow and the S&P 500 were down 30% and 40% from their early 2000 all-time highs. Yes, this was indeed a bear market.
Fortunately,
we’d long since shifted to the defensive—and stayed there. Cash early in 2001
ranged from 70% to 90% of our portfolio assets. There was a temptation to
reinvest in an early 2001 rally attempt, with stocks down so much. But in
February a drumfire of downbeat economic and earnings reports signaled that the
recession was getting worse, not better. The market overall suffered a awful
first quarter, a flat second quarter, then a horrible third quarter—when the Nasdaq fell 29%, giving it a 46% loss year to date. Even
our lightly invested Conservative and Growth Leaders Portfolio were stung by
losses of 16-17% in the first quarter--their worst ever. But with ample cash
reserves, and with holdings restricted to small positions in a handful of
leading sectors, we reduced those losses significantly during the summer—before
the 9/11 disaster came along. Our Growth Leaders and Conservative Portfolios
were close to break even when the
The market’s sharp rally from its two-week plunge after the 9/11 attacks was exciting yet brief—merely a relief reaction to the panic selling that preceded it. The recession was far from over. So while the Nasdaq bounced back more than 40% in the ten-week spurt, it ground to a halt in December and ended 2001 down 30% for the year, and destined for deeper declines in 2002. We bought cautiously into the rally, holding enough of the right stocks to out-gain the Dow and S&P 500 (but not the Nasdaq) during the short post 9/11 rally. As a result, we wound up 2001 with losses of only 4% and 6% in the Conservative and Growth Leaders Portfolio—and with a startling 23% gain for the year in the our Emerging Growth Portfolio.
Oct.
2002: Was that really The Bottom?
By 2002 the Fed had cut interest rates to the bone, yet economy remained sluggish. The lack of renewed economic drive, plus confidence-sapping corporate and Wall Street scandals, kept stocks reeling to lower lows during the first nine months of 2002. The Dow, which had popped above 10000 in the post 9/11 rally, slumped to a new bear market low of 7200 by Oct. 9. The Nasdaq Composite, which had edged back to 2100 in the late 2001 rally, plunged back to 1100, also a new bear market low.
In the USIR Portfolios we continued to sit on large cash reserves, using tight stops and nimble sector rotation into currently favored stocks to minimize losses and snare occasional gains. It wasn’t exactly style; we favor investing for long-term gains and keeping portfolio turnover to a minimum. But in a nervous bear market, in the midst of a persistent recession, momentum tactics were the way to avoid losses and occasionally bag some gains. Thus we kept our first nine-month portfolio losses to 10% to 14%, at time when the Nasdaq was down 40% for the year and the Dow was down 25%. Not wonderful, to be sure, but a lot better than the market and most mutual funds were doing.
By the fourth quarter, the economy was showing grudging signs of starting to recover. And stock valuations had been reduced significantly by months of selling. All three major market averages bottomed on Oct. 9 and in the ensuing two-month rally pushed Dow back to 9000 and the Nasdaq back to above 1500. Consumer, retailing, homebuilding, home finance, medical care and biotechnology stocks led the rally. Even so, the Dow and the Nasdaq wound up 2002 down by 15% and to 30% for the year. And while we continued to hold comfortable cash reserves, we reinvested in enough of these momentum plays to break even for the full year in our Growth Leaders Portfolio and lose only 6% in the Emerging Growth Portfolio.
Was Oct. 9 really The Bottom of the bear market? Despite daunting geo-political developments in 2003, and mounting deficits at all levels of government, the consumer-driven U.S economy gained strength steadily in 2003 and corporate earnings, enhanced by vigorous recession cost-cutting, began to recover. Stocks came close to retesting their 2002 lows during the build-up to the invasion of Iraq. But when the fighting began in March a new rally erupted. We began reinvesting our cash reserves in March and April, gradually at first, then aggressively. By mid-2003, with the USIR Portfolios ahead over 20% year to date vs. 5% and 10% gains for the Dow and S&P 500, it was clear that the bear market was finally over. A new bull market was underway. By the final quarter of 2003, the Growth Leaders and Emerging Growth Portfolios were both up more than 50% for the year. The Conservative Growth Portfolio was up 35%, twice the gains in the Dow and S&P 500.
2003
and Beyond: A Bull’s Postscript
My long-term bullishness on stocks is based on years of studying the market, public companies, economic and historical cycles, and human nature. I have learned, as the ancient saying goes, to look adversity in the eye and tell myself that “this too shall pass.” Over the long haul, shares of leading growth companies in our free enterprise economy will reward intelligent, patient investors. The new bull market may not match the historic 1982-2000 bull market. But the basic principles of stock selection and portfolio strategy that served USIR so well then, and through the bear market, remain valid today—and will continue to produce handsome, consistent gains.