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Is it Safe Yet?

After three excruciating years, the equity markets posted impressive gains this spring. But don't let the feel-good rally go to your head.

Does the phone ring with a sweeter tone? Is the workday flying by? Do clients smile at you when you bump into them at restaurants? Has perhaps the market found its bottom and have clients recovered their nerve? Is it safe to go back to business as usual?

Certainly the market's performance this spring and the enthusiastic reaction of investors have changed the mood among financial advisors. After three years in the bunker, absorbing blow after blow, reps have reason to be more relaxed — because their clients are.

“I've had people who have picked up the phone, and called in and said, ‘It's nice to see our statement showed a positive,’ ” says Carol Rogers, president of Rogers & Co./Wachovia Securities in St. Louis.

Conversations about losses and portfolio repair have turned to talk of opportunity. And why not? Nearly every major index is up strongly this year. In June, the Dow Jones Industrial Average closed above 9,000 for the first time since August 2002, racking up a 19 percent advance from March. The Nasdaq, a veritable wasteland since 2000, made an even better showing, jumping 23 percent from mid-March to mid-June. The fuel? The end of the war against Iraq, encouraging first-quarter earnings and the prospects of even better returns in the second half, rebounding consumer confidence, plus a little jet fuel from President Bush's tax cuts, which reduce capital gains rates and taxes on dividends (see related story, p. 35).

So what do you do now? First, curb your enthusiasm. Sure, you can do the end-zone victory dance in your office when one of those shell-shocked clients who wasn't returning your calls agrees to schedule a portfolio review. But, it's critical to keep clients focused on the fundamentals that will carry them through the inevitable fits and starts of a rebound.

When those upbeat clients call Rogers, she tries to talk them down from visions of 1999. “We're reacting very conservatively,” she says. “This could be the total return that we see in the markets this year — and we could give back a portion of it, and that's the end of it. I don't think we've promised too much to them or pushed expectations.”

Given the rapid advances of major indices in the first half — and the uncertain pace of actual economic recovery — many market strategists remain leery. “Corporate profits are improving, but the quid pro quo is the consumer is going to back down a bit,” says Jeffrey Saut, chief investment strategist at Raymond James. “And inflation is going to come back to some degree — if that happens, you're going to get a muddling economy, and a trading-range market.”

Saut says the secular market remains range-bound and that history suggests it's too soon to see a sustained bull market. “If you parse the numbers, there have been three secular bull markets in the past 102 years. That's 1921 to 1929, 1946 to 1966, and 1982 to 2000,” he says. “If you look at what happened after each of one of those secular peaks the markets went sideways for years.” In particular, he finds large-cap stocks overvalued.

In other words, even if clients are banging on your desk, demanding a quick fix, help them resist temptation. That doesn't mean that it isn't a good time to review asset allocations and present some new options to clients. “As things continue to improve, we're asking clients whether they want to start lifting their equity exposure — but we're still telling clients to be patient,” says Lincoln Anderson, chief investment officer at LPL Financial Services.

Managing Expectations

Anderson and other strategists say that it helps to remind clients that markets move on expectations of where the economy (and earnings) will be six months in the future. And, because of that, the market is sometimes wrong. Think back to last July when the markets soared and some analysts predicted the end of the bear market — just before the WorldCom bankruptcy, faltering economic growth and the specter of war with Iraq took the markets down below post-September 11 levels.

This summer, the economic recovery remains theoretical: Job losses are mounting and business investment has still not recovered. And, by mid-June, metrics such as the proportion of new highs recorded by NYSE issues were indicating that the market might be overbought, according to Richard McCabe, chief market strategist at Merrill Lynch.

How do you keep clients focused? “You almost have to be a little bit of a psychologist,” says one Morgan Stanley broker. “Left to their own devices, people often do stuff that's the opposite of what they should be doing. What happens is, if you're on a train frequently, you often hear people say, ‘My golf partner says do this…’ What you try to do is point out how doing what the herd has done hasn't worked.”

Then again, there are investors who don't want to listen — even though the lessons of irrational exuberance are still so fresh. One veteran Wachovia advisor says he lost a client recently because his buddies convinced him to switch to a more aggressive broker. The client felt he should have gotten more out of the market's spring sprint, which would have meant abandoning his investment discipline. “I've tried being realistic as far as telling people what the market has done for us,” says the rep.

Pleasant Conversations

There are certainly plenty of good things to talk to clients about. The 200-day moving average (an important technical barometer) of the S&P 500, Nasdaq and Russell 2000 all started to trend upward in the spring. Stock mutual funds finally stopped hemorrhaging money too, posting an inflow of $16.1 billion in April, compared with an outflow of $276 million in March, according to the Investment Company Institute.

The positive mood swing is palpable — in the business media, in client conversations, at seminars. Advisors say that clients have been more relaxed, more upbeat than at any time since before the market stalled in 2000. “Without a doubt, the fear is no longer there — people were scared to death,” says one Merrill broker. “A few people are starting to call. It changes my attitude. Now, I feel comfortable to call and say, ‘Let's buy something.’”

The result, according to various financial advisors, is an improvement in the prospecting environment. New account openings at Schwab rose to 69,400 in April, up 26 percent from the previous month. But that's still down 35 percent from the previous year, according to Sanford C. Bernstein. Schwab's daily average revenue trades (DARTs) figure reached 120,000 in April, up 5 percent from March. Bernstein brokerage analyst Kelly Tang points out that Schwab's DARTs is up 18 percent from the lows reached in February, and May's figures looked to be strong as well. However, this measure of activity is still down more than 60 percent from this time last year, and Bernstein's analysis predicts that a retail recovery isn't really in the offing until 2004. (Bernstein uses the Schwab data as a proxy for retail investor activity; the wirehouses don't release such figures.)

Brokers say they're stepping up their use of seminars, especially those focused specifically on market conditions. But the advisors who are making the most of this brighter climate are the ones who worked with investors throughout the downturn to lay the groundwork for an eventual recovery.

Process is King

“Those who have grounded their clients in a strategy — money is flowing towards those guys in an amazing way right now,” says Michael Brizz, president of the Center for Professional Achievement in Cleveland, a consulting firm that works with reps at major broker/dealers to increase referrals.

This group is not restricted to the few — the lucky — who prevented losses over the past three years. “Unless you moved to cash and 80 percent bonds, you lost, and if you did that, you're somewhat of a market-timer, and that's not a historically proven process,” says one Wachovia advisor. He says despite the run-up, he continues to focus clients on complete financial planning, looking at the entire wealth picture and then at the markets.

And, at this point, a little risk insurance couldn't hurt. Some advisors suggest writing covered calls to protect against downside risk.

Meanwhile, advisors tell Rep. that they're moving into dividend-paying stocks to take advantage of the new tax laws. But beware that strategy, warns Merrill Lynch's chief strategist, Richard Bernstein. He wrote that the tax cuts are not likely to result in a large number of companies offering increased dividends. His view is that any gains attributable to the dividend cut will be restricted to the traditional dividend vehicles in energy, industrials, consumer staples and drugs.

Other brokers are playing the cycle, emphasizing the small- and medium-cap stocks that tend to lead the market out of recessions. In each of nine recessions going back to 1949, according to Ibbotson Associates, this has been the pattern. In fact, small caps boomed in the first half, leading all indexes. Through June 9, the Russell 2000 was up 16.11 percent year-to-date, compared with a 7.65 percent gain on the Dow and an 11 percent rise in the S&P 500. Again, strategists caution that such a rapid advance is not likely to be sustained.

A Soft Rebound

And for all the reports of upbeat customers listening to new ideas and even bringing in fresh assets, reps say that the market's rebound hasn't done much for their bottom lines yet. Yes, clients are feeling better, and they're more interested in buying equities, but the volume is not there that transaction-oriented brokers need. Nor are fee-based advisors seeing a surge in assets.

“It's tougher and tougher to sustain a 3 percent increase in new business” every month, says one Wachovia producer. “On the first of every month, you get those ‘first of the month’ blues.” He says he's currently switching to a fee-based approach to avoid having to start over in terms of income every month.

Meanwhile, brokers who are already focused on fee-based business say the payoff from better markets is not yet evident. “The annuitization doesn't come back as quickly a we'd like it to,” says a Merrill rep. “It'll be another six months to a year; there's not much way to control it. You just have to accept it as part of what you do for a living.”

Brizz of the Center for Professional Achievement says the way for advisors to improve their business has not changed: Reps who thrive are the ones who create a smart investing discipline for their clients and stick with it — they don't rely on the markets to do the work for them. “What you can do is provide guidance and ask a few questions,” he says. “It's not a situation of, ‘How do we capitalize on this particular stock or rally?’ but a well-grounded strategy, and if you're well-grounded, you're not subject to the whims of the market volatility.”

This is sound advice, because when it comes to the market, there is good reason to remain cautious.

“It's a breather,” says Carol Rogers, the St. Louis advisor. “Don't confuse that with good. Keep your head down, because we're still not at good. We've been sucker-punched so many times.”

On the Rebound

After months of outflows, equity mutual funds are starting to attract investment dollars again.

Millions $
July-02 -52,608
August-02 -3,063
September-02 -16,095
October-02 -7,502
November-02 6,953
December-02 -8,301
January-03 -371
February-03 -11,094
March-03 276
April-03 16,096
SOURCE: Investment Company Institute
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