Wednesday, June 17, 2009

How to Make Money in Range-Bound Markets


Independent Investment Advisers



June 30, 2005

How to Make Money in Range-Bound Markets

As we all know, stock and bond prices move up and down over time. Persistent price movements in one direction or the other eventually develop into trends. Investors, of course, favor up trends and frown upon down trends.

There is a third price pattern however that is almost as common as the up & down price actions we are all familiar with. This is an essentially flat pattern that occurs when security prices fail to move decisively in either an up or down direction. Instead, they do little more than hover around the same level. We find ourselves in this situation today.

The major stock market averages, year-to-date, have bounced around a fair amount but, despite the volatility, remain within a few percentage points of where they began 2005. The trend is essentially flat. Be that as it may, investors remain interested in earning a positive return on their money even as stock and bond prices aren’t cooperating much. There are a number of alternatives available to combat flat market cycles.

1. Increase the income component of the portfolio. This is accomplished by shifting the asset allocation of the portfolio away from growth-oriented investments and toward income-producing securities like bonds and dividend-paying stocks. The interest and dividends earned on these types of securities is real cash paid to the portfolio regardless of what the prices of these securities are doing. We frequently hear this referred to as “getting paid while you wait.”

While this sounds good, there is a trade-off. The income generated comes at the expense of capital appreciation (i.e., growth). Consequently, when security prices do eventually break out of their trading range, assuming an upside move, the income-oriented portfolio will under perform. Therefore, investors must consider whether it is better to stick with the original asset allocation and simply wait out the doldrums or change the portfolio mix as described above.

2. Sell call options. A call option is simply the right to buy a share of stock at a fixed price at a fixed date in the future. A conservative way to sell call options is to sell them on stocks that you already own in your portfolio. These are called covered calls. Selling a covered call is a bet on your part that the share price will drop below a certain level at which the buyer of the call will decline his/her right to buy your stock. He/she already paid you real cash for the right to purchase your stock and now that right has expired. You retain your stock and keep the cash from the sale of the covered call. Successfully executing this strategy again & again can have a materially positive impact on portfolio performance.

As always, however, there is a trade-off. If the price of your stock rises instead of falling, the buyer of the covered call will exercise their right to buy your stock at a lower than market price. You lose your shares and forgo the incremental gain in the stock. Ouch!

3. Security Selection. You’ve probably heard the phrase, “This is a stock picker’s market.” This means that the markets overall aren’t doing much so investors have to pick their spots in order to achieve a positive rate-of-return. This is a research-intensive and time consuming approach.

Utilizing this approach in 2005, investors who over-weighted the energy (+18.84%), utility (+13.16%), and health care (+2.69%) sectors were rewarded. These are the only industrial sectors of the US economy that showed positive performance year-to-date. Interestingly, focusing on just the 12 weeks that comprise the second quarter is also revealing. Utilities (+8.35%) and healthcare (+3.75%) did well again. But financials (+3.65%), telecommunications services (+2.64%) and information technology (+1.60%) all delivered positive performance and surpassed the energy sector (+1.52%). By not owning these newcomers, investors would have hurt their portfolio performance in the second quarter.

So what’s the best solution? Meyer Capital Management uses a combination of all three of the techniques discussed above. Prevailing market conditions and individual client objectives dictate how and to what extent we implement each method. As each client is different, each investment portfolio is also different. Utilizing a case-by-case approach enables us to customize our methods to meet individual circumstances.

How good are the results? Fully, two-thirds of the MCM-managed portfolios show positive, market-beating returns year-to-date. For the second quarter alone, that figure increases to almost ninety percent.

We hope you are having an enjoyable summer. As always, just let us know if there is any way that we can meet your needs better.

Timothy R. Meyer


Investors Want Same Rules for Advisors, Brokers

Survey: Investors Want Same Rules For Advisors, Brokers

November 22, 2004

WASHINGTON (Dow Jones) – Investors don’t understand the difference between brokers and financial advisors and are very concerned that both can offer financial advice without being subject to the same rules, according to a new survey to be issued Monday by a leading discount brokerage firm.

A whopping 90% of the investors surveyed want Congress to step in and set uniform standards of protection for stockbrokers and investment advisors who provide fee-based financial advice, said TD Waterhouse Group, Inc., a subsidiary of Toronto-Dominion Bank (TD), which sponsored the poll.

Confusion abounds when it comes to current laws: The survey found a majority of investors mistakenly believe brokers are legally obligated to act in the investor’s best interest, and only 25% know that investment advisors have such an obligation. It found similar confusion about other rules required of investment advisors, but not brokers, such as the duty to inform customers of any conflicts of interest before providing investment advice.

Fully 84% of those questioned said financial advisors and brokers that offer fee-based financial advice should come under the same industry regulation, according to TD Waterhouse. Almost as many said they are concerned about the differences and agreed they would be more likely to choose an investment advisor over a broker if they knew they would receive more protections by doing so.

Release of the findings comes as the issue returns to the front burner at the SEC. In 1999, the agency proposed allowing brokers to offer discretionary, fee-based advisory accounts without coming under the stricter rules governing investment advisors. The SEC never approved the proposal, dubbed “the Merrill Lynch rule,” but promised not to sue brokers who act as if it were in effect.

Financial planners complained the SEC’s approach was a boon to Merrill Lynch & Co. (MER) and other brokerage firms, allowing them to market advisory services while avoiding stricter advisory rules. Earlier this year, the Financial Planning Association sued the SEC, saying its implicit approval of the 1999 rule without a formal vote violates federal administrative procedures. The lawsuit prompted the SEC to reopen the matter for comment, and it has promised to resolve the matter shortly.

TD Waterhouse said the fight should be decided in favor of investors, not planners or brokers. It suggests the SEC scrap distinctions between brokers and financial advisors, ensuring that investors get equal protection when they get professional financial advice.

“We recommend a common industry standard that provides investors uniform protection,” TD Waterhouse USA President and Chief Executive Timothy Pinnington said in a statement announcing the survey results.

Distinctions between brokers and advisors have blurred over the years, making separate rules a mistake, Pinnington wrote in a Sept. 22 comment letter to the SEC. He said anyone offering fee-based investment advice should be subject to the same disclosure and sale practice rules, and be required to provide the best execution of customer trades while eliminating bans on principal trading now in place for investment advisors. Since distinctions between brokers and advisors are contained in existing laws, TD Waterhouse said the SEC likely would need Congress to rework and update those laws.

The survey, conducted in October, covered 1,000 investors who hold stocks, bonds or mutual funds outside an employer-sponsored retirement plan, such as a 401(k), and has a margin of error of plus or minus three percentage points, TD Waterhouse said.

By Judith Burns, Dow Jones Newswires, 202-862-6692

Buy Low - Sell High: Putting Theory into Practice

Investment Commentary March 2001
Copyright © 2000 Meyer Capital Management, Inc. All Rights Reserved.

March 30, 2001

% Change From 12/31/00




S&P 500:






Russell 2000:



If it Sounds too Easy to be True…It Probably is
To many of us, skydiving sounds like it would be a blast, just hop from the plane and float softly to the ground. To others, climbing Mt. Everest drips with the promise of excitement and adventure. In both instances, what sounds great at first takes on a very different meaning when, for example, the moment arrives to throw yourself from the plane or the oxygen on Everest begins to get thin.
So it is with "buy low-sell high." It may be the most basic of all investment axioms. Its appeal is easy to understand because everyone can relate to its simplicity. What isn’t so obvious is the difficulty of putting it into practice.

Investors’ Resolve is Put to the Test
One of the most meaningful benefits a good investment manager can provide for his/her clients is assistance in viewing market events realistically and dispassionately. For the client, whose hard-earned money is on the line, this can be pretty difficult since we’re talking about more than just money. For individual investors, we’re likely to be talking about a sense of security, personal achievement, goals, and dreams. Likewise, institutional investors feel the weight of responsibility for the assets entrusted to their care. If these matters aren’t worth getting a little emotional about, what is? Yet, therein lies the problem, be it fear, panic, greed, or just a loss of patience, emotion makes a poor basis for investment decisions. In fact, most investment mistakes are of an emotional, rather than intellectual, nature.

Today, for the first time in almost 15 years, investors find themselves in the midst of a full-blown bear market. This is foreign territory for anyone who wasn’t an active investor in 1987 or 1981-82, the most recent prior bear markets. The first key to surviving the tumult is coping effectively with the strong feelings that the current market conditions can evoke. During challenging times like these, a brilliant investment decision may be synonymous with avoiding a fear-driven mistake.

While perhaps not immediately obvious, buying low and selling high is intimately associated with the kind of market volatility we’re currently experiencing. Before discussing that more fully, we need some additional perspective. Exhibit 1.1 shows unequivocally that the stock market does deliver higher rates of return over time than alternative investments, in this case long-term bonds. Remember, however, that the length of the investment time period is key.

Contrary to some popular opinion recently, which held that all you have to do is hold some Nasdaq stocks to make loads of money, the stock returns shown above didn’t come easily or cheaply when you look at what investors endured to realize them.

Exhibit 1.2 shows the year-to-year volatility of stock market returns (blue line) since the mid-1920’s. As you can see, the ups and downs occur regularly and randomly. This is normal stock market behavior and it is not possible to predict the pattern. There are two conclusions, each of paramount importance, to glean from this chart:

1. The blue line indicates that, in any given year, it is not unusual for stock market returns to fluctuate +/- 50% and, occasionally, even more. This is what we saw in 1999 when the Nasdaq was up almost 86%. In 2000, it reversed course and dropped 30%, and is down another 30% thus far in 2001.

2. The red line shows that, since the early 1950’s, the average annual return of the market has held pretty steady at or about the 10% return level. This is significantly greater than the historical rate of inflation and the historical rate of return on long-term bonds. Remember also that there were numerous economic recessions, bear markets and stock market corrections during this time period.

People I meet on the street ask me "What’s wrong with the stock market?" I answer, "Nothing is wrong, the market is behaving normally and is doing what markets do." That is to say, they fluctuate, and hidden in the ongoing fluctuation, lies both risk and opportunity. Hence, a basic precept at MCM is that market volatility is not to be feared or avoided, but should be viewed as an opportunity.

Say What?
In modern society, we’ve forsaken mattresses as savings vehicles and we invest our money for two primary reasons. They are to prevent inflation from eroding the purchasing power of our money and to build wealth. Exhibit 1.3 shows that since the mid-1920’s the returns on long-term bonds have been sufficient to offset the negative impact of inflation on purchasing power, but not enough to build much in the way of new wealth. So, if you’re an institutional investor trying to build an endowment fund or a private investor wanting to retire in comfort, long-term bonds alone are not going to get you there.

The difference between the bond curve and the stock curve constitutes new incremental wealth created by investment in common stocks. The question is "how do we get there?" Simply stated, we have to find ways of coping emotionally with stock market volatility.

Let’s look at volatility again, only this time in a slightly different way. Exhibit 1.4 shows the actual volatility of returns, annually, from 1926-1990 for stocks, bonds, and inflation, respectively. You can see that bond returns have been modestly more volatile than inflation. Stock returns, on a year-to-year basis, have been significantly more volatile than bonds.

During short time periods, bond returns frequently under perform the rate of inflation and stock returns frequently under perform both bonds and inflation. Over the long-term, stock returns outperform both bonds and inflation. This is why patient investors win and the impulsive investors invariably lose. Investor patience is the critical ingredient to realizing the rewards.

One final chart demonstrates what has happened historically when investors ignore short-term volatility and remain focused on a long-term investment strategy. Exhibit 1.5 shows historical, cumulative stock market returns. It is clear how patient investors have built considerable wealth despite the Great Depression, numerous economic recessions, several bear markets, and countless stock market corrections. It only looks easy when you smooth out the gut wrenching highs and lows.

The Case for a Balanced Portfolio
A balanced portfolio combines stocks and bonds within the same investment account. Assets can be divided in any proportion between the two asset classes, depending on the investor’s objectives and risk tolerance. Bonds pay interest rather than growing in value over time, as stocks do. So, a balanced portfolio has both an income component and a growth component. One would expect the investment rate of return on a balanced account to fall somewhere in between the stock curve and the bond curve shown in Exhibit 1.3.

The balanced approach works very well and is commonly used by individuals and institutions to achieve a wide variety of investment objectives.

Buy Low - Sell High
Many investors think this common catch phrase refers to deftly calling tops and bottoms in market and/or single security price movements. In fact, it doesn’t. As we discussed earlier, market tops and bottoms occur randomly and aren’t knowable in advance. The buy low/sell high concept is really about overcoming two very powerful emotions: greed and fear. So, while it is intellectually simple, putting it into practice is quite difficult.

For example, think of how hard it is sell a stock that has generated huge gains for your portfolio and continues to appreciate in price almost everyday. You’ve got a winner! Let it ride. Taking some or all of your unrealized gains and rolling them into another investment with a better valuation and greater upside potential, seems crazy. In this case, greed has taken over and is now making the investment decisions.

Conversely, putting new money into the stock market or even remaining invested during a market correction or bear market seems equally ill advised. Stock prices are declining almost every day and the values of our portfolios are dropping right along with them. The popular market pundits all say that the market outlook is poor and that it is the worst time to be invested. Fear, even panic, is widespread on Wall Street.

I’ve heard it said that the stock market is the only place where people get upset when things go on sale. Yet, that is exactly what happens to stock prices during a correction or bear market. Great companies whose stocks were prohibitively expensive to buy earlier can now be purchased for a fraction of their former cost. This dramatically increases the future rate-of-return potential for these holdings and for our portfolios in general.

Overcoming fear and greed poses a challenge for most of us, but it can be done. Again, the solution is to remain focused on the length of your investment time horizon. If that is to maximize investment rate-of-return over say, a 15 or 20-year period, then what happens during any given month, quarter or even full year, isn’t very significant. Look for the opportunity.

Summary & Conclusions
It is not uncommon for market events to become exceedingly complex and threaten to distract us from doing the things that bring investment success. The news media, in particular, fan these flames in their intensely competitive pursuit of viewers. Dramatizing market events obviously works as the success of CNBC, Bloomberg, CNNfn, and the other business news shows would attest.

Our objective is to help you filter out the noise from the markets and the news media so that you can focus on the important things and make objective, well informed investment decisions.

Dealing with the emotional aspects of investing is paramount. Understanding how the markets normally function allows us to maintain perspective. Knowing that patience is an essential element to executing any investment plan, can lower anxiety not only in bear markets, but in bull markets as well. Remember the euphoria of 1999 and the fear of being left out?

Timothy R. Meyer

Portfolio Management 101

Investment Commentary June 2000
Copyright © 2000 Meyer Capital Management, Inc. All Rights Reserved.

An Evening with Pachelbel
Recently, while waiting for my son John’s middle school strings concert to begin, a neighbor settled into the seat beside me. By way of background, this friend regularly lets me know that he is a do-it-yourself investor because, in his words, "there is no magic to picking stocks." Curiously, this doesn’t prevent him from routinely seeking my investment advice, for free of course.

This particular evening he lamented about how he purchased Procter & Gamble stock only a few months earlier at close to its 52-week high of $118.50/share because it looked like the stock price was breaking out to the upside. He then watched in horror as the price of his newly acquired shares fell dramatically to $55.00/share in only a few weeks. I asked if he was a momentum investor since he based his original purchase decision on a short-term movement in the stock price. "No," he said, "I just figured the price would continue to go up and the stock would split two-for-one." If only the world were so simple.

He went on to tell me how, after P&G’s initial free-fall, he swallowed hard and bought more P&G shares near their recent lows only to have the company announce that earnings would fall short of Wall Street’s expectations again and that it’s President and CEO was stepping down. I asked if he was a technician since technical analysts base their investment decisions on movements in stock prices relative to historical price patterns. "No," he said, "I just figured that the price was so low compared to where it had been just a few days earlier that it had to be a bargain." The expression on his face made it clear that these events had taken an emotional toll on him.

His voice took on a hint of hopefulness as he asked me at what price I thought P&G would end the year 2000. I told him, truthfully, that I had no idea whatsoever. I went on to explain that at MCM we are fundamental investors. That means we base our investment decisions and advice on fundamental variables like sales, earnings growth, profit margins, competitiveness, economics, valuation, etc., not on past or present stock prices. This research provides us with a clear basis for making buy/sell decisions.

My friend looked at me, somewhat incredulously, as if I couldn’t possibly know anything about investing if I wouldn’t make a price prediction on a stock six months into the future. With renewed conviction, he said that he thought P&G’s share price would end the year around $85.00/share, up from its current $55.00/share. I asked him what he based this prediction on. He responded with, "I don’t know, I just think it will."

At last, I understood. He is not a momentum investor or a technician or a fundamentalist. He is a speculator and, as Webster’s Ninth New Collegiate Dictionary indicates, speculators base their investment decision on insufficient evidence and unadulterated hope. The fact that my friend construes this to be investing is, I fear, an all too common mistake among professionals and non-professionals alike.

Portfolio Management 101
I share this story with you because it illustrates the naiveté with which people can approach the capital markets and the very real and painful experiences that often result. Even for those who employ investment professionals to manage their assets, it is necessary to understand something of the "what" and "why" underlying the investment activities undertaken on your behalf, lest you become frustrated and dissatisfied.

Risk Aversion
Investment risk is the probability of losing one’s money. Portfolio management, at least as we practice it at MCM, assumes that our clients are more or less risk averse. This means that given the choice between two investments with equal rates-of-return, you will chose the investment with the lower level of risk. Choosing the other only guarantees a higher probability of losing your money. Evidence that most people are risk averse lies in our purchase of various types of insurance, including life, auto, health, etc. Buying insurance implies that we are willing to pay the current known cost of the insurance premiums to avoid the uncertainty of a potentially large future cost related to a car accident or major illness.

This does not mean that everyone is equally risk averse or that investors are completely risk averse. For example, not everybody buys insurance for everything, either by choice or because they cannot afford it. In addition, some of us buy insurance related to some risks such as auto accidents and illness, but also buy lottery tickets or gamble in Las Vegas where it is known that the expected rates-of-return are negative. The latter point means that we are willing to pay for the excitement of the risk involved and that earning a positive rate-of-return is of secondary concern.

This combination of risk preference and risk aversion can be explained by an attitude toward risk that is not completely risk averse or risk preferring, but is a combination of the two that depends on the amount of money involved. Taking on more risk doesn’t guarantee a higher rate-of-return. It can just be a way to go broke faster. My neighbor was attracted to P&G by what he thought would be an attractive rate-of-return, but since he did not act in a risk averse fashion, he failed to earn a positive return at all. While we recognize these various attitudes, our basic assumption is that MCM clients committing large sums of money to developing investment portfolios are risk averse and expect positive rates-of-return.

Expected Rate of Return
I am often asked, "What can I reasonably expect to make annually on my investment portfolio?" It is a fair question. The short answer for an all-stock portfolio is about 10% annually, which is the historical average rate of return for the entire stock market since its inception decades ago. For example, you could lose 10% one year and make 20% the next. The results are different for balanced and/or fixed income accounts.

The real answer is a little more involved. It begins with the idea of a risk-free rate-of-return. This is nothing more than the pure time value of money (i.e., having $1.00 today is worth more than receiving $1.00 sometime in the future because money has the ability to earn interest). The interest rate paid on short-term US Government Treasury Bills is widely accepted as a proxy for the risk free rate. Since an investor buying treasury securities doesn’t incur any risk, he/she should expect to earn a relatively low rate-of-return. We can see that this is the case today with short-term treasuries paying about 6% interest.

We know, however, that inflation exists in the world and acts to erode the purchasing power of our cash and any investments that pay a fixed rate of interest, like treasury bills. Therefore, many investors require that an inflation premium be added to the risk free rate before we will agree to invest. In doing so, we are compensated for any expected rise in inflation. Failing to do so is irrational.

Some investors will still not be satisfied earning the risk-free rate plus the inflation premium. In order to have a chance to earn even greater investment returns, we are forced to overcome our basic tendency toward risk aversion and expose our hard-earned money to risk of loss. In exchange for taking on this increased risk, we have a right to expect potentially higher returns. This added return potential is called the risk premium. The level of risk involved in each and every investment opportunity we consider determines the amount or size of the risk premium. The risk premium has two main parts:

  1. Systematic Risk -- Also called market risk, this is the portion of an individual asset’s price variability attributable to the variability in the total market. In other words, this is simply the risk of being in the market and there is nothing any individual investor or professional investment manager can do to minimize or avoid it. Significantly, this explains why an individual security tends to move up and down with the market regardless of what security it is (i.e., its not a matter of holding the right ones). Market forces impact all securities that, combined, make up the market.
  2. Non-Systematic Risk -- Also called fundamental risk, this is the portion of an individual asset’s price variability attributable to it’s own unique features, unrelated to total market variability. Non-systematic risk is comprised of the following components:

    Business risk – the unpredictability of income due to the nature of the business.
    Financial risk – the uncertainty coming from how the firm finances itself. The more debt the firm takes on, the higher the financial risk.
    Liquidity risk – how easy (or hard) it is for the investor to convert his/her investment to cash, should they so desire.
    Exchange rate risk – factors in the uncertainty relating to currency changes.
    Country risk – political and economic uncertainty within a country.


Total Risk = Systematic Risk + Non-Systematic Risk


Expected Rate of Return = Risk-Free Rate + Inflation Premium + Risk Premium

By carefully combining individual securities with different risk/return characteristics into a single portfolio, non-systematic risk can be completely diversified away! That sounds almost too good to be true, doesn’t it? Wow! This is why crafting well-diversified portfolios is the main focus of our daily research and the primary basis for our trading activity. Moreover, it becomes easy to see how a well-diversified portfolio is far more than just a collection of hot stocks whose all-important inter-relationships may not even be known, let alone understood.

The Efficient Portfolio
In the 1950’s and early 1960’s, a man named Harry Markowitz published what has since become the definitive model for optimizing the relationship between investment risk and return. A portfolio that does so is said to be efficient in that no other portfolio of assets offers higher expected return for the same (or lower) risk, or lower risk for the same (or higher) expected return. An efficient portfolio is, by definition, well diversified. Adequate diversification can be achieved with as few as ten to twenty individual stock holdings. Less than that leaves one exposed to nasty surprises like the one suffered by my neighbor. As too many stocks are added to a portfolio, the additional diversification benefit becomes immaterial. The investor would do better to simply buy more shares of his/her existing holdings.

The name of the game then for investors serious about making money is to invest at the point where we can get the most return for a given level of risk or, conversely, the least risk for a given level of return. Where might that point be? It is unique to each individual investor depending on his/her investment objectives and risk tolerance. Hence, the criticality of understanding these aspects of one’s own or client’s psychological makeup.

Know What to Look For In a Money Manager
We are proud of the diligence, rigor, and expertise we bring to client portfolios. Anyone can buy & sell a stock; that does not make them an investor. It’s likely they are only speculating. It concerns us that many falling into this category are professionals within our own industry. Over the past year, thanks largely to your referrals, we have had the opportunity to establish new working relationships with a variety of institutions, families and individuals. Frequently, we begin by correcting damages incurred previously. Unfortunately, important monies have usually been lost by then and people find themselves trapped in undesirable securities by penalties, fees and/or taxes.

At MCM, all clients can talk directly with the individual making the investment decisions for their account. We encourage questions and are happy to explain our thinking and processes. We operate under a full disclosure policy at all times. Nothing is hidden. There are no soft-dollar arrangements, no sales charges and no product commissions of any kind. As a result, we are free of the conflicts of interest that often accompany these practices.

Timothy R. Meyer

Understanding Stock Market Averages

Investment Commentary March 1999
Copyright © 1999 Meyer Capital Management, Inc. All Rights Reserved.

March 31, 1999
DJIA: 9786.16
S&P 500: 1313.60
NASDAQ: 2461.40
Russell 2000: 397.63

1st Quarter Review
On a recent weeknight evening, my family was sitting around the dinner table discussing the day's events. As I contemplated a second helping of mashed potatoes, my wife Joan posed the following question. "Tim, I heard today that over a billion shares traded on the New York Stock Exchange, the Dow Jones Industrial Average (DJIA) set a new all-time high and advancing stocks outnumbered decliners by a four to three margin, yet the price of an average share actually declined. How can this be?"

Joan's question could be something of a metaphor for the first quarter and I'll share my response later in this report. While the MCM master portfolio performed strongly in January, outpacing all the major averages, the increasingly narrow stock participation across the equity markets dragged us back in February. March saw positive though unspectacular returns. The major market averages were similarly mixed. The DJIA and the S&P 500 Index were up strongly at +6.6% and +4.6%, respectively. Yet within the DJIA and the S&P 500, only a few stocks did well. How can this be?

As I've discussed in previous reports, the answer traces to the way in which the averages are calculated. As reported in the Wall Street Journal, the S&P 500's total year-to-date gain can be traced to only 21 stocks. The other 479 under performed the index. One third of the S&P's performance came from just two stocks, Microsoft and America Online! In the Dow Industrials, just three of its 30 component companies accounted for more than one half its gain. These were United Technologies, J. P. Morgan and American Express. Broader market measures like the Value Line Index, an average of 1700 stocks, fell -3.7% during the quarter, as did the Russell 2000 by -5.8%. These broader measures yield a more revealing view of the stock market's price activity.

The performance gap between the select few large cap high priced stocks driving the Dow Industrials & the S&P 500 and the rest of the market is exceptionally large. Some market historians argue that it is without precedent. Investing in the market movers is not a matter of stock picking prowess. The reality is that concentrating assets in these few stocks would be enormously risky. MCM holds a variety of the large-cap stocks that performed well during the quarter, but we also hold a broader selection of companies in order to keep overall portfolio risk within client guidelines.

One market commentator noted that since America Online was added to the S&P 500 last year, it appreciated so much in price that any money manager who didn't own it would, by definition, under perform the S&P 500 regardless of any other holdings. This is not hard to believe since America Online trades at more than 600 times trailing earnings and its market value is equal to that of Coca-Cola. eBay, the online-auction company, has a market value almost equal to Sears despite significantly lower sales and profits. To equal Sears, eBay would have to double its own sales and profits every year for the next 10 years, according to Ed Keon, director of quantitative research at Prudential Securities. This isn't impossible, but predicting the future 10 years out and betting money on it is, at best, an uncertain business.

The solution, in our view, is to avoid the temptation to chase market strength, hold to fundamentally sound investments, and wait for the market to turn convincingly in our direction. This is what happened, albeit fleetingly, in January. Since then the market has been signaling with increasing frequency that the narrowness of the big-cap rally is waning. One only has to look at the oil sector for example. Crude oil prices have recovered significantly from their lows of last year. So too have the stock prices of integrated oil stocks in general and oil service stocks like Schlumberger, Haliburton, Global Industries, and Nabors Industries, in particular.

Asian economies have stabilized and we believe the recovery will continue. This bodes well for technology companies like Atmel and Texas Instruments as well as big manufacturers like Boeing Co. We also continue to like our holdings in financial services, telecommunications, healthcare and toys.

Now, for the answer to Joan's question. The DJIA is comprised of only thirty of the New York Stock Exchange's 3,098 listed companies. Since this represents less than 1% of the companies traded on the big board, it does not fairly represent the broader market activity. Moreover, each listed company has a different number of outstanding shares of stock available for trading on any given day. Some have many millions of shares while others have fewer in number. When stocks with declining share prices trade a greater number of shares than those with increasing share prices, the average price per share will decline regardless of the number of companies advancing or declining. The magnitude of share price changes also figures into the result.

Bottom line, this illustrates how the major market averages can fool unsuspecting investors by disguising what is actually going on in the overall market. Now, can I have more mashed potatoes please?

Timothy R. Meyer