THE YEAR AHEAD: Lessons of 2000''s bear market

If investors learned anything in 2000, they've learned that stocks can tank, profits matter and manias end abruptly. With investors' expectations in check, maybe 2001 will produce a kindler, gentler market.

The Nasdaq's year can be summarized in one word -- carnage. The tech-heavy index hit a peak of 5,048 early in the year and has lost more than half of its value in December before a slight rebound. For the year so far, the Nasdaq is logging one its worst performances ever, down 37 percent.

In the tech sector, it was hard to pick a category that didn't bomb. Of CNET's 18 Tech Indexes, only two were in the black through the first 11 months of the year. And things only got worse in December. The usual sectors -- Internet retailers, services, PC hardware, Internet content and telecom equipment -- plunged.

CNET's Tech index started the year at 2,801, surged to 3,155 by March 1 and hit 2,356.16 on 12/6. Interactive Week's @100 index started at 6,508 in January, hit 7,175 on March 1 and slumped to 5,732 by the first week of December.

Lessons learned

So what have investors learned from all this carnage?

One big takeaway for 2000 is that manias die hard. The dot-com run got way out of hand as Wall Street cooked up new metrics to justify valuations that just didn't make sense. Was Yahoo! (Nasdaq: YHOO) worth more than $200 a share? Is Amazon.com (Nasdaq: AMZN) anything more than a retailer with low margins?

"I think investors have learned a lesson," said Jeremy J. Siegel, a Wharton Professor and author of "Stocks for the Long Run." "The important thing is to get the big picture."

And that big picture is stock returns of about 7 percent adjusting for inflation from 1802 to 1999. There was quite a disconnect between what investors expected and what the historical norm actually is, said Siegel.

"A lot of investors ask, 'is that all?'" said Siegel.

According to a CS First Boston survey conducted in December, the number of investors expecting stock market returns to average 15 percent to 20 percent over the next five years has been halved from April to December. The majority of investors expect 10 percent returns to 15 percent returns.

Harold Evensky, a financial planner based in Coral Gables, FL., said he hopes investors shy away from "naive investing" following the Nasdaq debacle. "Hopefully, they learned that you don't get rich by trying to play the market," he said.

Unfortunately, a lot of investors, including the alleged smart money, got carried away and paid the price in 2000. "It wasn't just individual investors, it was money managers and old investors who lost touch with reality," said Evensky.

CS First Boston's survey may indicate that investors have received the message. Only 13 percent of respondents predict that the Nasdaq will be 4,500 or higher in 12 months. In April, 47 percent were predicting the Nasdaq to land between 4,500 and 5,500. About 19 percent put the Nasdaq above the 5,500 mark.

The long run

Market watchers are entering 2001 with restrained optimism.

Evensky said he's recommending to clients that they take the time to figure out what they are currently invested in -- many folks just don't know. "It's a time to stop, catch your breath and do some planning," he said.

The planner also said it makes sense to stay invested once you have a plan. "If you have cash, you should invest it," he said.

Few are taking Evensky's advice, however. There's a lot of cash sitting on the sidelines.

In a research note highlighting his 2001 forecast, CS First Boston market strategist Thomas Galvin said the cash allocations are among the highest levels he can recall. In the CS First Boston survey, 19 percent of respondents said they were holding 10 percent to 15 percent of their portfolio in cash, with another 15 percent holding 20 percent or more.

"A mere eight months has virtually turned a sky of optimism into an ocean of pessimism," said Galvin, who is calling "high-octane stock returns between 20 percent to 50 percent in 2001." Galvin said he expects technology fundamentals to "rescusitate sooner than expected."

Even if Galvin's prediction doesn't happen, Siegel's research indicates it makes a lot of sense to think long term. The stock market has finished up 3 out of 5 years for the last 200 years, but the key to good returns is sticking to your plan in those two down years.

With any luck, 2000's volatile markets taught investors to go a back-to-basics approach when picking stocks.