How much worse can things get?
How can I protect myself?
What can I watch as a barometer of change?
Those are the questions we're all asking as we watch stock prices sink day after day.
The short answer to the first question: much worse. I'm not writing this as a gloom-and-doom advocate. Stock prices can fall further because the historical record shows they can. Here are some of the figures:
· From 1926 through 2001, large-company stocks provided negative returns (including dividends) in 21 of 76 years. Stock prices go up more often than they go down, which is the way we like it.
· Stocks have fallen for two (or more) consecutive years only four times. They fell in 2000 and 2001. They fell in 1973 and 1974. They fell for three consecutive years at the beginning of World War II -- 1939, 1940 and 1941. And they fell four consecutive years during the Great Depression -- 1929, 1930, 1931 and 1932.
With a 9.1 percent loss in 2000, an 11.9 percent loss in 2001 and a 13 percent loss so far this year, we are already in rare-event territory. Without a significant turnaround in prices, we'll leave the first OPEC debacle, the '73-'74 crash, behind. Instead, we'll be measuring this decline against the big ones: World War II or the Great Depression.
So take heart in at least one thing -- if you're worried, it's not because you're neurotic. You've got good reason to be concerned.
The second question: How can we protect ourselves?
One answer comes from Gerry Perritt, the Chicago-based publisher of the Mutual Fund Letter. (It was Perritt, some readers may recall, who started a quest for "the All Weather Portfolio" in August 1987. He asked a simple question: Is there some combination of assets that will do well in all markets? Extensions of that quest led to the creation of my Couch Potato Portfolio. You can read about the history, development and performance of that portfolio on my Web site, www.scottburns.com.)
His solution? Diversification.
Yes, I know. You've heard that before.
But consider these figures. Writing in the May issue of his newsletter, he points out that $10,000 invested in stocks at the end of 1928 would have been reduced to $1,640 by the end of 1932. If you didn't get discouraged and could have held your breath for a long time, you would have been back to a $10,000 break-even by March 1943.
If you had invested the same money in an equal mixture of stocks, government bonds and Treasury bills and rebalanced at the end of each year, however, your investment would have declined to $8,170, a much smaller loss -- 18.3 percent of your money. During the same four-year period, consumer prices fell 23.5 percent. As a result, your buying power increased even though you had less money! The diversified portfolio, he writes, "would buy 6.5 percent more goods and services than it would when the initial investment was made," even though the stock market had gone through the worst crash in its history.
Bottom line: Diversify. Grit your teeth, pick a mixture of stocks, bonds and cash, and go back to it regularly.
The third question is a truly gritty one: Is there a barometer we can watch?
I believe the most reliable sign of a market bottom is a change in the flow of money into, or out of, common stocks. So far this year money has continued to flow into stocks. It's a diminished flow, to be sure, but it's still positive.
At major bottoms, people don't invest in stocks. They shun them. They wish they had never heard of them. We're not there yet. Collectively, we're still wishing for stocks that double while we visit the Laundromat.
Legg Mason analyst Raymond F. DeVoe Jr., a man with an acute sense of history, points out that mutual fund investors were net sellers of equity mutual funds in all but one month in the 96 months between November 1971 and October 1979. Granted, things have changed since then -- 401(k) accounts provide a regular flow of new investment money -- but flow may still be the best measure of investor sentiment.
The Investment Company Institute provides downloadable monthly reports on the flow of money into, or out of, different fund types. You can access them by going to www.ici.org and clicking on "Latest Statistical Reports." So far this year, twice as much money has gone into equity funds as into fixed-income funds.
You can also check on where money is going in 401(k) plans by visiting the Hewitt Associates Web site (www.hewitt.com) and checking its "Hewitt 401(k) Index." In May, the last reported month, plan participants were redeeming equity funds and company stock while buying money market funds, bond funds and guaranteed insurance contracts.
I call that mixed signals, so we probably haven't hit bottom.
The last time I saw the headline "Dow Breaks 9000, it was going the other way!! And I was getting a little worried then.
Meyer's prediction, Dow bottoms at about 7500 or so, in mid-September. Then, a slow, choppy climb as things start to slowly improve. This is based on absolutely nothing. Just a goofy hunch.
People are fools to listen to these people again.
The last time the market fell for 3 consecutive years, the best investment was gold and treasuries. Those people who bought equities at all in 1929-1930 has to wait 20 years to return to that same level.
In an extended bear market, any amount blindly thrown at equities is likely to lose money. The smartest people now are not in equities at all, but in treasuries and material (gold, silver, tangible assets), and CDs. They aren't going to be making much money - but at the least they are not losing it.
If only I had went with my gut 4 months ago and given up the DOW 15000 dream, I could have saved 20%. Unfortunately, I bought into the fantasy and lies.