Stock Market News
What can we learn from our brothers and sisters of past bear markets? As it turns out, quite a lot can be learned. First, all severe bear markets had the same cause: excessive valuation. Too many investors piled into the same stocks at the same time. The companies, both then and now, couldn't deliver the expected results. Secondly, all severe bear markets ended with a preponderance of really awful events, when sentiment hit rock bottom and it looked as though the pain would never end. Third, and most significant, all bear markets were followed by a period of stabilization and recovery.
What do we know? Well, using hindsight we can see that too many investors were piling into the same stocks. Hundreds of billions of dollars flowed into the top 100 companies' stocks during the late 1990s. Also, we know that these companies failed to deliver on the expected results. Company after company has come up short in earnings and some companies are dropping into bankruptcy. Finally, the horrendous sell-off during the last six months, with the S&P 500 Index down 14% and the NASDAQ Index down 25% year-to-date respectively, we can see the despair manifest in investor action. This is truly a dark time in the financial markets.
Scandals are now a daily occurrence. Just think about the number of hits our markets have taken in the past year alone. Any one of the calamities since 9/11, such as Enron or WorldCom could, unto itself, have been the single major event of an entire year. But please keep reading. The story does get better.
Masked by the fear of terrorism, obscured by the concern over corporate governance and accounting shenanigans, is an important yet often overlooked issue. The economy continues to hold up under the mounting pessimism about the stock market. Some of the leading economic indicators are actually registering gains. The stock market is tanking just as companies are poised to benefit from a better general business climate.
At this defining moment, we must divorce our emotions from our actions. We must be analytical in our approach, not irrational. When do you want to buy something? When it is on sale, of course. As we speak, there is sale going on over at the NASDAQ. Everything is marked down 75%. That's not a misprint. The NASDAQ Composite average, not one or two high profile stocks, but the entire average, is down 75% from its peak just two years ago. Some of the merchandise is damaged and out of style, but there are some legitimate opportunities as well. Think about the circumstances that face even the most gifted surgeon. Sometimes a patient fails to survive despite the best efforts and most thorough preparation.
Think about the circumstances that face the most talented commander on the battlefield. Inevitably, men are lost to the enemy despite the best tactics and most extensive training. Think now about the circumstances that face even the most earnest investment managers. Inevitably, an investment collapses despite the best strategy and most comprehensive research. Anyone who faces occupational risk understands that eventually something negative occurs outside the scope of your immediate control. You deal with it, learn from the experience, then adapt your actions going forward. Surgeons don't quit operating, commanders don't stop leading, and investors don't stop investing due to some losses, no matter how bad even a single loss may feel at the time. The reason is that the objective is too powerful and too valuable to let some short-term setbacks deter one from the mission. In the case of investing, the long-term benefits of owning equities far outweigh the occasional hits, even hits as abysmal as the current one. Any person who doubts the veracity of that assertion, needs only to compare any 10-year period in the U.S. stock market to, say, the average rate paid on "safe" bank deposits. Even the ten-year periods that include 1929-30, 1973-74, and 2000-02 show gains worthy of commitment. We must not focus on the few collapses within our holdings, but rather the many years of gains, on average, that stocks provide.
In these tumultuous times, you might be curious about how big firms and big-time portfolio managers are faring. You might find it interesting to compare the performance record of the portfolios whose managers who have billions under management and hundreds of analysts running around asking questions to the performance of your portfolio. Taking the biggest 100 Growth Mutual Funds in the U.S. (on average each manages about $6.0 billion dollars), we find that year-to-date through May 31 (we don't have stats through June 30 yet) the average fund has lost 9.72% and lost 19.02% for the past 12 months. Taking into account the dismal June we experienced, their performance would look even worse. The point is that's how the rest of the world looks.
You may also be curious about whether some of the smartest fund managers in the business saw the accounting surprises coming on the horizon. Well, let's take one of the more high profile companies, Tyco, as our example. The company had been an excellent performer through January of this year when a series of negative stories surfaced about possible accounting problems and their CEO was indicted on personal tax fraud. Did the "smart" managers run for cover? Not really. Of 14 funds that owned at least $100 million in Tyco stock as of their most recent holdings filing (most within the last 30 days)
at least two reported owning more than $1 billion worth of Tyco! Only time will tell whether patience will be rewarded with a strong recovery in Tyco's stock price. Again, the point is not everything is black and white or as obvious at it may seem to the casual observer.
Amidst all of the uncertainty about strategies and about individual holdings, one thing seems clear. The once asymmetrical risk of being invested in stocks (limited upside in the bullish case, significant downside when something goes wrong) is quickly rolling over to asymmetrical reward: limited downside on more bad news, significant upside if we see any good news. Resisting the temptation to capitulate will be rewarded.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.