Facing Reality of a Slide
The smartest thing any investor can do when a bear market arrives is to acknowledge it. That’s half the battle, because the denial stage will get you into nothing but trouble.
OK, so the Dow Jones industrial index now is off exactly 20% from its July peak. It closed at 2,398.02 Friday, off 112.62 for the week, or 4.5%. At the down-20% mark on the Dow, stocks are officially in a bear market, according to the usual rule of thumb.
Now what? How much lower stocks will go, and for how long, is as good your guess as anyone’s. Rather than try to pick the bottom, the better strategy is just to understand the nature of what you’re dealing with and mold your buy and sell decisions accordingly.
In a nutshell, you must be realistic about the likelihood of a long slide, totally comfortable with whatever stocks you own for the long haul, sober about what holds real value in this market, suspicious of signals that have previously signaled market turns and willing to admit mistakes when the market says “Forget it.”
Here, a few signposts that have cropped up along the road into this bear market brier patch and why they’re worth heeding from here on out:
* “Low probability” events increasingly become reality. The economic and market turmoil thus far in 1990 have been marked by amazing surprises, things almost no one would have thought possible two years ago. Donald J. Trump in financial trouble. One Arab state invading another. Chase Manhattan Corp. cutting its dividend. Southern California real estate plunging. The lesson seems to be that if most people can’t imagine it happening, it probably will. So just because no one can imagine the Dow falling for another year doesn’t mean it won’t.
In 1989, the surprises were mostly pleasant, such as the fall of the Berlin Wall. But now, with the world economy teetering, the surprises are far more likely to be negative.
* The market knows what it’s doing. After the one-day crash in October, 1987, many investors thought a depression was coming. It didn’t. So some people began to argue that market declines no longer were good indicators of the economic outlook.
But there’s a big difference between the one-day crash of 1987 and what’s happened since mid-July. The one-day crash clearly was computer-driven. The decline since mid-July has resulted from well-thought-out decisions by real human beings.
The proof that the market understands that there’s trouble ahead lies in the early destruction this year of stocks such as Marriott, Software Toolworks, Unisys and Chase. Long before the firms disclosed how troubled their businesses had become, the market somehow knew, and the stocks plummeted. When a stock is falling relentlessly in a bear market, there isn’t much to do but get out of the way. The market sees something. Don’t be a hero.
* All the cash in the world won’t guarantee a new bull market. People are pointing to the incredible levels of cash that are building up--$411 billion in money market mutual funds alone. The bulls say that money is going to come pouring back into the market at some point soon. “Cash is at record levels” is an oft-heard line when the bulls get together.
What they’re forgetting is that cash can stay at record levels for a long, long time. People won’t invest just because they have a lot of cash. They’ll invest only when they feel better about the economy and the prospects of making money again.
* Rallies happen in bear markets. No bear market goes straight down. The will to believe that the bad times are over is a strong sentiment, and it surfaces periodically. There will be plenty of trading opportunities in this bear market--days or weeks when the market rebounds 5% or even 10%.
If war breaks out in the Mideast and the Western allies quickly destroy Iraq’s military machine, the market could rally mightily. At that point, the only question for the long-term investor would be: Does a military victory mean an end to the economic slide--or has that slide now taken on a life of its own?
Indeed, it’s crucial for investors to remember that the downfall of Saddam Hussein wouldn’t do much of anything to improve corporate balance sheets. For many heavily indebted companies, the sudden slowdown in the economy means that their fates are practically sealed by now: Even if their revenues were to turn around by early 1991, the losses they may sustain between now and then could force many into awful financial straits.
* Good companies will survive. At the depths of the 1974 recession, stocks of many solid companies had been cut to ridiculously cheap prices. The rebound in 1975--when investors finally could see an end to the economic shakeout--was dramatic. The Dow rocketed from 577 at the end of 1974 to 850 by the end of 1975, a 47% rise. By mid-1976, it was back to 1,000.
When this is all over--whenever that is--the survivors will stage amazing comebacks. That’s why long-term investors who own high-quality companies should still sleep at night. When fear grips the market, it takes the good and bad down alike. Most bears believe the worst pessimism lies ahead, because not enough good stocks have been dragged down with the bad. “At the bottom,” says Richard Russell of Dow Theory Letter in La Jolla, “you won’t be able to convince people that things will ever get better.”
THE BEARS WERE RIGHT Here are some examples of stocks that collapsed this year well in advance of the companies’ announcements of trouble. Clearly, the sellers had a good sense that something was wrong.
1990 Pct. Stock high Fri. drop Software Toolworks $24 3/8 $2 3/8 -90% Oracle Systems 28 3/8 5 5/8 -80% Unisys 17 1/8 4 -77% Marriott 33 5/8 8 7/8 -74% Computer Associates 16 7/8 5 3/8 -68% Chase Manhattan 35 3/4 12 1/2 -65% Caterpillar 68 1/2 39 5/8 -42%
