Market Turmoil Gives Investors a Good Reason to Take Inventory
The unofficial Olympic greeting: “Welcome to America--please buy our stocks!”
The market’s first serious “correction” since 1994 struck with a vengeance early last week, though if you blinked you might have missed it.
After losing 328 points from Monday through midday Tuesday, the Dow Jones industrial average roared back Tuesday afternoon and continued to advance Wednesday and Thursday before easing 37.36 points Friday, closing at 5,426.82.
The Dow’s net loss for the week was 1.5%, leaving it 6.1% below its May 22 record high. The Russell index of 2,000 smaller stocks lost just 0.7% for the week and now is 11.8% below its record.
Much ado about little? Maybe. The average investor probably did absolutely nothing with his or her stocks or stock mutual funds last week, and that may have been the smartest reaction, or non-reaction. Historically, market pullbacks on the scale of the current one aren’t unusual, after all.
Even so, many Wall Street pros suggest that investors view the stock market’s turmoil as an early warning, offering everyone a chance to sober up. On the whole, stocks aren’t down much at all, especially relative to their gains since 1990. Even with the recent decline, the average stock mutual fund is still up year-to-date, on the order of about 5%.
But the near-panic that briefly engulfed the market Monday and Tuesday was a reminder of how quickly sentiment can change, and how much damage can ensue.
The point being, if you were ever going to do a serious review of your stock investments (including those in retirement accounts) and judge how appropriate they really are for the kind of investor you are, this is the time.
As you make that review, here are some factors to keep in mind, issues whose importance was recognized by--or perhaps just reinforced for--many investors last week:
* The “decoupling” of stock and bond markets may be over. Remember how interest rates rose in winter and spring, taking their cue from the economy’s strength--and yet stocks’ bull market just kept roaring ahead?
For most of the past two decades, higher interest rates have been deadly for stocks. But in the first half of this year stock-hungry investors continually tried to look on the bright side: If the economy was stronger, rates might rise, but so would corporate earnings. So buy more shares!
Now, the outlook for corporate earnings growth is much murkier in the wake of some weaker-than-expected second-quarter reports (one of the triggers for the market’s recent slide). Even in the best of circumstances, most companies are likely to post slower earnings growth this year and in 1997, compared with the heady growth of the last few years as corporate cost-cutting sharply boosted results.
“I think investors are beginning to realize that profit margins have begun to peak out” for many companies in this business cycle, said Charles Crane, research director at money manager Spear, Benzak, Salomon & Farrell in New York.
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And if you can’t count on spectacular earnings gains to support stock prices, the level of interest rates--the other key determinant of prices--becomes much more important once again.
“The stock market is going to be much more sensitive to interest-rate moves” going forward, warned Martin Sass, head of M.D. Sass Investors in New York.
But didn’t Federal Reserve Board Chairman Alan Greenspan indicate to Congress on Thursday that the Fed doesn’t necessarily expect to officially raise rates soon?
That’s what investors wanted to hear, Sass said. He heard something different: “Greenspan pointed out that we’re at a critical juncture,” Sass said. The Fed chief suggested that the central bank will hold back from tightening credit if economic data over the next few weeks indicate that the economy, and inflationary pressures, are weakening.
If that data hints otherwise, however, Greenspan made it clear that he will act. And if the Fed indeed raises rates--especially in an environment where corporate earnings growth is more suspect--the market could get walloped.
* Stock prices go down a lot faster than they go up. This may sound obvious now, but plenty of investors probably forgot this truism before last week.
It took from Jan. 1 to June 5 to push the Nasdaq composite index of mostly smaller stocks up nearly 19%. It took only 6 1/2 days, to midday last Tuesday, to slash that index’s value by 13%.
Gravity works as well in markets as it does in real life: It generally takes a lot of effort (and money) to push a stock up, just as it takes a lot of effort to carry a big rock up a hill. But once let go, stocks can fall as fast as rocks.
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Why? Because you don’t need an army of sellers to kick a stock lower, just an absence of buyers. We saw that on Monday and Tuesday as many frightened investors were frozen in place. Those who did try to sell found themselves being quoted ever-lower prices, especially for Nasdaq-traded issues.
(Recent stories in this newspaper about the Justice Department’s investigation into the way Nasdaq dealers set prices for stocks ought to be required reading for anyone who has ever owned a Nasdaq-traded share. Thinly traded Nasdaq issues can be like Roach Motels: Easy to get into, tough to get out of alive.)
The moral here is that if you have significant gains in this 5 1/2-year-old bull market, and you may actually need some of that money to live off soon, don’t fool yourself into thinking that you’ll have plenty of time in which to sell should a genuine bear market arrive. When the market begins to slide, prices move like lightning.
* It’s not the heat--it’s the volatility. Many investors have purchased stock mutual funds over the past five years based on the returns the funds have achieved--without paying much attention to how those returns were achieved.
The last few weeks have provided a good lesson in just how volatile some funds can be. As a fund owner, now’s a good time to make sure that your funds’ typical volatility matches your risk tolerance. You’ll want to know two measures of fund volatility (which you should be able to get from the funds themselves).
One measure is standard deviation, which is a statistical measure of the range of a fund’s performance over a given time period. The higher that standard deviation figure (on a scale of one to 10), the wider the fund’s range of returns.
Another key measure of a fund’s performance is beta. Beta measures a fund’s sensitivity to market movements. The market (as measured by a broad stock index like the Standard & Poor’s 500) has a beta of one. Thus, a fund with a beta above one tends to move faster than the market, both in bullish periods and bearish periods. A fund with a beta below one tends not to track the market closely.
There is no “right” standard deviation or beta--as a fund owner, you just need to assure yourself that the deviations and betas of the funds you own are consistent with the type of investor you really are.
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Can You Handle Volatility?
Stock mutual fund investors have just learned how bad volatility can feel, when the market is moving against you. Fund-tracker Morningstar Inc. says these stock funds have the highest “standard deviations” as measured over the last three years. A high standard deviation means a fund’s returns can swing in a wide range. Notice how much these funds have lost since June 5--the peak in the small-stock market--versus the average fund. (Funds are ranked in order of standard deviation.)
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Percentage return: June 5 Year- Fund to Thursday to-date Steadman Technology Growth -25.0% -19.6% Keystone Amer. Hartwell Em. Gro. -15.1 +0.7 Dominion Insight Growth -16.2 +6.9 Pin Oak Aggressive Stock -14.1 -5.7 Smith Barney Special Equities A -15.9 -5.0 20th Century Giftrust -16.0 -0.7 Govett Smaller Companies A -16.1 -6.5 Parkstone Small Cap Inv. A -12.9 +15.3 J. Hancock Special Equities A -14.6 +0.6 Oberweis Emerging Growth -19.6 +6.1 AVERAGE STOCK FUND: -6.7 +5.4
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Source: Morningstar Inc.
