Recently we have experienced one of the most severe market sell offs in history. The S&P 500 is now down over 22% since the start of November. This sell-off would be clearer if there was a specific tangible event that we could grasp onto to justify this market move. Instead, this market is being driven down by investor panic, a lack of buyers and huge redemptions at hedge funds and mutual funds.
Our economy and stock market has survived a number of stock market crises and panics. First, take the crash of 1962. In this panic, the stock ticker ran four hours late. Then in the 1973-1974 bear market, the S&P 500 fell 48% and the average stock fell 70%. In October of 1987 the market fell over 20% in a single session, more than twice as much as the largest daily decline during October 2008. Then, of course, there was the 2002 “tech bubble” with the S&P 500 down 49% and tech stocks down over 75%.
As I write this email, the S&P 500 is down over 48% in the 2008 calendar year. If we finish the year at these levels, 2008 will go down as being the worst performing stock market since 1926 (with the prior worst being 1931 with a return of -43.3%). As of October 27 the Emerging Countries were down an average of 66% (China down 75%). Like the previous bear markets cited above, now is absolutely the wrong time to bail out of the market. Emotion is an investor’s greatest enemy, be it greed, or in this case fear.
Consider the following: The global liquidity crisis, the probable cause of the last half of the current decline, has peaked and is now easing thanks to the concerted efforts of governments around the world, including new support from China, Russia and the Middle East. Economies in the U.S., Europe and Japan are now in recessions with the U.S. recession getting under way about a year ago (in hindsight). The stock market, being a leading economic indicator, typically turns positive about midway into a recession. If the U.S. recession lasts 20 months (which would make it the longest since WWII – with the average being approximately 12 months), one would predict that the stock market could begin to rebound in December of 2008.
Although it seems extremely difficult to believe that the market could rebound under the current dreary economic cloud, markets typically begin advance while economic news is getting worse. In our view, this is a terrible time to reduce or liquidate stock market holdings. Since 1900, the market rebounded an average of 47% in the 12 months following a bear market bottom and 60% over the next two years. Although this constant drumming we are taking in the market on a daily basis is hard to bear, we must visualize how difficult it will be if we sell at these levels and watch the market advance to levels much higher.
What can we do? We can all revisit our budget and look for ways to reduce spending during these difficult times. We can harvest tax losses in order to make sure we do not pay any more taxes (this year and in the future) than necessary. We can reallocate our portfolio into higher dividend yielding stocks (which there are currently many) in order to maximize portfolio returns (or minimize losses) while we wait for market and economic conditions to improve. We can stay strong and not allow the daily panic to lessen our confidence in the fact that ownership in companies and real estate are the only proven way to build long-term wealth.
Michael J. Ziemer, CFP®