Welcome to reality. Stocks really do go down as well as up. Yes, stocks have made about 10.5 percent a year, compounded, since 1926, according to Ibbotson Associates, almost double what long-term bonds have made. But stocks don’t rise in a straight line. Think of the market as a roller coaster in which highs are higher than previous highs, and lows are higher than previous lows. That still leaves plenty of disturbing dips that can make you lose your cookies.
So why shouldn’t I tell you to bail out now and wait for better days? Because it’s easy to miss the up moves while you’re trying to duck the downs. One of the stock market’s dirty little secrets is that most of its gains are packed into small, concentrated periods. If you miss them, you’re as good as toast. According to a University of Michigan study, 95 percent of the market’s gains from 1963 through 1993 were posted in just 90 trading days: Looking at it another way, that’s a mere 1.2 percent of the days the market was open.
Having said all this, is it time to get out of stocks? Is the market on the edge of an abyss that will swallow up years of your profits? I don’t know–nobody does, really. But I can try to give you some perspective. Some very smart people are predicting drops of 500 to 1,000 points in the Dow. And they’re not necessarily pessimists. That drop would be only 10 to 20 percent–much less than last year’s rise–but it could give palpitations to even the strongest-hearted investors.
Any number of things could trigger a huge drop in the Dow: a war, a financial collapse in Tokyo, a natural disaster, an invasion from Mars. But you can’t predict those. For me, the two biggest worries the average investor can cope with involve stock mutual funds and long-term interest rates.
Mutual funds first. Investors have poured almost half a trillion dollars- that’s trillion, with a ‘T’–into stock funds since the end of 1990. That helps explain why the Dow has almost doubled in the past five years. What happens if mutual-fund investors get scared and start pulling out money en masse? Nothing good. It’s the disaster scenario: managers sell to raise cash to pay departing holders, driving down stock prices. That decline causes more redemptions, setting off a downward spiral that feeds on itself much as last year’s upward spiral fed on itself. Anything could set this in motion. For all we know, fund managers are even now aping Fidelity Magellan, the world’s biggest stock fund, which had almost 12 percent of its assets in bonds at the end of. November.
Which brings us to long-term interest rates. A big reason that stocks rose so much last year is that interest rates on 30-year Treasury securities fell to 6 percent from 8 percent. But one school of thought has it that long-term Treasury rates are artificially low because of the financial problems in Japan. Japanese banks are supposedly trying to make big profits by borrowing yen at less than 1 percent in Japan; converting-the yen to dollars and buying 6 percent Treasuries.
But this Japanese money could depart at any moment for any reason-say, the dollar weakens against the yen. If long-term rates then ran up to 7 percent, it would tank the market in a hurry. You’ll notice that I’ve not talked about budget negotiations in Washington. I don’t think that stuff has long-term effects on the market. Look. Since 1982, we’ve had huge federal deficits and the biggest bull market in history. Why should the fate of the markets hang on whether the federal budget will supposedly be balanced in 2002? Especially since everyone is using seven-year projections, which are so long term I don’t think they’re worth the paper they’re printed on.
But even without mutual-fund redemptions or rising interest rates, it’s just time for something bad to happen to the stock market, at least temporarily. Stock prices have been defying nature by rising as sharply and steadily as they have in the past five years. Two of the market experts I consulted – Joseph Rosenberg, chief investment strategist of Loews Corp., and Chris Davis of Davis Selected Advisers, one of the country’s best-regarded fund companies–both said that the Dow could drop 1,000 points sometime this year. The interesting thing is that Rosenberg is bearish, and has pulled most of his personal money out of stocks, while the Davises, whose investors include me, are still heavily invested in stocks.
Now for some advice, for whatever it’s worth. I’m staying heavily in stocks, at least for now, because I know I can’t time the market. But I’m only 51, so I’ve got lots of time to recover from any mistakes. My stocks still seem sound to me and I still have confidence in my mutual funds’ managers. I’m not telling you what to do with your money; that’s your decision, not mine. I can’t help myself. Whenever I try to balance greed and fear, greed almost always wins.
