NEW YORK -- Market drops test an investor's resolve. Are you really in stocks for the long term, or do TV's breathless reports on a price plunge scare you away?
It's hard not to be scared, when you're unused to sudden price drops of 10 percent. Generally speaking, blue chip stocks haven't seesawed much in recent years -- they've just cheerfully gone up.
Historically, however, drops are as common as crows, according to Ned Davis Research. Going back to 1900, the market has fallen 10 percent (or a bit more) an average of about once a year, and at least 15 percent about once every three years.
Financial planners tell you ad nauseam that you need to understand your personal "tolerance for risk." Sudden market drops show you pretty clearly where your tolerance lies. Investors should seize this moment to reassess their current investment plans, before the day that stocks stumble into something worse.
The recent weakness in blue-chip stocks had nothing to do with sex or politics, despite the heavy breathing over Monica's dress. Profits, profits, profits were on the market's mind.
As Asia's currencies declined, so did the dollar value of earnings from U.S. subsidiaries there. As Asia's economies tanked, so have their imports from the rest of the world. Slowed global growth eats into profits at the big multinational corporations, trading companies and firms that deal in oil and other international commodities.
Profits at blue-chip companies have been on an extraordinary roll. From 1992 to 1995, operating earnings for the S&P 500 stocks soared at double-digit rates, and at nearly that pace in 1996 and 1997. "At no time in our history has there been such growth," says Allen Sinai, chief global economist for Primark Decision Economics in New York.
Investors rewarded that performance with huge run-ups in the prices of the company stocks. But with the spread of Asian flu, those days are gone.
How much should you worry now? That depends on whom you ask. Many technical analysts, who use complex charts to divine market trends, see deeper drops in prices ahead.
Fundamental analysts, on the other hand, are predominantly bullish. They follow business and economic trends, and find the underpinnings strong.
Sinai, for one, sees much slower growth in corporate operating profits, consistent with a 10 percent to 15 percent swoon in stocks -- but he classifies it simply as a "big correction" in a continuing bull trend. Abby Joseph Cohen, chief strategist for Goldman, Sachs in New York, thinks that stocks have already dropped too far and will recover.
This month, investors rediscovered some of the smaller stocks. Steve Norwitz of the T. Rowe Price mutual fund company in Baltimore looked back at 23 periods when smaller stocks were priced at low valuations relative to the blue chips. In 19 of those periods, smaller stocks outperformed over the next five years.
The big unknown today is whether the risks in business and stocks are off the forecasters' charts. The Asian depression is the world's most dangerous economic event in 50 years. I'm not a doomsday thinker, but investors need to plan for the worst as well as the best. In view of what happened to your own stocks and mutual funds last week, ask yourself:
1. Might I lose money I know I'm going to need sometime soon?
Cash set aside to buy a house, start a business, pay for college or cover essential living expenses for the next three or four years doesn't belong in the stock market, period. Keep this kind of money in short-term bond funds (if you won't need the cash for a couple of years), money market funds or banks.
2. Could a deep slide in stocks put my long-term security at risk?
The younger you are, the easier it is to whistle while stocks fall. You don't have much money invested and have decades to earn any losses back.
But people closing in on retirement have a lot to lose, especially if much of their net worth lies in a single stock. This is the age for balanced investing -- say, half in stocks and half in shorter-term bonds. The safe half of your money can tide you over a market drop; the growth half should pay off for you 10 or 20 years from now.
3. What was I thinking, if I panicked and sold?
You may be in thrall to what Richard Hoey, chief economist for the Dreyfus Corp. in New York, calls "the conceit that investors or gurus can reliably forecast the fluctuations in the market." They can't, and you can't. If you're not a long-term investor, you're not an investor at all.
Pub Date: 8/17/98