Unsurprising drop

The stock market was down 2.5% on its first trading day of June. This follows a decline of 6.8% in May, leaving stocks down 10.2% since its high of April this year, and down 18.9% since the high of October 2007. This seems to have surprised, and even shocked, many investors.

When asked what the stock market would do, J.P. Morgan famously said, “It will fluctuate.” Benjamin Graham told investors (in his book The Intelligent Investor) to resign themselves in advance “to the probability rather than the mere possibility that most of his holdings will advance, say, 50% or more from their low point and decline the equivalent of one-third or more from their high point at various periods.”

In other words, the stock market is a roller coaster, and investors should anticipate and even expect frequent stomach-churning drops and thrilling climbs along the way. These drops are not a sign of something unusual and dreaded, but something expected and even eagerly anticipated. Why? Because drops lead to opportunity as merchandise that cost $100 a few days ago is now on sale for less (sometimes, much less).

As I pointed out in my posts, Better than zero and “Where’s the market going next year?”, the math underlying expected future returns should have warned investors to anticipate drops. And, as I expressed in my post, All eyes on China, news of slowing growth from China would likely lead markets lower, and it has.

I think investors were surprised because they don’t think of the stock market as a roller coaster, or they try too hard to relish the climbs and forget the inevitable drops. Perhaps they also suffer from myopia, attending to recent company reports and economic news instead of thinking about longer term data. 

Nevertheless, drops will happen, and they should be exploited instead of feared. Lower prices mean higher future returns–clearly a good thing. Panicky investors that sell as the market drops benefit longer term investors that buy from them. I’m not saying the drops won’t pull at your stomach–they will. What I’m saying is drops are to be expected and wise investors will have the courage to act as the market drops to exploit short-term oriented investors.

I’m not panicking as my portfolio drops, but lining up my buy list and making purchases as the market sinks. The more it sinks, the more I’ll buy. Just like riding a roller coaster, I look forward to the plunges and climbs, because that’s the nature of the beast.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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Unsurprising drop

The triumph of hope over experience

The Fed bailed out Bear Stearns and now everything is okay. Right? RIGHT???

Wrong.

The Fed bailed out Bear Stearns in a forced marriage to J.P. Morgan because they feared (and still fear) a collapse of our financial system. That isn’t good news.

The Fed cut interest rates another 75 basis points, down to 2.25%, because it’s trying to re-ignite economic growth. They are more worried about growth than inflation despite surging commodity prices and a tanking US dollar.

Economic reports this week showed worse employment data, worse leading economic indicators, worse business outlook, worse housing starts, worse producer price inflation, worse capacity utilization, worse industrial production, and worse forecast auto sales.

So why did the market rally this week?

The triumph of hope over experience.

The stock market is simply not reflecting economic reality or previous experience with economic slowdowns. Those who believe we’ll ride this out without an even 20% decline in the major indexes need to prepare themselves for a bumpy ride.

I’m not moving into a fallout shelter, but I’m also not ignoring a long and vivid stock market history, either. I’m ready for a rough couple of years that will, eventually, be followed by another economic and stock market boom.

This is not the time to think the Fed and Treasury can solve all economic problems (have they ever really succeeded in the past?). This is not a time to expect a mid-cycle slowdown or light stock market downturn. This is the time to prepare for tough sledding.

I’m ready for a downturn, and I’m finding good things to buy. But, I’m not expecting this to be a pleasant or smooth ride!

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.