Tuesday, May 22, 2018
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Plunging market carried lessons for investors

As grim as the stock market was last year, it served as a wonderful object lesson in investing.

Many brand-name stocks took a mighty tumble in the worst year on Wall Street in decades - Lucent, down 81 percent, AT&T, down 66 percent, Microsoft, down 63 percent, America Online, down 54 percent. Locally, it was the same: Stock of Toledo's three largest corporations, its Fortune 500 firms, dropped an average of 74 percent.

The slump of 2000 reminds all investors of rules of thumb and axioms we should never have strayed from. Diversification is still very important. Earnings and dividends do mean something after all. What goes up can, indeed, come crashing back to earth. To get more reward, you still have to take more risk.

Successful stock picking involves more than just throwing money into a can't-lose market. Investors need to choose carefully, looking at fundamentals as well as past and recent stock performance. Don't fall for the latest fads (they're called “stories” now) - the bursting of the dot-com bubble last year is good evidence of the truth of that old lesson.

Investors should have realistic expectations of market returns. It may be a long time before they see returns like those in the late 1990s, marked by five straight years of 20-plus-percent gains. Historically, stocks gain an average of 10-12 percent a year, and bull markets are interspersed by bear markets that occur every few years (or at least they did until 1990, the last time both the Dow and the Standard & Poor's 500-stock average both fell 20 percent). And now many experts predict returns will drop to low single digits in coming years.

Diversification is a guiding principle investors should never violate. In the 1990s, it seemed that diversification was a drag on a portfolio's return. During the big run-up in the Nasdaq, tech stocks were the drivers, and everything else was too stodgy.

But what if you held only one sector, and that sector was technology? Your losses would be in the high double digits by now.

Or what if you held only one stock, and that stock was Owens Corning? Your stock price would have plunged 96 percent when Owens Corning filed for Chapter 11 bankruptcy reorganization to deal with mounting asbestos-injury claims. If that stock had been Owens-Illinois, you wouldn't have fared much better in 2000: O-I's stock fell 77 per cent, largely because of its asbestos exposure. And Dana Corp.'s stock, also brushed by the asbestos phenomenon as well as earnings problems and the auto-industry slowdown, dropped 49 percent.

Many investors forgot about bonds during stocks' tremendous rise in the late 1990s, and they paid the price in 2000. Bonds are looking very good at the moment, especially compared with negative returns from the stock market last year and so far in 2001.

Many investors - especially those who got into the market through 401(k) plans in the 1990s - are seeing their first serious market downturn. Those 401(k) plans, which turn 20 years old this month, largely fueled the tremendous market gains of the 1990s, when it was relatively easy to pick a winning portfolio. Just throw it all in stocks - the riskier the better. After all, that would produce higher returns. Right?

Investors forgot to pay attention to traditional yardsticks like price-earnings ratios. Even after the tech crash, many tech stocks still carry PE ratios of 80 to 100 or more, and the S&P 500 may still be somewhat overpriced with a collective PE of 22, compared with an average of 18 for the last decade.

The tumultuous market of the last few months raises the questions: How low can it go and how long could a bear market last? Even though Nasdaq is clearly in a bear market, the S&P is not quite there yet, and the Dow has a way to before it hits bear territory (a bear market occurs when an index drops 20 percent from its peak).

Investors should hope that neither the Dow nor the Nasdaq goes for a record. Already the Nasdaq is in its biggest slump since the devastating bear market of 1973 and '74, when it plummeted 60 percent (Nasdaq is now 53 percent under its peak of last March). The 1973-74 bear lasted 21 months, compared with 10 months for the average bear and 12 months for the median, according to InvesTech Research. It took Nasdaq seven years to get back the value it lost in that tumble.

The Dow's longest bear market lasted three years, in the late 1940s, and the Dow's average bear is 18 months, which means if this becomes an honest-to-goodness bear market it could be mid-2001 before it bottoms out, says InvesTech. The Dow's worst drop? You don't want to hear it - the index plunged a mind-boggling 89 per cent from 1929 to 1932, and it took 24 years to get back to pre-crash levels.

Those who invested too heavily in hometown stocks or in stock of their own employers often paid a horrible price last year. In recent months, many a Toledoan has been heard to say: “I'll never buy stock in a Toledo company again.”

However, that's learning the wrong lesson. If a brave investor had bought O-I stock at $2.50 a share when it recently hit a historic low, he or she could have pocketed a piece of change when O-I hit $8 yesterday: a tidy 220 percent gain from its trough.

Perhaps the most forgotten lesson, one we're re-learning even now as the market continues to falter in the new year, is: Don't panic.

Investors pay a big penalty for being out of the market when an eventual upturn occurs.

Homer Brickey is The Blade's senior business writer.

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