Monday, November 3, 2008

Stocks: Rating the 2008 Meltdown

Stocks: Rating the 2008 Meltdown

For many who work and invest in the stock market, the past two months have been an unmitigated, once-in-a-lifetime disaster. You only have once chance to save for retirement, so a 40% drop in your stock portfolio feels like the end of the world.

You start to question all the advice that you've been given. With major indexes trading at the same levels as in 1998, folks who have been equity fans start to wonder whether it's really true that, over the long term, stocks tend to outperform other investments (BusinessWeek, Oct. 30, 2008). Ask economic historians for their read on the situation, and, not surprisingly, they take the longer view. They don't say, "Don't worry about it. It's no big deal."

Many financial experts think the crisis has scrambled our assumptions about the risks and returns of investing in stocks. But experts do know this is hardly the first—nor will it be the last—time that the world's investors have been seized with panic and hit with deep losses.

Another Dark October

For investors wondering what the future holds, the key question may be whether this crisis is just another (very big) bump along a road to prosperity, or whether the financial markets have driven off the road into a ditch.

So how bad is the current mess? It's worth crunching some numbers:

In October 2008, the broad Standard & Poor's 500-stock index fell 16.8%, following a 9.2% drop in September. The Dow Jones industrial average dropped 14.1% in October, following a 6% decline in September.

Other Months Were Worse

Through the first 10 months of the year, the S&P 500 has lost 34% and the Dow shed 29.7%. From their all-time high points—on Oct. 9, 2007—the Dow is down 34.2% and the S&P 500 has lost 38.1%. (Those are much better than the losses of about 45% that the indexes had registered at their lowest levels this fall.)

How does this compare to history? For the Dow, the percentage losses of October 2008 are exceeded by 15 other months since 1928, including September 1931, when the Dow plunged 30.7%. Other rough months, according to the Stock Trader's Almanac, were in 1929, 1930, 1931, 1932, 1933, 1938, 1940, 1987, and 1998.

If the S&P 500 finishes 2008 at this level, its 34% annual decline would be the third worst since 1930, beaten out by 1931 and 1937. However, if stocks recover a bit, 1974's 29.7% drop for the S&P 500 and 2002's 23.4% fall in the index might be worse.

Rules Haven't Been Rewritten

For Richard Sylla of New York University's Stern School of Business, this year's crisis is one of a long line of rough periods for equity investors. "It's a bear market like a number of bear markets," he says. It's not as if the fundamental rules of investing have been rewritten, he says. "The stock market hasn't changed its stripes."

For current investors saving for retirement or other needs, a big worry is that the stock market is a big bubble that has collapsed. Stocks got way overpriced, this theory says, and investors might never get back those losses. A prime example is the bubble in technology stocks in the early 2000s, when the tech-heavy Nasdaq composite hit a high of 5,132.52 in March 2000.

With the Nasdaq now trading at 1,720, it could be a lifetime or two before it approaches its heights during the bubble.

Reacting to Banking Bad News

Eugene White, a financial historian at Rutgers University, doesn't think this is a similar situation. "What's happening now is the stock market is reacting to the bad news in the banking sector and to the economy as a whole," White says, not an overvaluation of stocks themselves. While neither White nor Sylla knows when stocks will recover, White insists "fundamentals look pretty good," especially the U.S. economy's ability to improve its own productivity over time.

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