the value of your portfolio decline can be excruciating, but the lesson
of the past is that stocks always fall as economies slow, and when
the recession (or the more modest slowdown) is reaching its depth,
stocks tend to rise again. There have been nine recessions since World
War II, and after each one the market rose to a level higher than
when the recession began.
a recent study by Ned Davis Associates looked at 28 major crises
since the Nazis marched into Paris in 1940. Nearly every crisis
produced the same powerful pattern: a sharp decline in stock prices
followed by an impressive recovery to considerably higher levels.
For example, stocks dropped 14% in the five months after the Japanese
bombed Pearl Harbor on Dec. 7, 1941, but for the full year of 1942
the market rose 20%. In the next three years, stocks doubled. Shortly
after the outbreak of the Persian Gulf War in the summer of 1990,
stocks fell 14% as well, but for the full year of 1991 they were
This does not
mean that the future is entirely predictable from the past. After
all, I am the co-author of a 1999 book called Dow
36,000, which made the claim that stocks were in a long-term
period of revaluation that began in 1982 with the Dow at 777 and
would continue until shares reached their "proper level"
a Dow of about 36,000. My co-author, economist Kevin Hassett,
and I did not predict when this blessed event would occur, and we
warned that outside events could send markets down in shocking ways.
of Pax Americana could end tomorrow," we wrote, "and it
is not hard to imagine investors becoming more nervous about their
stocks, not to mention their survival."
The basic argument of Dow 36,000 was that Americans had come
to understand that stocks were an exceptional investment
no more risky than bonds when held for long periods. So investors
since the early 1980s were rationally bidding up the price of stocks
and, we wrote, would continue to do so (with interruptions) until
prices roughly quadrupled. Of course, if you call your book Dow
36,000, you set yourself up as a target. To many critics, our
book was a manifestation of the Internet mania, of day trading and
momentum investing even though Kevin and I had a strong aversion
to high-tech stocks, never made claims that we were in a "new
economy," and preached a buy-and-hold creed. The list of 15
stocks we highlighted was dominated by boring companies such as
Cintas, which rents work uniforms; Tootsie Roll, the century-old
candy maker; and Johnson & Johnson. On the list were just two
high-tech firms Microsoft and Cisco, each with a strong history
Still, it was
an inflammatory title, and maybe we had it coming to us. Kevin joked
that we should have called the book A Treatise on the Declining
Equity Risk Premium. That was the guts of our theory: Investors
were so scared of stocks that they demanded a premium a much
bigger return than bonds to make up for the increased risk.
But, we concluded, for long-term investors that increased risk was
was based on two big assumptions: first, that the economy would
keep growing at the same rate it had since World War II, and second,
that investors would not panic if the market turned down for an
extended period. This is a time of severe testing, but, for now,
the assumptions are holding. The consensus is that the economy will
grow by about 3% annually over the next decade, and as for investors:
In 2000, a terrible year for the market, they added $300 billion
in net new money (after redemptions) to stock mutual funds. This
year (through September), they added another $13 billion.
But the jury
is still out. The attacks of Sept. 11 and their aftermath may yet
change both the prospects for U.S. economic growth and the long-term
confidence of investors. Right now, I believe the crisis is no more
threatening than others this country has faced from Pearl
Harbor to the Kennedy assassination and I think investors
should proceed on that assumption. But it could be worse, and, if
it is, then the old rules of investing may not hold. For now, however,
those rules are more important than ever.
It is the very
uncertainty of the markets and the world that require investors
to go back to basics and to form a strategy to guide their investment
decisions. In the late 1990s you could get away with bad habits.
The wind was at your back and an infield pop-up would blow over
the fence for a home run. Foolish maneuvers like buying shares
in companies that had never made a profit, concentrating your portfolio
in a single sector, or jumping in and out of stocks on a whim
often paid off handsomely.
are over. The wind has shifted. It's swirling all around the ballpark.
This is a time to stay cool and keep disciplined.
- Let me
repeat, in condensed form, the "10 truths" from a
column I wrote in 1999:
you invest a penny, know why you are putting money away: for
retirement, to buy a house in a few years. Your answers determine
how much you'll put into stocks, bonds, and cash. Those allocations
serve as your guide; they can change over time, but only to
meet changes in your plan.
early. The most critical element in investing success is time,
not stock picking.
- If you
can't stay in stocks for at least seven years, then stay out.
Stocks are very volatile in the short run, but in the long run
the risk dissipates.
try to "time" the market, or guess when it will rise
- The best
time to sell a stock is never. Yes, there are times to
sell, but they involve the fundamentals of the company whose
stock you own not the stock's price or the state of the
funds are magnificent, democratic inventions, but they have
deficiencies. Watch out for high expenses, tax surprises, high
turnover, and managers who deviate from their stated goals.
investors can't do it themselves. They need professional help
not so much to pick stocks as to hold hands.
it comes to bonds, the best deals are Treasury Inflation-Protection
Securities (TIPS), which pay a flat "real" rate plus
an inflation kicker.
- On technology
stocks: It's fine to own them, but don't get carried away. Tech
should not represent more than one-fourth of your portfolio.
guidelines would not have prevented losses over the past 2 1/2 years.
(After all, another essential truth is that stocks never go straight
up. The Standard & Poor's 500-stock index, a good proxy for
the market, has produced negative returns, after inflation, in 21
of the past 75 years.) But diversification, for example, would have
limited the decline in the value of your shares.
From the date
of printing of my "10 truths" through Oct. 31, 2001, the
tech-heavy Nasdaq composite index fell 34%, but if you had invested
in Spiders an exchange-traded fund that's the soul of diversification,
behaving like the S&P itself your loss would have been
18%. And if you had continued to buy stocks on a regular basis throughout
the decline, you could have cut your losses to 15 percent or less.
column originally appeared in the Washington Post.