By JANE BRYANT QUINN
Owning stocks is like riding the roller coaster at Disney World, where you’re entirely in the dark. You feel every rise and fall, every sharp and shallow turn, but you can’t see what’s ahead. You can only guess when the ride might end from what has gone before.
So as you consider your investments, it might help to know what has gone before and what the possibilities are.
If we’re approaching a genuine bear market, stocks will drop some 20 percent or more, as measured by the Dow Jones industrial average. That would bring us back to around 5,600 on the Dow, and probably lower.
At the start, you can rarely tell if you’re in that kind of decline, even if stocks are trending down. We’ve had nine bear markets over the past 40 years, most of them lasting six to 18 months.
If we’re in a lesser decline say, down 10 to 15 percent market pros will call it a correction. Shallower drops aren’t worth talking about. They’re mere fluctuations in the market’s ordinary course.
True bears appear whenever interest rates climb too high, which is usually for one of two reasons.
Most often, the U.S. economy is heading for trouble. Strong business conditions drive up interest rates. At some point, the cost of borrowing gets high enough to undermine the boom. Sometimes a recession follows, sometimes a marked slowdown in growth.
When interest rates move up, investors shift money out of stocks and into fixed-income investments, which look more attractive. Money doesn’t shift back to stocks until interest rates fall again. Falling rates also generate a business upturn.
Don’t ask me how to tell when these turning points arrive. Only the stock market knows. The bear markets of 1973-74 (down 45.1 percent) and 1981-82 (down 24.1 percent) were in this tradition.
The other bear-market trigger is an economic shock that unexpectedly drives interest rates up. A classic example came in 1990, when Saddam Hussein first threatened, then invaded, Kuwait. Oil prices and interest rates jumped. Stocks dropped 21.2 percent in less than three months. A mild recession was generated, too.
No recession accompanied the 1987 crash. But in the months prior to the crash, interest rates ran up as international investors speculated against the dollar a shock that most Americans didn’t notice until too late.
This year, we’ve had no outside shock. But business has been good, profits strong and unemployment low. Those are the very conditions that generate high demand for money, hence rising interest rates.
When the Federal Reserve boosted short-term rates last month, it was playing catch-up with the market, which already had driven longer-term Treasury rates above 7 percent.
No recession seems in the air. But, like bear markets, it takes a while to know you’re in one. At the very least, growth and business profits are expected to slow this year.
At 7 percent, bonds may seem pretty tame to people who started their life as investors after 1982. Since then, stocks have risen an astonishing 800 percent, as measured by the Dow.
But stocks don’t always make new highs after a decline, hard as that is for younger investors to believe. From 1966 to 1983 17 years stocks did nothing but zigzag, with no net gains.
During that discouraging period, investors in big-company stocks earned around 7 percent annually, entirely from compounded dividends, according to the investment firm Goldman Sachs. In the 10 years from 1965 to 1974, they earned only 1.2 percent annually an entire decade when it didn’t pay to buy and hold the nation’s leading stocks.
So that’s another scenario: a flat market for a period of time, with stocks earning below-average returns.
A handful of aggressive mutual funds are in bear markets of their own. Over the past six months, the following popular no-load funds have lost 23 to 30 percent: Dreyfus Aggressive Growth, IAI Emerging Growth, SteinRoe Capital Opportunity, Van Wagoner Emerging Growth, two of the American Century funds and four of the PBHG funds.
By contrast, the Dow rose 11.9 percent over the past six months, while the average growth-and-income fund gained 8 percent.
But even these latter measures dropped over the first quarter of this year. To weather a downturn, serious or mild, you need to be diversified over different types of stock and bond funds, and plan not to touch your money for at least four years.
Bear Market Strategies
A radio producer called me this week, wanting to set up an interview. His question: “If people are afraid of the stock market, where should they put their money?”
My answer: If you run your money by fear today and joy tomorrow, you’re destined to be a loser. Investors who try to time the market can never be sure when to buy or sell.
Say that you sell, the market drops and you feel like a genius. To profit, however, you’ll have to rebuy in time for the following upturn, which is incredibly hard to do.
In a typical bear market (not a crash), stocks rise a little and then drop, rise again then drop some more, over and over again. You’re suckered into investing at what looks like a bottom, then the market sinks further down.
The upswing, when it comes, will start as a series of sudden, amazing spurts in price that are concentrated in just a few days or a few weeks, at most. At first, they’ll look like just another phony rise.
The average investor who’s scared of the market’s dips today will almost certainly put off rebuying if stocks keep zigzagging down. When you finally get up your nerve, the market may have leaped up again.
All this assumes a bear market or serious correction is upon us. That assumption may be wrong, although we cannot know it now.
So to answer the radio producer’s question, you should put your money into investments directed toward your long-term goals and leave it there. In investing, nothing is more important than your time horizon.
For a free booklet on bear markets, how to handle them, and appropriate risks for different ages and temperaments, call the Vanguard Group of mutual funds at 800-257-9998 (you’ll get a recorded menu; press any button for the booklet).
Vanguard Chairman John Bogle likes to quote the legendary investor and billionaire, Warren Buffett, who said that when it comes to stocks, “inactivity strikes us as intelligent behavior.” That seems pretty smart to me.
Syndicated columnist Jane Bryant Quinn can be reached in care of the Washington Post Writers Group, 1150 15th St., Washington D.C. 20071-9200.