Ed Douglas Publications... News and Press
Whatís a person to do in todayís stock market?
Friday, November 28, 2008

What should a person do in todayís stock market? With this bear market here are some new stock market terms:

  • Standard and Poor: Your life in a nutshell.
  • Market correction: The day after you buy stocks.
  • Institutional Investor: Past year investor who is now locked in a nuthouse.
  • Cash Flow: The movement your money makes as it flushes down the toilet
  • P/E Ratio: The percentage of stock market investors wetting their pants as the market keeps crashing

As my first Money Marathon column, I have chosen the timely topic of the stock market. What should a person expect from here and what should he do to protect himself?

First letís look at what has happened. As of the close of business on Nov. 20, (what I hope was the low) the market as measured by the Standard and Poorís 500 index was down 48 percent for the year and 52 percent from its high in October of last year. To put this in perspective, since 1942 there have only been two bear markets nearly this severe, a 48 percent drop in 1973-74, and a 49 percent drop in 2000-2002 Since we now have had two terrible bear markets in this decade the market as measured by the S&P 500 as of the low was down for this decade 38 percent. Only one other decade from the 20s forward has been down for the entire decade and that was the 30s in which the market was down only .1 percent compounded for the entire decade. At that low point of the close of business Thursday Nov. 20, eight years into this decade the market was down at a compounded rate of (5 percent). From that day forward the market would have to compound at 27 percent a year for the next two years to be flat for the decade.

Since I stared in banking in 1974, I have never seen any thing this bad in the stock market. The bear market from 00-02 was nothing like this, in that if a person didnít own tech stocks during that period, his return was basically flat, which was not bad. In this bear market there has been no place to hide and the market has taken no prisoners. I wish I had seen this coming a year ago, but I didnít.

In normal times I would say that a nearly 50 percent decline would be a terrific, once in a lifetime buying opportunity and again maybe this is the case. But this might not be normal. In fact it has been down right scary. When I first started writing this article I thought there was a small chance that the economy, confidence and the market could spiral downward out of control-maybe a 5-10 percent chance. After the Federal Reserve and the Treasury made decisive moves last week to save Citigroup, buy mortgages and become very aggressive at providing liquidity I think it is much less likely of a downward spiral but still possible.

What should a person do to in this market?

First, a person should examine how much he has in stocks as a percent of his overall investments (this is called asset allocation). The rule of thumb has been to subtract a personís age from 120 to determine how much of a personís portfolio should be invested in stocks. As an example, under this scenario, a 50 year old should have 70 percent in stocks (120-50) and a 20 year old should have 100 percent in stocks (120-20). In this market to implement this rule, I would use a more conservative rule of thumb of 100 rather than 120 which would lower the stock allocation in my two examples by 20 percent, to 50 percent for the 50 year old and 80 percent for the 20 year old. Rather than owning individual stocks, I would also suggest owning well diversified high quality stock funds (funds that purchase big companies that are less likely to go broke.) 

Secondly, if a person has a sizeable amount or large percentage in stocks and a further significant loss of that current amount of money could be ruin his financial future; I would consider developing a plan to protect against a market collapse, possibly selling stocks to put into cash investments at incremental levels as the market goes down. This protects against disaster.

A very possible scenario I think is for the market to bounce around going higher by 10 to 20 percent and then coming back down to current lows and doing this several times over the next several months. This seems to be what happened last week with a five day upward movement and then a big sell of Monday. If the economy doesnít recover until 2010, which is a possibility then a person can potentially make some money by selling part of his portfolio, say 10 percent on a 10 percent up move in stocks. Then if the market drops back down to its previous level, a person could put half of those funds withdrawn back in the market and repeat this as many times as it occurs until the market breaks out on the upside for the next bull market.

If a person has not invested in stocks before, has only a small amount invested or is prepared to take some risk, this could be a great time to invest for the long term and again this is the most likely the current situation.. But again, if a person has a lot invested, be prepared to protect against that small chance that this is a once in a century bear market that could continue downward as described above.

Hopefully, Standard and Poor can become again a term of a way to participate in the growth of the American economy and the upswing for the next bull market.

(Remember every investorís situation is unique and it is important to review your specific situation with a financial professional.)

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