Heeding Market Warnings

May 15, 2008

If there’s one place an investor can find clear direction in a sea of opposing opinions, it’s BusinessWeek. According to the following excerpt, we’re in for some tough times:

Stocks
are swinging up and down more often and more violently than at any time
since the Great Depression. As recently as 1995, the Standard &
Poor’s 500-stock index traded all year without once changing 2% in a
day. But [recently], it gyrated that much or more on 52 days — once in
every five trading sessions — the most since 1938. The tech-laden
NASDAQ now swings by at least 2% on two days out of five, vs. just once
every 10 days nearly 30 years ago.

…fundamental changes are
taking place that will likely alter investing and the very structure of
the market for years to come. Millions of ordinary buy-and-hold
investors, who have been a major stabilizing force in the stock market,
are bailing out. If history is any guide, those investors won’t jump
back in quickly… “This is a new, rapid-fire trading kind of
environment that just stymies average investors,” says James W.
Paulsen, chief investment officer at Wells Capital Management. “Old
dogmas like ‘buy and hold’ just don’t work.”

In fact, says
Richard Bernstein, chief U.S. equity strategist at Merrill Lynch &
Co., a big reason for the recent market volatility and falling
stock prices is that investors are just beginning to see how vulnerable
stocks are to unpredictable corporate earnings. “Investors have been
underanticipating risk,” he says. Sooner or later, they’ll become less
willing to pay up for stocks with more volatile earnings and wild price
swings. And they’ll demand lower share prices as compensation for the
extra risk they’re taking. “Even if a cyclical bull market reappears,
it’s likely to be modest,” says Charles Pradilla, chief strategist at
SG Cowen Securities Corp.

On top of all that, the markets have to deal with heightened geopolitical risk.

We
aren’t necessarily condemned to a multiyear bear market. But perhaps
investors should be prepared for several “mini-bear” and “mini-bull”
swings of at least 20%, which occurred in the five years preceding the
1973-74 bear market and in the eight subsequent years. There are, of
course, big differences today: Inflation is nowhere near the heights it
reached then, interest rates are low, and the Federal Reserve has been
proactive.

In any case, many average investors are again
paralyzed by market uncertainty. Hiding behind decimated portfolios –
or cash, if they’re lucky — they’re afraid to jump back into the fray.