Personal Finance: Past isn’t always prelude

rutlandherald.nybor.com March 8, 2003 By KAREN PAUL

It may not surprise you to know that there is no mere mortal on this planet who knows where the stock market will head or what magic number it will close at as dusk falls on the last day of this coming December. Ok, so that’s not a riveting statement nor is it rocket science or brain surgery (although a brain surgeon once told me that brain surgery isn’t really all that complex but I think he just said that.)

Riveting or not, it still does not stop Wall Street from hiring gurus and paying them stratospheric seven-figure incomes to tell us what the stock market is going to do six, 12 and 18 months down the road. You don’t hear Alan Greenspan forecasting interest rates or the stock market but then again, his pay isn’t in the ozone.

There are a great many myths in the investing crystal ball and some have repeated themselves so an argument can be made that they could happen again. Still others are just a lot of hopeful thinking or perhaps praying better describes it. Let’s talk about those that seem possible but really are far from it.

We know that there has been one time in history when the stock market has declined four years in a row. It’s so historical that it garners a title in capital letters, The Great Depression. From 1929 to its low in 1931, the stock market fell over 70% in four years before advancing into 1932.

We are not in the next great depression. I won’t bore you with all the reasons the last three years are different from those dark days around 1930. There is a myth whirling around Wall Street that just because the stock market has already declined 50 to 80%, depending on what average you cry over, the market can’t decline in 2003. We have already sunk low enough. Not necessarily true.

History is a guide, not a law. An argument can be made that valuations are still very high, that the economy is still very weak and that investors still face a deep crisis of confidence in American business and their ability to accurately inform the public. Last but certainly always on our collective minds, Iraq, North Korea and Venezuela loom with the darkness of immense uncertainty. A recent study by some noted British academic economists stated that in the course of “stock market performance shows that across 16 markets, the probability of a fourth down year is 40 percent.” Interestingly, according to market historian Yale Hirsch and others, that is also the probability than any year will be a down year. In other words, while the bullish side may have an edge here, it’s just that and nothing more.

Shortly after the beginning of this millennium, there was a widespread and wide-eyed belief that if Alan Greenspan would just lower interest rates, all our problems would be solved. Most investors would have thought I was losing my stock market marbles if I told you in 2000 that after a dozen interest rate cuts, the stock market was down over 50 percent. Case in point: lower interest rates do not guarantee a higher stock market. No one thing causes the stock market to go up, at least for very long. Granted, during the Gulf War in 1991, the stock market took off when it appeared we would be victorious but there were other factors in place that perpetuated that advance. An economy recovering from recession, improved corporate profitability, Wall Street expectations for companies that were met or were exceeded, and falling interest rates continued to fuel that rally.

Another investing myth portends that if you just wait long enough, buying and holding a stock will pay off in the long run. That may be true with some stocks but so untrue with so many others. While I might agree that it is possible to have an inkling of the future probability that some companies will be profitable over two or three years, believing that you know what some company will do over 10 or 20 years is unreasonable. You can take a leap of faith and buy a stock and hold it for 20 years, dust it off and hope for the best but that’s what it is. In this same British study, the authors observed that out of those same 16 national stock markets, investors in only five of those markets would have been guaranteed positive annualreturns over every 20-year period during the last century.” Wow, put that in your buy and hold pipe and well, up in smoke.

The ultimate truth is that there is always risk in the stock market. Diversifying can lessen the some of these ugly menaces that can erode returns. Having cash on the sidelines will give you the tool needed to participate in the stock market when your comfort level is reached.

In the meantime, put aside the rumors and the myths and concentrate on the reality, which is that no one has all the answers. You are going to make mistakes on your road to realizing your investment goals. As long as your decisions are diversified and grounded in fact, your rewards will be as well.