Recently stock markets around the world have experienced a significant decline and increased volatility as investors worry about the slowdown in the U.S. economy. Some economists think the recession has already begun. Others argue that growth will slow to 1 percent but a recession (defined as two back-to-back negative quarters of GDP — gross domestic product) will be averted. Some managers say we have already entered a bear market, especially if you look at the decline in small cap stocks. Others hold on to the belief that although more severe than the other 5 to 9 percent corrections we witnessed in 2007, it still is just a correction and not the beginning of a prolonged and deeper decline.
We can debate these issues and guess where the market will be in six, 12 and 18 months. While it is fun to do that and maybe speculate a little on your individual guesses, I think it is more important to review and remember some basic principles of investing.
Bear markets, while painful to endure, are necessary for one reason. If they did not exist, if they were not volatile, risky investments, then they would not provide a risk premium. Periods like 1929-32, 1973-74 and 2000-02, when the S&P 500 index lost 23, 21 and 15 percent per year, are why stocks have produced an annual risk premium of 8 per cent over one month Treasury bills. Without risk there would be no reward.
The years 2003, 2004, 2005, 2006, and almost all of 2007 except for December were five good years. If you had any portion of your portfolio invested in emerging markets, they were great years. So while we all hate to see our accounts drop in value, it acts as a reminder that stocks do have risk but we continue to invest in them because over the very long term (10 years and more) stocks do outperform bonds and other fixed income investments. We choose to accept the risk because we want the potential of higher returns.
The year 2008 marks 30 years that I have been in the investment business. In February 1978, the Dow Jones Industrial Average closed at 751 and the S&P 500 at 89. Those are pretty amazing numbers when you think about where we are now. Today, Feb. 6, 2008, the Dow is trading at 12,343 and the S&P 500 at 1,345. As every investor knows it did not go up in a straight line. In those 30 years, there were some pretty nasty declines. There is a word in Italian, agiada. Loosely translated it means upset stomach.
The stock market has given me lots of days when I have had a major case of agiada. I pop Tums into my mouth the way some children eat candy. But like many other long-term investors, I have also been rewarded with good returns. And more important than money, all of the wonderful people that I had the privilege of meeting over those years.
So try not to let these volatile days get you down. Just review your portfolio to make sure it is still properly allocated to your risk tolerance. And for you trivia buffs, 30 years ago the great Muhammad Ali lost his title to 25-year-old Leon Spinks in a 15-round decision at Las Vegas. And Robin Williams made his debut as a fast-talking space alien on an episode of the sitcom, "Happy Days."
Fonzie! We baby boomers sure do miss you.
Thomas Grella Sr. is president of Grella Financial Services. Questions or comments can be sent to him at tom@grellafinancial.com.
