The Stock Market: When Will Stocks Bounce Back?

The Stock Market

When Will Stocks Bounce Back?

Don't expect an immediate rebound. "Investors shouldn't get overly enthusiastic," says Jean-Marie Eveillard, portfolio manager for the First Eagle Funds. Why? Even if Washington gets its act together, the economy will remain a drag. "In a time of slow growth, profits will not be that great," Eveillard says.

Remember too that a massive government rescue plan could have unintended consequences. If the budget deficit were to balloon - as many economists assume it would - that could further weaken the dollar, which would lead to another bout of inflation fears.

Rising inflation and a falling dollar, in turn, would likely boost market interest rates, since it will take a big carrot to entice foreign investors to buy U.S. bonds. When rates are on the rise, investors typically aren't willing to pay up for stocks in the form of higher price/earnings ratios.

Economists are predicting that a recession could last through next spring or even the fall. Does this mean stocks will languish that entire time? No. Equities have a knack for rallying in anticipation of an eventual recovery. So a stock market rebound could take place sometime in the first half of 2009. Until then, don't hold your breath.

If the Outlook Is So Bad, Why Not Dump Stocks?

Selling stocks after they've sunk to a three-year low in hopes of buying them back after they're trading at higher prices is a surefire recipe for losing your shirt.

While it's understandable to want to flee, Bohemia, N.Y. financial planner Ronald Rogé suggests taking a cue from Warren Buffett. "Here's the smartest guy on the block, and his firm, Berkshire Hathaway, is down like most other stocks this year." But instead of looking to sell, Buffett is buying. Recently he agreed to plow $5 billion into Goldman Sachs.

Still have the urge to purge your portfolio? Consider this: So far this year, fund investors have yanked more money out of their stock funds than they've put in, marking only the third time in recent memory this has happened. The other two times? In 2002, just before a five-year bull market, and 1988, the start of a 12-year bull.

"If you leave the market now entirely, you probably won't make it back in time to enjoy the recovery," says Torrance, Calif. financial planner Phillip Cook. According to Standard & Poor's, equities typically recoup a third of what they lost in a bear market in the first 40 days of a new bull.

Are Stocks Still Best for the Long Run?

If you've been a stock investor over the past decade, you probably feel like the mythical Sisyphus: You've been trying to roll your portfolio up the hill, only to see the market keep batting it back down. Stocks are trading lower than they were at the start of 2000. Even boring bonds have beaten equities during this time.

But disappointing performance doesn't erase the case for stocks. Over the long term (meaning more than a decade), equities give you something fixed-income investments can't: a share of growth. The benefit of owning a stake in a company - as the Treasury Department, no doubt, understands with the majority position it is taking in exchange for helping AIG - is that you get to share in the earnings of the firm. And because stock prices, over time, reflect corporate profit growth, you're likely to far outpace the long-term rate of inflation.

If your faith in stocks is still wavering, consider the last time they performed so poorly: the 1930s. "What if you concluded then that stocks weren't the best place to be?" says Alan Skrainka, chief market strategist for Edward Jones. "You'd have missed out on decades of bull markets."

The long run can turn out to be extraordinarily long, far longer than an investor's investment horizon.

If an investor entered the market last century when the Dow was one-standard deviation above its long-term trend line, an exuberant bull market top, how long did they have to wait? Leuthold (InvestmentNews, 5/21/2001) notes that an investor at the peak in 1929 took until August, 1998, almost 69 years, to reach a nominal return of 10% on their money, including dividends. This is an after inflation yearly return of about 7%. Thus, it took 69 years for an investor to reach the long-term average return for stocks, and had an investor in 1929 relied upon long-term stock returns data to calculate their future net worth or retirement income, they would have been sorely disappointed.

In addition, from its peak in 1929, our long-term investor had to endure an 86% decline in the value of his portfolio to its low in July, 1932. The Dow Industrials holds some of America's largest and financially soundest companies, and cannot be considered an aggressive or speculative part of the stock market. Yet, investors choosing this relatively conservative sector of the stock market would have had to have extraordinary nerves, and an abundance of decades to see a long-term average return on their investment. This is far more than can be realistically expected.