In the past 20 trading sessions up to 24 May, there have been eight up days and 12 down days as meas...
In the past 20 trading sessions up to 24 May, there have been eight up days and 12 down days as measured by the Standard & Poor's 500 Index. The net decline was 4.2%.
This is the kind of market action you see in a traditional bear market. An old-fashioned bear does not stab you with a sword, as in the crash of 1987 and the mini-crash of 1989. It nicks you with a thousand cuts.
I doubt there will be stock market crash in this decade because investors have been trained to buy the dips. But we could see a year or two in which stocks rise two days a week and decline for three days. In other words, we could have an old-fashioned, saw-toothed, gradual, excruciating bear market. We might even be in one now.
My guess is that the Dow Jones Industrial Average, which closed yesterday at 10,535, will end the year below 10,000.
Stocks usually rise in a US presidential election year. The S&P 500 has risen in each of the past 14 election years. I would not bet this will happen for the fifteenth time in a row. The election precedent is a strong one. History also makes a strong case that high stock valuations and a hostile Federal Reserve are a lethal combination.
Inexperienced investors may wonder how stock valuations can still be high. After all, the Nasdaq Composite Index has declined 18% this year and 35% from its 10 March high. But the declines of the past 10 weeks were preceded by 50 months of manic gains. At the end of 1995, the Nasdaq stood at 1052.14. At its peak on 10 March it was 5048.62, a 380% gain.
Even after a 10-week bear market in the computer-related stocks which dominate the Nasdaq, the index still sells for 130 times earnings if you include companies that have losses. The Dow average and the S&P 500 are more reasonably valued at 23 and 28 times earnings, respectively. Although 28 times earnings is still about double the historical norm.
As for the Fed, it has made it plain it intends to keep tightening until the economy slows. It will probably take its foot off the brakes in the months immediately preceding the election. But investors will probably see that as a reprieve, not a pardon. It looks as if rates will continue to creep up into 2001. Rising rates are about as nourishing to stocks as toxic waste is to your garden.
I do not advocate bailing out of stocks, but I do suggest doing two things. First, check the asset-allocation plan you made when you were organising your financial life. Make sure the bull market of the past nine years has not inflated the stock portion way beyond your plan. If it has, do some selling.
Second, include in your equity portfolio a sprinkling of stocks that are likely to hold up fairly well if there is a further decline. Traditionally, food, beverage, tobacco, drug, gold and utility shares are considered 'defensive'. Some people put energy and defence stocks in this category as well.
Most food and beverage shares are too expensive now to perform their traditional defensive function. But Interstate Bakeries Corp. and Earthgrains Co - the US's two largest wholesale bakeries - are cheap and might make good defensive holdings.
It is also interesting to see what groups have been bucking the trend and rising lately. In the past month, the tobacco subgroup of the S&P 500 is up 28%. Pollution control is up 26%. Oil exploration and production is up 19%, property and casualty insurance 14% and life insurance 11%.
Finally, any stock that sells for a low price/earnings ratio or pays a high dividend probably is defensive to some degree. Some of my stocks with defensive characteristics are Loews (insurance, tobacco and oil drilling), Mattel (toys) and McDermott International (oil drilling platforms, nuclear submarines fuel).
Loews' business touches three of the five industries that have performed well in the past month. It would take quite a slowdown before parents cut back on buying Mattel toys such as Barbie dolls. As for McDermott International, the oil drilling platform business looks good for the next year or two. I hope the Navy does not adjust orders for submarine supplies based on what the economy is doing.
John Dorfman in the Bloomberg New York office
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