Taking Stock: If History Is A Guide, The Worst Of The Bear Market May Be Over

Since this is a financial column, I decided to take the liberty of talking about something other than a specific company or technology to give some perspective to the recent market meltdown. Why am I spending time to try to boost investor confidence? Because the underlying companies that the public markets support are the companies that most of InformationWeek's readers work for. Anyone who's been at the wrong end of a pink slip knows what a downturn feels like. The more severe the decline, the more likely the economy in general will be affected--and the less confident companies are to grow and expand. Ultimately, this lack of confidence shows up in IT budgets as cuts to programs and staff.

The Nasdaq 100 Index is down 43.1% through July 23 but "only" --14.7% in July. Interestingly, the Standard & Poor's 500 is down 30.5% year-to-date but is off 19.4% in July. The rest of the stock market is finally starting to catch up with the pain felt in the Nasdaq earlier in the year. This is little consolation for the average investor. Clearly, there are few places for investors to hide.

As with most broad sell-offs, investors' fears are driving much of the decline: corporate accounting and ethical scandals, terrorism, and a slowdown in the economy are all behind this. While it may be tempting to simply sell everything and watch from the sidelines, history shows us that investors selling to cash in during negative markets can expect to see substantial underperformance when the equity markets return to health. In fact, the market may rebound near-term. Let me explain.

There's light at the end of the tunnel, despite how dark it may seem today. July has been truly horrifying for investors, but how does this compare historically? Most of the worst declines were in the 1930s during the Great Depression, when they ranged from-16% to-29%. The only other really bad months were in 1987 (Black Monday) and 1998 (the Asian crisis). Historically, the interesting part has been what happened over the five months following a bad month. In the five-month periods following the 10 declines of more than 14%, eight were positive and six of those had total returns of 22% or more. The average five-month return for these 10 instances was 26%, while the median was 28%.

The averages and median figures look very attractive and provide some hope that we may be getting closer to the end of the bear market. This also means that an attempt to time the market by moving your entire portfolio into cash and then back into stocks once the coast is clear will most likely fail.

There is a downside, though. There remains a 20% chance (two out of 10 instances) of a continuing market downturn if the news gets worse. The odds of the market appreciating are good, but some investors may not want to take any risk at all.

The stock market correction, while painful, establishes a clearing-out process whereby equity valuations aren't overvalued. It's the first time in several years we can say that. Further substantial downside in the markets shouldn't be expected as long as business profitability trends continue as expected and investors' fears subside.

Our primary conclusion is the same: Remain diversified and understand your personal risk profile and what levels of risk and volatility you're comfortable with. Most, if not all, investment professionals will never be able to call the bottom of this market.

Try not to make your investment and financial decisions while you're in a panic. Experience tells us that decisions about money made while emotions are high are rarely good decisions.

William Schaff is chief investment officer at Bay Isle Financial LLC, which manages the InformationWeek 100 Stock Index. reach him at [email protected].

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