Step Away from the Ledge, Part 2

When I wrote yesterday’s article, it was Friday, practically another century from where we are now. I had no idea that overseas markets would stage a two-day collapse on fears that the US may be in a deep recession. From India to China to Europe, there was a sea of panic-selling that swept across the globe. The only reprieve came when markets closed.

The US markets could not avoid the problems, although our stocks had already fallen more than those of other countries. It is difficult for reason to prevail when euphoria propels financial markets higher and when fear throttles them lower. That’s why the anticipation of yesterday’s market action had many worried about the worst case scenario. Fortunately, the day was not as bad as feared, because the Fed stepped in with an emergency ¾ point rate cut. Still, the Dow Jones Industrial Average fell 128.11 points, or 1.1%, to 11971.19; the Standard & Poor's 500-stock index shed 14.69 points, or 1.1%, to 1310.50; and the Nasdaq Composite Index dropped 47.75 points, or 2%, to 2292.27.

It took about two seconds for people to look back to 1987’s crash, when the Dow Jones Industrial Average lost 22.6% on October 19. To put that into today’s terms, we would have needed to see a one-day plunge of over 2700 points today to match that gut-wrenching day. Still, there are some similarities between 1987 and yesterday’s drubbing. The 1987 crash followed a multi-year bull market; leading up to the day, there was pressure on the US dollar; the US was running deficits; oil was rising; stocks reached an all-time high in the summer; then sold off and recovered into October. In 1987, the crash then occurred on a single day, while today, the sell-off from the top has been more orderly. Through yesterday, the large stock indices are down between 15-19% from the October highs.

Before you sell the farm, here are some significant differences: in 1987, the price to earnings ratio of stocks was far higher than it is today; Fed policy makers were tightening interest rates in 1987, while today they are easing them; and most importantly, bonds were yielding over 10% in 1987 and today they are below 4%. Even if the selling continues today, you may be heartened by the fact that in 1987, the stock market regained its footing after October 19th. The crash marked the low point for stocks in 1987 and by year-end, the Dow actually showed a gain for the year! Within nine months, stocks recovered all of the losses incurred on October 19th and the US economy never went into a recession as a result of the crash. That may or may not happen this time, but in any event, my prescription is to step away from the ledge and remember your long term goals.