S&P 500, NASDAQ likely to end second year with a net loss, barring a miracle

By DAVID MOON, Moon Capital Management
October 28, 2001

Unless we have a drastic change in the final nine weeks of the year, the S&P 500 is likely to experience its second consecutive calendar year decline this year. After falling nine percent last year, the broad market index is off another 20 percent so far this year. The once high-flying NASDAQ has fallen more than 60 percent in the last 21 months, on its way to an almost certain second year decline. A couple of years ago, it seemed investors were most concerned about what they might miss ' so they invested out of a fear of missing the next big thing. Many of today's investors invest out of a fear of missing their money ' not the next Microsoft. Concern about risk is back in vogue. Like good, solid shoes or a warm jacket in winter, concern about risk should have never been out of favor. But now that more investors than ever are actually concerned about the potential for losing money, what should they actually do?

Don't stick your head in the sand. In the last year, I have met so many people upset, shocked or just disappointed by huge losses in certain investments ' many of these worn folks let their brokerage statements pile up, unopened, on that table in the kitchen that catches things you don't want to deal with right now but don't want to throw away, either. Open your mail. It may be years before some of your stocks return to their heights of 1999.

If you own a stock and would not be willing to buy it at this level, consider selling it. In a nontaxable account, this decision is easy. If there are no tax consequences for selling a stock, sell anything you wouldn't buy today, at today's price. Put the money in investments you would buy today, at today's price.

Have realistic expectations. The long-term average return of the stock market is about 11 percent a year. A lot of people would love to have made eleven percent in the last two years, but few people think of long term stock returns as that low. They are. And they are likely to be lower for a while, given the extraordinarily high returns during much of the last 20 years.

But don't give up on stocks in general. If the returns on stocks are going to be low, bond returns are likely to be even lower. Bonds are usually the less risky portion of an investor's portfolio, but over the last 20 years, even this less risky component generated excellent returns. In 1982, short-term interest rates were close to 20 percent. As interest rates fell, the value of most bonds increased. Today, short-term US Treasury bill rates hover around two percent. Two. Not twenty. I have no idea if we will see 20 percent rates again in the next decade or so. But I will guarantee rates are not going to decline another 18 percentage points from here. If rates increase, the total return on bonds will be negative. If rates remain steady, bond returns will be anemic.

When you look at stocks or stock mutual funds, understand that there is a difference between the price and value of a thing. As strange as it sounds, do not try to predict the future price movement of a stock you are considering. That sort of decision process is simple; that's why so many people talk about 'let's buy XYZ Widget Company. It's moving up and looks like it may go to a hundred.' That process may be simple, but it is no more scientific than betting on the football team with the prettiest socks. You must determine what XYZ Widget is actually worth. Of course, it is more complicated to estimate the value of a company, then compare the value to the current price, taking into account all of the assumptions you make to estimate the value. But that's how to manage your investment risk ' understand the value of the things you own.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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