On Feb. 27, 2007, investors were "treated" to the largest one-day percentage drop in U.S. stocks since March 2003.
Although the Dow Jones Industrial Average fell over 400 points (the most since 2001 in terms of points), the actual percentages were somewhat mild at 3.29 percent for the Dow, and 3.47 percent for the S&P 500. In actual terms, the markets gave back the gains it had since the beginning of the year. In fact, it didn't even make the Dow's top 10 single-day percentage losses.
Investors must understand that since last August the market has been steadily rising. I would compare it to an airplane taking off. We have been in a slow ascent and just hit a bit of turbulence. Although further drops are quite likely over the near term, economic conditions are still in tact for a promising 2007.
There were a number of events that precipitated the fall: China's stock market dropping 9 percent the previous day; the largest one-month drop in durable goods orders; former Fed chairman Alan Greenspan's remarks of a possible recession; and oil price going back to more than $62 a barrel. It is critical to remember that corrections are always healthy for the market, and more importantly, necessary to power higher moves in the future.
The important thing for the individual investor to realize is that the fundamental underpinnings of the market remain in tact. Interest rates are lower than they were a year ago, and the prospect for future corporate earnings look good. In addition, the current stabilization in the housing market, the possibility of interest-rate cuts and subdued inflation pressure could help in moving the market higher once this pullback is digested fully — which, in fact, is just what has happened.
Steady Goes It
Investors need to maintain their long-term approach and understand that market declines are a normal occurrence. I have never met anyone who has made a profit by panicking.
Smart investors learn to anticipate and use market drops to add to their equity position that may now have come down to a more fairly valued, or even undervalued price. Barring a fundamental reason for the decline, as we have seen in the past (i.e., long-term capital or the Asian financial crisis), investors need to remain committed to sound investment principles with a diversified portfolio using a variety of asset classes to ease the volatility of any portfolio.
Although it may seem a cliché, it is certainly still the time to "stay the course."
We also must realize that the market as represented by the S&P 500 has not had a 10 percent correction for four years. The last time we experienced a "correction"– defined as a drop of 10 percent or more — was from November 2002 to March 2003. So, it can be said that this drop was certainly expected and somewhat overdue by many market-watchers.
History shows us that stock market's near-term prospects are no worse off due to February's drop. Look at monthly returns for the Dow Jones Industrial Average (back to its inception in 1896), and what occurs following a break is a win streak of seven months or more.
This criteria includes just 14 cases, suggesting that the strength the market exhibited in the last half of 2006 and earlier this year was quite rare.
In conclusion, it's rare that any one day's activity should be the impetus for an investor to abandon what is a sound investment strategy. Portfolios that have experienced large gains over the past few years in outperforming asset classes, such as emerging markets, could possibly be tweaked to reduce exposure, or to take some well-earned gains and deploy the assets to other underperforming asset classes.
As for those jitters … just take a look at the market now to gain some perspective.
Craig Langweiler is president of the Langweiler Financial Group, in Newtown. He can be reached at 215-860-8088 or at: clangweiler@ americanportfolios.com.