Smart401k Blog

In the headlines

A look at some of the market movers over the past week:

• European Union regulators spent the weekend trying to buoy their financial system, including providing a $68 billion bailout for German lender Hypo Real Estate
• ImClone (Nasdaq: IMCL) agreed to be taken over by Eli Lilly (NYSE: LLY) for $6.5 billion
• Bank of America‘s (NYSE: BAC) third quarter was soft and the bank announced it was cutting its dividend in half and raising $10 billion of new stock
• Abu Dhabi came to the aid of chipmaker AMD (NYSE: AMD)
• Central banks around the world coordinated on a surprise interest rate cut
• Alcoa (NYSE: AA) kicked off earnings season on a rough note
• MetLife‘s (NYSE: MET) earnings were in line with expectations, but the company was stung by its announcement to sell $2.8 billion in new shares
• Early in the week the US Treasury was looking hard at taking ownership stakes in major US banks; by the end of the week it was becoming a reality
• Iceland nationalized its largest bank as the financial crisis continues to spread around the world
• Citigroup (NYSE: C) gave way for Wells Fargo (NYSE: WFC) to acquire Wachovia (NYSE: WB)
• GE (NYSE: GE) pleased investors as it met its revenue and earnings guidance

Commentary

If I was running out of superlatives last week, then I’m fresh out of them this week. The markets have deteriorated unbelievably quickly and finished a stomach churning week down more than 18% from where we finished last week. Over the past two weeks the S&P 500 index has now lost almost 26% and hasn’t seen an up day since Tuesday September 30th.

I wouldn’t want to discount the events of the week, since some were very notable. For instance, the Federal Reserve’s half point rate cut was note worthy for its size, the extent of global coordination, and the lack of impact that it had on the markets all at the same time. Meanwhile, the news from outside of the US from Germany to Italy to Iceland conveyed just how global the financial problem has become.

And while US markets took a major hit during the week, international markets were hit astonishingly hard as well. Japan’s Nikkei, for example, lost more than 9% on two separate trading days this week, and finished the week down 24%. Europe’s FTSE index wasn’t hit as quite as hard as the Nikkei, but still bested the declines of the US indexes, falling 21% for the week.

And of course we can’t overlook the end-of-week announcement that the US Treasury would start taking stakes in banks.

Looking ahead

The beginning of next week (which is Tuesday due to the Columbus Day holiday) will likely be filled with chatter about the Treasury’s potential actions and what they might mean for the broader market and the financial system. Meanwhile, earnings will start pouring out. Though the market is likely to overlook most of the releases, there is little doubt that investors will key in on earnings releases from major financial players like JPMorgan (NYSE: JPM) and Wells Fargo, both of whom report on Wednesday.

On the economic front, inflation readings will dominate next week, with both the producer price index and consumer price index being released. It’s assumed with commodity prices well down from their highs that inflation will moderate substantially, but it’s questionable whether the market will take this as a bullish indicator at this point. The Fed also releases its “beige book” next week, which will be picked over for signs on the economy’s direction.

With very few comparable periods on the market to look to, we don’t have too much of a model for what to expect in the coming weeks and months. However, it could be instructive to look at the few models that we do have. In terms of 10-day periods where the market fell 20% or more, there are five main examples outside of the current period: October of 1929, October of 1931, April of 1932, May of 1940, and October of 1987. At the peak of each of these rapid declines the average 10-day loss was 26.7% and the median was 22.7%, which puts our current 24.2% 10-day loss roughly in the middle of the pack.

More importantly, though, let’s look at what happened following these fast drops. The situations varied greatly with October 1929 — which was right off the peak of the pre-Great Depression bull market — on one end and October 1987 — which consisted primarily of a one-day aberrational drop — at the other end. On average, the Dow rebounded 9.5% in the first month after each of these declines. In fact, a positive advance of 7% or more was the case for every instance except April 1932. All but one instance (October 1931) showed positive gains over the next six months — 4.2% on average.

As usual, though, we’re more concerned with longer periods of time, and those results look promising. On average, the Dow gained 16.1% (5.1% per year) over the next three years, 71.2% (11.4% per year) over the next five years, and 102.5% (7.3% per year) over the next ten years.

But let’s go one step further. The laggard among our group over these longer periods is October of 1929. Why? Well, that was the initial salvo in the stock market crash of the Great Depression. Looking at our current situation, the Dow was already down around 20% when the market started hitting the brakes hard, so we could argue that the performance following the October 1929 drop is less comparable. Take that out and our numbers look even better: up 38.5% (11.5% per year) over the next three years, up 103.1% (15.2% per year) over the next five years, and up 137.3% (9.0% per year) over the next ten years.

While there really aren’t enough examples to draw any certain conclusions, all of this is just a long way of saying that this is not an advisable time to be yanking your money from the market. The commitment when you’re saving for retirement is to put the money in the market and allow the impact of compounding to serve you over the decades that it’s in there. While it may seem torturous to have your money invested right now, your future, comfortably retired self will thank you for keeping it invested.

This entry was posted on Saturday, October 11th, 2008 at 3:37 pm and is filed under SmartUpdate Market News. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.