Downward stock market flirts with correction territory
After several weeks of slipping and sliding, the stock market is now on the verge of tumbling into an official correction—something that hasn't happened since late 2002.
In afternoon trading today, the Dow fell another 100 points or so, bringing the benchmark index's four-week loss to around 800 points. What was surprising was that stocks lost so much ground on a day when the White House had good news to report: the confirmed death of Abu Musab Zarqawi, the face of al Qaeda in Iraq.
Over the past month, the Dow has lost around 7 percent of its value, which means the benchmark index is only a few percentage points away from entering an official correction (generally defined as a short-term drop of 10 percent or more).
Some areas of the stock market are already entering correction territory. The Nasdaq composite index, for instance, is down more than 9 percent from its May highs. The Russell 2000 index of small stocks has lost more than 11 percent. And emerging markets stocks and gold are both off nearly 20 percent since their recent highs.
"Investors should never underestimate how quickly the financial markets can turn," said Joseph Quinlan, chief market strategist for Bank of America's investment strategies group.
Quinlan notes that the biggest losers over the past month had been the biggest winners on Wall Street for most of this year. For example, between Jan. 1, 2006, and May 8, the Morgan Stanley Capital Emerging Markets index was up a stunning 25 percent. Now, it's near bear-market territory.
What's causing all this rumbling on Wall Street? Renewed inflation fears–fanned by recent remarks made by new Federal Reserve Board Chairman Ben Bernanke–have led to a growing feeling of insecurity and fear on Wall Street. And when investors get scared, they lose their appetite for risk taking.
So what can investors do to seek a little shelter from this market storm?
- Dial down the risk in your portfolio. For the past three years, investors have made huge gains in high-risk areas of the stock market, such as small-capitalization shares and emerging markets equities. But after posting double-digit annual gains for the past three years, these stocks have the most room to fall in a market correction.
- Think big. Though large-capitalization equities are getting walloped just like the rest of the market, their losses are modest compared with those of speculative stocks. Moreover, large-cap stocks have been overlooked since the late 1990s. So in terms of price, they're among the cheapest stocks in the market. And if the economy is really threatened by inflation, big companies that dominate their industries should offer the safest rides.
- Think dividends. Stocks that pay out dividends hold up better during volatile times in the market. This doesn't guarantee you'll make money in dividend-paying stocks during a downturn. But chances are, you'll lose much less. In May, for instance, which marked one of the worst months for stocks in recent years, S&P 500 companies that paid out dividends lost around 2 percent of their value. But nondividend payers lost around twice as much.
"This is a different market" from the one investors enjoyed at the start of this year, says Howard Silverblatt, equity market analyst for S&P. And the more volatile this market gets, the more investors will have to focus on stability and quality rather than greed and speculation.
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