Stock Market Meltdown: What You Need to Know
Wall Street might be in a panic, but here's how you can keep calm and maybe even profit
Be wary of financial stocks. It seems that every day, another financial institution is announcing its exposure to subprime-related debt. And they're getting punished for their risk-taking. Bear Stearns, for instance, which recently announced troubles at three of its hedge funds due to this mortgage mess, has seen its stock lose more than a quarter of its value in less than three months. Not surprisingly, the financial services sector has been among the hardest hit since the stock market began to quiver in mid July. Financial stocks in the S&P 500 have fallen 7.4 percent since July 19 and are down 9.4 percent since the start of the year.
Expect a traditional flight to safety. In times of financial turmoil—such as the bursting of the tech bubble in 2000 or the Asian currency crisis in 1997—investors often sell the riskiest assets in their portfolios and head for the safest. And the safe haven of choice for global investors is still U.S. treasury bonds, which are backed by the full faith and credit of Uncle Sam. Not surprisingly, the flood of investments into U.S. treasuries has pushed the yield on 10-year notes down from 5.25 percent in mid June to 4.78 percent today.
Expect a corresponding flight to quality. For equity investors, this means a growing demand for two things: high-quality, industry-leading companies and dividend-paying firms. For example, since the market began to slide on July 19, stocks that received an A grade by S&P—based on the quality of their earnings and other fundamental factors—have fallen 5.9 percent on average. By comparison, stocks graded B have lost 9 percent. And the C stocks are down 12.8 percent. As for dividend-paying stocks, the situation is the same. Those stocks that pay out a dividend have lost only 0.6 percent on average since the start of August, versus a drop of 2.8 percent for stocks that don't pay out any dividend income.
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