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BEING STREET SMART

by Sy Harding

 What market always comes back? August, 1999.

The phrase "The market always comes back" is a powerful confidence builder for investors. It says we don't have to be concerned about risk, or market downturns. Even if a nasty bear market comes along, it shouldn't be a cause for concern. After all, as long as we have a long-term outlook, the market always comes back.

The phrase is a great selling tool for Wall Street. There's never a need to wait for better market conditions. Just invest any time and let time take care of it.

But, wait a minute! Aren't there a couple of problems with the theory?

Never mind that after the market top in 1929, it was twenty-six years before the market `came back'. A forty-five year old investor in 1929 was a seventy-one year old retiree in 1955 before he saw the market back to break-even. Some investors died waiting. 

Never mind that after the Dow hit 1000 for the first time in 1966, a period of sixteen years followed during which there were five bear markets with declines of as much as 45%, and it was not until 1982 that the Dow `came back' and climbed above 1000. Another 16 years of waiting.

Never mind that U.S. investors in the exciting Japanese market of the late 1980s have been waiting since the Japanese market's peak in 1989, for those stocks to come back, with the Japanese market, in spite of its recent rally, still 55% below its 1989 peak.

A bigger problem with the theory is that it usually isn't even the same market we were invested in that comes back.

The theory is based on the fact that the Dow and S&P 500 always come back to their previous highs, sometimes quickly, sometimes only after a very long time, and then go on to make new highs.

However, the composition of those indexes undergoes such frequent revision it makes their comeback meaningless as far as an investor's portfolio is concerned.

For example, 43 percent of the stocks that composed the Dow just ten years ago are no longer part of the Dow now.

More than 60% of the stocks that composed the S&P 500 twenty years ago, are no longer in that index.

They were replaced, one at a time, by stocks of newer, stronger companies that became more representative of the changing economy.

It's been the same since the turn of the century when the first market indexes were developed to measure what the overall market is doing. I hope no one is still waiting for Distilling & Cattle Feeding or American Locomotive Inc. to come back. They were once components of the Dow, as were American Cotton Oil, U.S. Leather, and Baldwin Locomotive.

They were replaced by the stocks of similarly forgotten early automobile makers, and the hot stocks of radio manufacturers and gold mining operations.

An endless parade of new industries continued to emerge; aircraft manufacturers, airlines, photography, publishing, packaged foods, medical equipment. The strongest stocks among them replaced fading companies in the indexes, and then in turn faded themselves.

Early computer stocks showed up. AST, Commodore, Encore, Tandy, Wang Laboratories, moved into the indexes. Royal Typewriter, Magnavox, National Cash Register, and hundreds of others, moved out.

In the 1990s, the latest wave of high-tech companies came on the scene. The early computer companies all but disappeared. Biotech companies, aerospace companies, cable TV companies, moved into the indexes to replace them.

The retail sector changed dramatically. Previously hot Woolworth, Montgomery Ward, Grants, were bumped to make room for WalMart, TOYS R US, Best Buy. Sears was recently bumped out to make room for Home Depot. Newly hot stocks MGM, Hilton Hotels, Marriott moved in. Suddenly out of favor Howard Johnson and Playboy moved out. Disney, Brunswick, Calloway Golf became part of the indexes. Chriscraft, Polaroid, and others virtually disappeared.

The point is what does it really mean, to say the market always comes back, if the indexes that supposedly prove that fact are constantly altered to include only the stocks that are the strongest at the time, while many of the popular stocks of the previous bull market, which investors really need to come back, have been dropped from the record, and in some cases no longer exist?

Almost none of this bull market's best performing stocks, the likes of Microsoft, Dell, Intel, WalMart, Home Depot, etc., even existed in the last bull market. How many new companies that currently exist only in the imaginations of a couple of guys or gals working in their parent's garages will fuel the next bull market?

Which currently strong stocks won't be around? Which are already on their way out to make room for Internet stocks?

My point is, don't let a deceptive slogan like "the market always comes back" lull you into a false sense of security that becomes a substitute for thoughtful portfolio and risk management.

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