I am writing this column on Jan. 15, 2001, a holiday for many since today is celebrated as the birthday of Dr. Martin Luther King Jr. Today is also celebrated as the birthday of Confederate General Robert E. Lee.
There is a corollary between Robert E. Lee and the dip in stock prices we are now experiencing.
Lee had enjoyed a string of military victories in Virginia before leading his army to Gettysburg. In every instance, he had fought against an army with more men, more ammunition and more food. Since his army had won virtually every battle, he was convinced that the Southern army was invincible and would prevail regardless of the strength of his enemy.
Gettysburg was a rude awakening for Lee. His army was soundly defeated and was able to limp back to Virginia only because the commander of the Union army was overly cautious and somewhat inept.
What does that have to do with a dip in the stock market? The last few years of 20%+ gains in the stock market has convinced some investors that the old rules of prudent investing are no longer applicable to the “new stock market.” In a sense, investors came to believe they were invincible and the market would only go higher and higher. Regardless of whether a company was making any money or not, the stock would continue to rise and rise and rise.
A good time was had by all.
We are now somewhat in the same position as Lee at Gettysburg. More men, ammunition and food do matter. Similarly, corporate earnings and interest rates do matter. It was inevitable that the market would shakeout the flood of dot-com companies and only the better ones would survive. It was also inevitable that the American economy must rest and refresh itself periodically.
At the risk of seeming old fashioned, let’s look at some economic fundamentals for a moment.
A stock’s value is based solely on its ability to generate profit and pay dividends to its stockholders. When a company is losing money, it is consuming capital. Over time, the capital all gets consumed and there is no money left to operate the business. Temporary losses are OK, but there must be the prospect of better times in the near future or the company will fail.
The economy as a whole can only absorb so much growth without generating serious inflation. Experts differ on how much growth is sustainable, however 2% to 4% seems to be about right. Alan Greenspan has done good service for our country in recognizing that we were growing at an unsustainable rate and raised interest rates in an attempt to slow us down. His strategy has worked. Current estimates put economic expansion at between zero and 2% for this year.
As painful as it may be, we need this cooling-off to allow capacity to catch-up with demand. The ultimate saboteur of economic stability, inflation, was the only option.
The stock market dip has impacted all areas of the market. From technology to blue chip, all sectors are languishing well below the highs of a year ago. Annual 401(k) reports are being mailed to participants and a loud cry of anguish is being heard across the land. Prospective early retirees are re-figuring their options in the face of lower stock market performance.
Everyone is wondering what to do now. I have the solution.
Re-examine your investment strategy, re-balance your portfolio if necessary and forget about it. If you own a broad cross-section of stocks and are thereby well diversified, then you will prosper as the American economy prospers. You can do no better and really have no logical choice but to ride out the storm and wait for a better day. Mutual funds offer diversity and professional management at nominal cost and are the best investment vehicle for most people.
The American economic system is the marvel of the world. Unfortunately, market fluctuations are part of the deal. However, over the long haul investing in American industry is a sure winner.
Thought for the Moment
Man must evolve for all human conflict a method which rejects revenge, aggression and retaliation. The foundation of such a method is love.
— Martin Luther King Jr.
Joe D. Jones, CPA, is publisher of the Mississippi Business Journal. Contact him at firstname.lastname@example.org.