Saturday, March 03, 2007

"Mind" -> Can We See Stock Disaster?

It is very hard to get an adequate return from putting your money into a bank account or into a CD. Why aren't you in the stock market? Probably because you heard that it is risky. Maybe you've been watching the stock market melt down for the last couple of days, and you are insisting that you're really glad that you aren't in the market.

Although, I don't suggest driving while looking in the rear view mirror, I do think that being ignorant of history is being doomed to repeat it. So, perhaps, we should look at the stock market over time.

I want you to click on the first picture in this chart. This is the S&P 500. What is the S&P 500? Well, this is a longer story that our short post tonight, but you can just think of the S&P as 500 leading companies. And the S&P 500 is just these 500 companies stock value, for the last 60 or so years. We put these companies into an "index" then we watch them.

You can see that this index, when looked at from the aspect of time, does nothing but go up. Again, if you start putting away $200 per month when you are 20 years old, by the time you are 65, you will have $1,000,000 dollars if the trend continues. (You should count on about 7-8% CAGR out of the S&P 500 index unless you can get a handle on a couple trends.)

Why am I talking about the S&P 500? Because the vast majority of money managers can't do as well as the S&P 500. Generally, over time, the S&P 500 out performs 70% of professional money managers. If you only had one thing to buy, a special "summary stock" called an index fund, which was basically made up of the S&P 500, would be the best thing to get. A common way of getting these types of stock is called buying a "spider" which is traded under SPY on the AMEX, and you can buy it through any broker.

However, if you buy the SPY, you still have the problem of the market crashing. And the S&P did take a hit this week.

However, this wasn't the big crash. The last big crash started to happen around 2000. Can we spot when we are getting into trouble? Could we see trouble in 2000?

Now, there are some people that just trade on trends. These people are called "technical traders." I don't believe on trading just on the trends, but I do believe that we can see "big trends" in the market. I believe we could have seen trouble in 2000.

If you simply draw a straight line on the S&P 500, you can see that something "unnatural" was happening in the mid 1990's. The 70's were a horrible time, and the market had no reason to perform well. However, the 80's recovered, and the 90's were doing well. However, the line simply just became too steep at the end of the 90's. If you look at the chart it is very clear. A bubble is forming.

I remember this time well, and some of the people at my work were saying that the market just seemed a little out of control. Some people were talking about "the new economy." For myself? I was busy just trying to buy the most expensive piece of land that I could, and this was consuming me. Therefore, I didn't have a lot in the stock market.

Here is the percentage that the market changed from year to year:

2005 3.01 up
2004 9.00 up
2003 26.39 up
2002 -23.37 down
2001 -13.04 down
2000 -10.14 down
1999 19.51 up
1998 26.67 up
1997 31.02 up
1996 20.27 up
1995 34.11 up

So, if you look at the data, we can see that the market was taking off like a rocket from 1995 to 2000. it should be a surprise to absolutely nobody that the market couldn't continue to grow at 20-30% growth per year. Interestingly, Warren Buffet said that it couldn't. He was right.

Now, here is the interesting thing. At such a long strong pull upwards, many people didn't get out of the market when it started down in 2000. As a matter of fact, the market had its worst year in 2002.

Now, let us take a look at the recent change from 2002. The last crash that has come puts us back onto the local line that has been established from the recovery from 2003.

Yes, the market has seen a correction, but there is nothing "extraordinary" to suggest that the market is going to go into another extended down turn as from 2000. As a matter of fact, once the correction is over (down turns are called corrections), we should see another good opportunity to buy back into the market. The crash of this week really wasn't a happy time for many people, but go back a year, and you still would have made 7-8% on your money, which is better than putting it into a bank.

In a future post, we'll talk about how things call "options" can help to mitigate some of that risk.

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