One Day Won't Fix Everything

Lots of investors breathed a sigh of relief yesterday. But we're not out of the woods yet.

For a while yesterday, it looked like stocks were ready to crash. Giving up a big gain, stocks dropped over the lunch hour to set new lows for the year. Yet the indexes pulled back from the edge, and by the end of the day, an up-and-down day had turned into a big 400-point rally for the Dow.

Does that mean this stomach-churning downdraft is over for good? Not by a long shot.

Looking at history
The past teaches us that throughout a number of past financial catastrophes, people have found solutions that allowed markets and economies to recover. Despite concerns from some that any government bailout would undermine the entire capitalist system, past problems show that the line we draw between completely free markets and government regulation often lands in the wrong place. Although the solutions proposed to fix these regulatory lapses have often proven costly -- just look back at the S&L crisis of the 1990s for a $160 billion example -- they've helped safeguard the life savings of millions of investors.

Despite the rush of news in the past few days, those solutions don't come overnight. And more importantly for investors, although we may look back on yesterday and decide that it was the turning point for the bear market, there's no guarantee that it actually marks the end of this painful episode for stock markets worldwide.

Lessons from 1987
For some guidance on past episodes, for instance, go back to the 1987 stock market crash. In hindsight, that dark episode in the markets has lost much of its sting. In fact, it instilled in many investors a confidence that all drops are followed by quick rebounds; in less than two years, the market was back at new highs.

At the time, though, it was far from obvious whether we'd be entering a Second Great Depression as a result of the 1987 crash. As easy as it is now to look at Black Monday as the ultimate low, it wasn't obvious at all at the time. Even weeks afterward, many big-company stocks had fallen even farther from their Black Monday levels:

Stock

10/19/1987 Close

12/4/1987 Close

AT&T (NYSE: T  )

35.00

33.75

General Electric (NYSE: GE  )

41.88

40.00

Altria Group (NYSE: MO  )

88.12

85.12

Microsoft (Nasdaq: MSFT  )

45.25

42.00

Wal-Mart (NYSE: WMT  )

26.62

21.62

Boeing (NYSE: BA  )

38.50

34.62

Citigroup (NYSE: C  )

34.13

23.00

Source: Yahoo! Finance. Historical prices not adjusted for later splits.

Even though we look back at the Crash of 1987 as a short-lived event, share prices show that there was plenty of anxiety for a long time afterward -- even though the Dow has never since closed below those Black Monday lows.

Be patient
You've already heard plenty about how you shouldn't panic while the market is going down. At the same time, though, you also shouldn't panic when the market goes up. The euphoria that comes from seeing the Dow rise 400 points in a single day can be just as destructive as the fear that comes from seeing it drop 400 points -- if you start acting emotionally.

When markets crash, fear makes you sell low. But when markets rebound, you become scared that you're missing the bottom. That sense of urgency prevents you from taking the time to research a stock fully and figure out whether buying it really makes sense. And often, you're so late that you pay a much higher price. Anyone who bought S&P index mutual fund shares yesterday afternoon, for instance, paid more than 6% extra, compared to those who picked the bottom earlier.

Whether yesterday proves to be the absolute bottom for the market, or just another step in a long trip down, you'll continue to have opportunities to invest in stocks at attractive prices. As long as you keep your cool and avoid letting either panic or euphoria lead you to making irrational decisions, you'll do fine in the long run.

More on the current financial crisis:

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Fool contributor Dan Caplinger wonders where it's all going to stop. He owns shares of General Electric and Altria. Wal-Mart and Microsoft are Motley Fool Inside Value recommendations. The Fool's disclosure policy doesn't need fixing.


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  • Report this Comment On September 19, 2008, at 4:16 PM, kpscott wrote:

    So perhaps the best way to profit from this current bloodletting is dollar cost averaging?

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