Don't Fear the Dow's Drop

Many investors are wondering where the good times went. After a supercharged entrance into 2012 had the Dow Jones Industrials Average (INDEX: ^DJI  ) trading above 13,000, it has fallen almost 10% and looks like it could go below 12,000 -- all the way back to where it was in January. The index is now exactly flat over the last twelve months, leaving investors wanting.

However, as investors, we need to resist our natural instincts to run for the "sell" button. The index still trades up some 16% from the 52-week low it hit in October, and for all of the fear caused by a potential "Grexit" and slowing growth in China, we're in a much better place than we were just a few years ago. Just take a look at the Volatility Index (INDEX: ^VIX  ) , or "fear index," which is trading at 27.4, up 2.8% today. If you were to take a narrow view, you'd see the index up some 44% in the last month. That's scary stuff. Zoom out to five years and you'll see three towers of terror where the volatility index peaked close to 80 in 2008 and then hit 40 in 2010 and 2011. So things aren't so bad right now.

^VIX Chart

^VIX data by YCharts.

The one thing to remember
As much as we may like to think we can time the market and jump in and out at the most opportune times, we can't. We don't know when it's going to go up or down; we only know that over the long run, it has historically always headed higher. Those upward trends aren't necessarily consistent or predictable, though. The general rule of thumb is that 80% of the returns you receive in risky assets, like stocks, come 20% of the time.

That means you've got to put up with a lot of noise in the meantime. That noise includes big market swings, like what we've seen over the last few weeks.

Today's Dogs of the Dow...aren't.
Just look at today's three worst-performing Dow stocks:

  • JPMorgan Chase (NYSE: JPM  ) , down 3.3%.
  • Caterpillar (NYSE: CAT  ) , down 3%.
  • General Electric (NYSE: GE  ) , down 2.5%.

These three companies aren't exactly super-risky, speculative bets -- in fact, they are three incredible businesses. Caterpillar was our analysts' top Dow stock for 2012 in a recent March Madness competition. JPMorgan is down big after a $2 billion trading loss, but it remains one of the best-run banks out there and trades for an absurdly cheap price-to-book-value of 0.7. Banking is risky, and even the best mess up sometimes, but JPMorgan's loss isn't indicative of a poorly run bank; it's one bet that went bad. Despite running into dividend trouble during the recession, General Electric recently announced that GE Capital will resume dividends to the parent company, and it still remains one of the best places to park your cash if you're an income investor.

No rational investor would sell these companies today, despite drops larger than 2.5% for each of them. That's because over the long run, great companies perform well and rise in price, and you'd be hard-pressed to find a more dense collection of great companies than the Dow Jones Industrials Average. It's no fun to watch the index head lower after falling hard the day before, but take a step back and realize that reacting to daily swings like this is a recipe for destroying wealth.

Making big bets
The seasoned investor instead sees drops like this as an opportunity to take some money off the sidelines and put it to work buying great companies like The Motley Fool's Top Stock for 2012. It's our chief investment officer's favorite stock for this year, and today's price gives investors a rare 20% discount over the last few weeks. Don't drag your feet on this one, because that haircut won't last long. You can read more about this top pick here.

Austin Smith owns no shares of the companies mentioned here. The Motley Fool owns shares of JPMorgan Chase. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (4) | Recommend This Article (21)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 04, 2012, at 6:18 PM, hanover67 wrote:

    Not panicking may be all well and good, but it is certainly a much better point to buy some of Motley Fool's recommendations now that before. I'm down 39% on WPRT and I bought it way below the recent high. So, it has to rise 40% for me just to get even. How likely is that?

    I learned during the dot-com decline that waiting for a stock to come back isn't an investment strategy, its denial.

  • Report this Comment On June 04, 2012, at 7:29 PM, Metaworld wrote:

    I'm sorry but I think you're way off on this one. The perfect storm is approaching. The VIX will be going higher overall. April was the top of the roller-coaster. There may be a few fun bumps but the ride is going down. I just moved 5 years of income into safety funds and will be relatively risk free before July. Sovereign egos in Europe will contribute to the decline as they're unable to coalesce in time. QE3 will not be effective given the current circumstances. And don't underestimate the power of retired Boomers and their need for safety as well as their memory from 2008. I'll be playing some inverse ETFs and taking my cash and loading up on the fire sale in 2013 when the VIX again hits 80 and high volume is selling into weakness. At least, that's my story for now. Don't undo your seat belt. Here comes the next ride.

  • Report this Comment On June 05, 2012, at 7:13 AM, shirtbrigade wrote:

    Credit swaps that include greek mortgages must drop if greece exists and defaults. The effect will be to discount the credit swaps, not just for greece' exit, but for the perceived and possibly impending domino effect. Even a tiny but sudden discount could harm the banks deeply. Imagine what a large and rapid decline will do? They leveraged themselves and risked their very existence, because, no one knows what a drop of say 10% in value to the trillions of dollars of credit swaps they are involved in, does to their net worth and bottom line. If they stop making money and their stated book value drops to "0" what must the stock price do? So the real question here is, what would just a 3% decline in face value of a credit swap which will never return or recover, do to these banks? This is the same issue as the movie "too big to fail" so vividly illuminated...Bernanke made illegal loans of some 4 trillion dollars last time. This time, he cannot. He risked a 20 year depression and possibly, world war III. He cannot loan trillions without Congress' express permission. It would be treason to do so. His hands are tied And he has not much room for stimulus. Obama is done. He hopped on the stage coach chanting all the way, and drove us straight to hell. This nation needs a real leader, regardless of any other factor including political party etc... Because the Supreme Court decided corporations have rights like humans, and organized crime can just buy a presidency (thanks Supremes) I say, this marks the end of ever meeting the right person for the job. This nation is now done in by its own "intellectual dishonesty"

  • Report this Comment On June 05, 2012, at 7:48 AM, Zankudo wrote:

    Agree with the last part which is the lack of leadership but neither party leader will be honest enough and courageous enough to do what is required with Wall Street, the military, or other third rail issues...for them, not for the rest of us. With regard to Europe I believe that the Germans will eventually come to their senses, since to do otherwise will hurt business, and make the Euro a fiscal union beginning slow and allowing Spain at least to overcome the current crisis. This isn't based wholly on economics. It is based on history. Insofar as the wipe-out of those holding onto credit swaps, well c'est la vie. It was a foolish bet but therein others make money. It is a zero sum game no.

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