For almost a year, it seemed that the stock market could do no wrong. Now, the prevailing attitude among investors appears to be changing. Unless you're prepared for what could happen next, your portfolio could start behaving like it did back in 2008.
Have we been here before?
Last Thursday's huge drop in the stock market brought back memories from uglier times. Recall that last January, the year got off to a reasonably good start, with stocks enjoying some solid gains during the first few days of 2009. But the mood quickly turned back to the pessimism that had dominated the financial markets for months, leading finally to March's selling climax.
Since then, we've come full circle. The market hit bottom, and instead of getting worried about the many disturbing problems that persist within the economy, investors instead chose to focus on whatever positives they could find to support assertions of an economic recovery. That helped support the nearly year-long rally that stocks enjoyed.
At least until now.
A mood shift
Now, pessimism is back. New concerns in Europe about the viability of some of the weaker countries within the Eurozone have reawakened anxiety about the general markets. Gold and silver sold off sharply, bringing related stocks like Freeport-McMoRan (NYSE: FCX ) and Silver Wheaton (NYSE: SLW ) down with them.
Perhaps more importantly, the current earnings season has exposed the lack of confidence that investors have about the future. Just consider some recent news:
- Credit card marketers Visa (NYSE: V ) and MasterCard (NYSE: MA ) both announced strong growth in earnings compared to the fourth quarter of 2008. Yet even though Visa did better than investors had expected, its stock nevertheless fell following the announcement -- and when MasterCard missed, its shares dropped 10%.
- Similarly, technology stocks like Qualcomm (Nasdaq: QCOM ) and Motorola (NYSE: MOT ) have not only improved profits but have also beaten analyst estimates. However, both stocks took big losses of 12% to 14% in the week immediately after the announcements, as future guidance disappointed shareholders.
- Even as energy prices rose in recent weeks to levels not seen since the oil bust in the summer of 2008, big oil companies like BP (NYSE: BP ) haven't been able to meet the high expectations that investors have -- and with the reversal in oil prices last week, those fears could weigh on shares for some time.
In short, investors appear to have priced shares of many companies for perfection. When a company's financial results fall short in even the tiniest way, its shares get pounded -- and even nice gains sometimes seem to be nothing more than signals for jumpy shareholders to sell.
Focus on fundamentals
Wall Street may be neurotic, but that doesn't mean you should be. Just as the market meltdown brought stock prices down to unreasonably low valuations, so too may the recent rally have pushed prices up further than was warranted.
Whether last week's turbulence proves to be just a short-term phenomenon or the beginning of a larger pullback, the key to your long-term success is to make sure that the companies whose shares you own will continue to operate their businesses successfully. In particular, I'd ask three questions:
- Has the company taken steps to prevent a repeat of whatever difficulties it faced during the 2008-09 bear market?
- Does the company have a ready supply of cash on hand to weather any future storm or take advantage of cheaper stock valuations to make strategic acquisitions?
- Is the company's stock price a realistic measure of its future prospects?
If the answer to any of these questions is no, then you need to take a hard look to make sure the stock belongs in your portfolio. After a huge runup, the last thing you want to do is to watch bad stocks fall right back to earth again.
There's no telling what the future may bring. Yet even if this minor slowdown proves to be nothing more than a pause in an even bigger bull market, it's never a waste of time to make sure you own the best stocks you can find. Weeding out bad stocks from your portfolio will improve your results no matter what the overall market does.