Originally published in The Papyrus, Summer 2001. A Publication of Hermes Econometrics

Investing In The 21st Century – Rational Exuberance

Did you think stocks were automatically safe and profitable if you held them long enough? Many did and many have lost money. The 1990’s marked a pinnacle of prosperity for equity investors. In contrast, today’s investors are speculating how much lower the market will go. It is important to understand market declines and how to protect against them.

During the late 1990's, many investors realized annual gains of 15-20%. Some investors expected returns of 30% or more. In 1999 alone, Nasdaqreturned a whopping 85% gain! By 2001, that 85% return turned into a loss of approximately 25%.

What happened? In the 1990's Wall Street experts wondered if US equity markets were witnessing the dawn of a new era. Technology had rendered so many devices, realities, and thinking obsolete. Perhaps bear markets would never occur again.

Another expectation created in the 1990's and shattered in the 21st Century was that the amount of time the market needed to recover from a stock decline would be brief. In that decade, every severe market loss was met with a nearly immediate rebound to higher price levels. Even the 500 point drop in the Dow Jones Industrial Average on October 27, 1997 recovered completely within 17 days. The markets of 2000 and so far in 2001 have shattered the brief recovery expectation. Few people expect that NASDAQ which closed at 2,160 on June 29, 2001 will quickly return to the high of 5,048 attained on March 10, 2000.

Individual stocks can be much riskier than indexes or managed funds. Many believe that if you purchase stock in a premier growth company and hold onto the stock long enough your investment will be safe. History furnishes many examples that prove this belief to be wrong. Even companies once considered blue chip can fail: from the 70’s, Xerox, Polaroid and Digital Equipment and more recently: Lucent, Intel and many dot com companies.

What can an investor do when the risk appears to outweigh the rewards of investing in the stock market? Concentration risk can be reduced by investing in a diversified or index mutual fund. Market risk can be reduced by employing a risk management system such as those available at Hermes Econometrics.

Evidence of the protection offeredthrough Hermes was demonstrated during the turbulent declines since 2000. Most Hermes accounts experienced little loss while some growth mutual funds fell by 40% or more. Hermes Econometrics clients' accounts have enjoyed reasonable gains in 2001 despite the fact that most markets have declined.