Zaks Investment Advisory Service

Market Drop of Tuesday, February 27, 2007 in Historical Perspective

As my listeners probably know, I prefer not to comment on the everyday stock exchange fluctuations. My programs are addressed to investors rather than traders, and investors are far more interested in long-term trends than up-to-the-minute ups and downs. Nevertheless, the market fall of Tuesday, February 27 was followed by a torrent of various commentaries – some of them reasonable, others less so. I decided that perhaps my listeners were curious to hear what my own take was. This, then, is what today’s program is about.

Let us take a look at last week’s events from a historical perspective. Using data about the Dow Jones level at each market close, we may count all of the major Dow Jones losses since October 1928. Last Tuesday, Dow Jones lost about 3.3 percent. So, since 1928, this drop ranks 196th in terms of severity. The biggest one occurred on October 19, 1987. The index fell that day by 22.6 percent. On October 28, 1929 it fell by 13.5 percent. But things did not end there in 1929: on the following day, October 29, the index fell another 11.7 percent, so over two days it fell by about 25 percent. The panic of 1929 was a long time ago, in an era when markets were less stable. So it would be interesting to take a look at the more recent past, when the state of our economy more resembled what we have now. Since 1946, the market has fallen by more than 3.3 percent in one day on 42 occasions.

But last week’s market fall was not confined to Tuesday. On Friday, for example, Dow Jones fell again, this time by almost one percent. For the week as a whole, the index lost 4.22 percent. How does this compare to other unlucky weeks? Since 1946, it turns out that it ranks 329th. In other words, since 1946, there have been 328 weeks (we are including not only Friday-to-Friday, but also Monday-to-Monday, etc.) in which the index fell by more than last week. So whatever we may think of last week’s events, there was nothing exceptional about them. But the media lives off of “accidents,” and so they lavished their attention on the drop.

By the way, a little more comparative history: as a result of the market fall of “Black Monday,” October 17, 1987 (as I mentioned, it lost 22.6 percent that day), the entire week’s drop amounted to nearly 30 percent. In other words, in the course of a week – from Monday, October 12 through Monday, October 19 – investors lost nearly one-third of their holdings. Some of them, of course, decided that this was too much, sold off their remaining investments and placed them in bonds or money market funds. And, as we now know, they made a mistake: over the subsequent two years, the market gained 54 percent and by Black Monday’s second anniversary, it stood above the level at which it had been prior to the fall on October 19. Moreover, the market was 8.5 percent higher than where it was a week before Black Monday. And, as we know, it continued to quickly grow for another 10 years.

Of course, a market drop of 3.3 percent is an unpleasant affair, especially for those who invested on the eve of the fall. But for most of us investors, who are in it for the long term, this was just a minor swerve in the road. Look at the Dow Jones index chart: after Tuesday’s fall, the index ended up where it was at the start of December 2006. And about 14 percent higher than where is was at the start of 2006. Yes, those who decided to make a short-term investment and who need to take money off the market right now, clearly suffered. But this only confirms once again that a short-term investment in the stock market is not a very wise move. If someone needs to invest over a very short term, money market funds are a better option.

Now, turning to the reasons behind the drop. Much has been said about how China was responsible for both the European and our market falls. The Chinese market is one-tenth the size of the American one. It grew remarkably fast the entire previous year and gained more than 100 percent. The Chinese government became concerned by such a quick jump, and rumors spread that it was planning certain measures intended to “cool” the market. This resulted in the Chinese market losing nine percent in one day. Chinese investors lost 150 billion dollars. Last Tuesday, our market lost 450 billion. To suggest that unconfirmed plans by Chinese bureaucrats could cause such a drop is ludicrous. But the Chinese market’s behavior could indeed have provided the excuse for the drop. Our market has been growing without a significant correction for many years. Such corrections occur from time to time. Very often, it is hard to determine what exactly brought them on. After Black Monday of 1987, several commissions were created to investigate what actually happened that day. And although they came to a certain conclusion about what effect computerized program trading had on the drop, they failed to identify the actual reasons behind the market drop itself. For us, what is important now is the market’s future perspective. It looks like our economy is in good shape, and that the odds of it falling into recession are fairly low. This, for example, is the opinion of Ben Bernanke, chairman of the Federal Reserve. Meanwhile, the fact that the market has again reminded us that investments are accompanied by risk may not be such a bad thing on the whole. All investors must weigh how much risk they can bear before deciding which asset classes to invest in. We have already talked about this, and will do so again.

But with this, we will have to draw our program to a close. This was Sergey Zaks. Thank you for your attention and until next time.