Take the Declines in Stride

02/06/2008 12:00 am EST

Focus: MARKETS

Janet Brown

Editor, NoLoad Fund*X

Janet Brown, editor of NoLoad Fund*X, says bear markets and recessions are a part of the market's normal cycle and stocks will ultimately move higher.

The Standard & Poor's 500 fell 6.1% in January, its worst performance to begin the year since 1990, a recession year. After reaching all-time highs last October, both the S&P 500 and the Dow Jones Industrial Average gave back 16% by late January. The tech-dominated NASDAQ Composite index and the small-cap Russell 2000 fell 20%.

Overseas declines were steep, yet superior gains before the drop kept some internationals in the top ranks. European funds were particularly hard hit, while Latin American and Japanese funds held up best. Gold funds and bear funds were the top performers for the month. And the recently hard-hit real estate and financial funds lost least, with several bringing in positive returns last month.

This month we see a healthy mix of domestic and international funds, as well as both growth and value funds. The long-anticipated rotation away from small-cap fund leadership held, and large-caps continue to lead. The worst damage domestically was in technology and communications funds. Bucking the prior trend, and typical of down markets, value outperformed growth in all size categories.

The market seems to be worried about recession. Yet surprisingly, over the past 50 years the average performance of the S&P 500 in recessions has been almost exactly the same as its average performance during expansions. For recessions, the average return was 12.1%, and for expansions, 12.7%. The average postwar recession lasted 10 months and by the time it got
under way, the market had priced in the bad news. The market typically bottoms about halfway into the average post-war recession, followed by a median gain of 23% over the next six months.

Be assured that declines are part of normal stock market behavior. Stock investors suffer through short-term declines in order to attain higher long-term returns. The S&P 500 index has suffered falls of at least 20% (i.e., a bear market) on nine separate occasions in the last 50 years, including a 33% fall in less than two months in 1987 and a 20% drop in less than three months in 1990.

Of course, we don't yet know that January 23rd marked the bottom of the recent downturn. Our job is to identify what's working in the current environment, whatever that may be. Since the picture is only clear in hindsight and no trend is a straight line, the best we can do is follow closely and make continual adjustments to align our portfolios with winning funds.

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