Stocks Down but Definitely Not Out

03/05/2007 12:00 am EST

Focus:

Jim Collins

Chairman and CEO, Insight Capital Research & Management, Inc.

Jim Collins, editor of OTC Insight, thinks the stock market has hit a bump in the road, but a good economy and strong earnings should help stocks rally again.

On February 27, stock prices took their biggest drop since the days following the terrorist attacks of September 11, 2001. The decline was triggered in large part due to a nearly 9% decline earlier in the day by the Chinese stock market. Investors there are concerned the government may try to pull in the reigns on the rapidly expanding economy.

However, it is unlikely there will be another Asian contagion similar to the one experienced nearly a decade ago. This time the Asian economies are in much better shape. In addition, China will have the eyes of the world focused on it when it hosts the 2008 Summer Olympics. The Chinese government is currently undertaking a massive modernization plan to improve its cities and keep employment rates high. This makes it nearly unthinkable that the Chinese economy will experience any serious slowdown before next summer.

The stock market has merely hit a bump in the road and not a brick wall. Investors have enjoyed a remarkably smooth ride for approximately seven months. It was not unexpected that stocks experience a small, short-term decline. Granted, nobody thought it would come in one day, but the bulk of the drop has likely been seen.

As Federal Reserve Chairman Ben Bernanke reiterated before Congress, the economy is doing moderately well and inflation expectations are moderating. The latest gross domestic product report indicates the economy expanded by 2.2% during the fourth quarter. Expectations are for the economy to do slightly better during the first half of this year, with future growth of 2.50% to 3.00% during the second half of 2007. This rate would allow corporate earnings to increase at a reasonably good pace.

The February 27 drop has increased uncertainty. The stock market does not like uncertainty. Therefore, it is likely that stock prices will remain volatile over the short term and then quiet down as reassuring data arrives. Investors can take advantage of the current drop to begin aggressively moving more assets into stocks. It is likely we will see more down days before this shakeout is over. We recommend making your investments in increments over the next few weeks.

Make no mistake, conditions will improve. Consumer confidence is at a multi-year high, and consumers have shown the willingness and ability to spend. Interest rates remain at relatively low levels. These conditions make it highly probable that the economy will do well. Stock prices are now reasonably valued. It could also be argued that they are undervalued, especially when taking a longer-term outlook. It has always been a wise long-term decision to buy stocks in the aftermath of a large decline. There is no reason to think this time will be any different.

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