FOCUS ON PERSONAL FINANCE
Investors Have Taken a Beating
Is it time to cut your stock losses or hold for better times ahead?

BY RICHARD J. ALPHONSO, JD, CPA/PFS, M.S.T., AND STEVEN A. ESTRIN M.B.A. 

As we face a third straight year of losses for the broad-based U.S. equities markets, the individual investor has been bloodied by staggering stock losses not seen since the devastating 1973-74 bear market. Then, the S&P 500 registered nearly a 50% decline in market value over a period of about 20 months. Today, investment pundits are divided on whether you should hold or sell stocks.

In this month's column, we'll try to put the recent sell-off of stocks in perspective. And we'll examine the economic factors that could influence the future direction of the stock market.

WHY HOLD STOCKS AT ALL?

Historically, stocks have surpassed all other assets classes in offering a combination of liquidity and growth. Studies dating back nearly a century prove that stocks return far more than any other asset class. But they also carry more risk and volatility in the short-term.

To negate risk, you must possess the capital to buy good stocks in troubled times, and the staying power to endure what could be a long wait. Amid desperation, you can find the greatest bargains.

That desperation exists today. The overall stock market is traditionally valued at a multiple of current and projected earnings. Because earnings are a key benchmark, they must accurately reflect the financial health of each company. The problem today is that investors don't trust the analysts who predict what earnings will be, or the CEOs who tell you what the earnings are. And now they mistrust the CPAs who certify what past earnings were. To restore this lost trust, the Securities and Exchange Commission is now requiring CEOs to personally sign off on their companies' earnings reports.

THE CASE FOR RECOVERY

But truthfulness alone won't jump- start the stock market. Investors also want to see a better economy. To rev up U.S. economic growth, consumers will have to continue to spend. And other key sectors of the economy, such as capital spending, government spending and net exports, will have to do their part.

Factors suggesting a return to economic growth include:

• historically low interest rates
• continued very low inflation
• A a purging of the economic excesses of the previous bull market "capitulation" in the stock market.

When investors simply become so fearful of the market that they dump stocks, they help to create a bottom for the ensuing recovery. It's analogous to a horrific forest fire that creates the environment for the subsequent growth of lush green forests. Painful but needed.

THE CASE FOR MORE RECESSION

But many factors exist for the case for continued economic decline:

• despite a decline of the broad-based S&P 500 index similar to the magnitude of 1973-74, stocks (as measured by their price/earnings ratio) are still high by historical standards
• the most recent employment data show signs of weakness
• we're seeing budget deficits again.

Other negative factors include the retreating dollar, fears of what some have called a housing "bubble" being burst, a threat of war against Iraq, and fears of further terrorism.

Bear markets are painful, but successful long-term investing demands that we respect the markets and protect our scarce capital through the inevitable down periods.

TAKE A LONG-TERM VIEW

From day to day, investor emotions affect stock prices. But over the long term, economic growth equates to a positive stock market. Rarely does the market have 3 bad years in a row. The market can experience the most significant portion of a rebound in a very short period of time, but you have to stay in to benefit from that rebound. Moral of the story: Stay invested!

Richard J. Alphonso, JD, CPA/PFS, M.S.T., and Steven A. Estrin, M.B.A., are president and chairman, respectively, of The Financial Advisory Group, Inc., in Houston. The Financial Advisory Group {(713) 627-7660} provides personalized fee-only financial planning, investment management and business consulting services.