When Danger Lurks

The S&P 500 has approached similar peaks to those reached in 2000 and 2007.  In each prior case, a sharp declined followed.  On both prior occasions, the corrections came after parabolic rises in the market.  That same parabolic effect has not been so evident on this past rise which may suggest another surge is possible.  Certainly, analysts who pay attention to the put/call ratio believe the current figures are suggestive of a market bottom.

But the last two times bubbles were sector specific, in technology and real estate.  Now we have the Russians slashing their purchases of US bonds, and the Federal Reserve forced to monetize debt.  An imminent default in Greece is widely speculated upon.  A contagion to the rest of Europe is at risk and sovereignty itself is in question: Jean-Claude Trichet proposed a European finance ministry with veto power over economic decisions of nation states.  The very lifeblood of the euro itself has been called into question.

As Buffett has stated, very powerful interests stand to gain from the euro remaining in effect.  So a short-term break-up is unlikely even if its long-term future is in question.  Irrespective of the currency considerations in Europe and the US, retail investors need only look to history to realize that reward to risk ratios on monthly basis are now unfavorable.

To mitigate risk, investors should look to their individual positions and analyze how those positions have performed when corrections do occur.  For example, in the stock market declines of 2000 and 2008, Dow Chemical and Alcoa were virtually annihilated.  In contrast, Colgate and Johnson & Johnson performed comparatively well and have continued to soar higher.

Analyze why this is the case and you will discover the key to successful long-term investing.  Think about what people need every day whether the market is rising or falling.  In spite of the fragility of currencies, business has always continued throughout the ages.  And the businesses that focus on the needs of people that must be met every day prosper over time, particularly when they have an existing foothold or competitive edge.

Sometimes it’s helpful to escape from the day to day movement and think long-term, otherwise the day-to-day fluctuations can narrow focus to the exclusion of real market and portfolio risks.

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