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Updated: May 3, 2013 12:14PM
In the next few weeks, the millions of Americans who have been investing their retirement funds in the stock market through their 401(k) plans or Individual Retirement Accounts are going to open their second-quarter statements and be shocked by the losses in their retirement nest eggs.
When they suddenly face these losses, the fear could trigger another wave of selling, this time out of panic. In fact, it's almost surprising that the stock market losses haven't made bigger headlines.
Perhaps the stock market's decline has been overshadowed by the rise in oil prices. Or by the soaring statistics for bankruptcies and foreclosures, which hit closer to home.
Perhaps investors are soothed by the promises of politicians that things will soon be better. That's why presidential election years are traditionally good for the stock market. But not this year. As consumer confidence statistics touch record lows, the stock market has fallen sharply in the first half of the year.
And I'm starting to get e-mail queries like this one:
"I'm losing money fast in my retirement account mutual funds. I'm 50 years old, what do I do if ALL of my money is Chicken Money? I'm in a panic and beginning to feel like it's a waste of time and money trying to save for retirement. I'm down to $105,000. What should I do?"
I'm torn about giving my standard answer, one in which I truly believe, that over the "long run" a diversified portfolio of stock market investments is your only real choice to grow your funds and beat inflation. After all, there has never been a 20-year period where you'd have lost money in a diversified portfolio of large company stocks with dividends reinvested.
But then I recognize that many individuals simply won't have the discipline -- or the time -- to ride out a true bear market. They'll panic and sell at the very bottom --in effect, "creating" the bottom! That's why I've always recommended a cushion of "Chicken Money" on the side -- money in low-yielding, but safe, money market funds and short-term CDs. That gives you courage to ride through a decline with appropriate investments for the rest of your money.
But in bear markets, fear tends to take over rational thought.
Is this a real bear market?
The "technical" definition of a bear market is a 20 percent decline in the Dow Jones industrial average -- and we've hit bear territory. But those 30 popular Dow stocks hardly reflect the market's breadth.
The Standard & Poor's 500 stock index is the measure used by most investment managers. And by that measure, we've indeed fallen into bear territory since the index hit its highs of last October.
On Oct. 11, the S&P 500 index reached an all-time intra-day high of 1,576.09. At the end of June, the closing level was 1,280 -- a decline of 18.8 percent. By July 9, the S&P 500 was off 21 percent from its peak.
According to the Morningstar Market Commentary, the worst performing group in the second quarter was the financial stocks -- which shed 17 percent of their value between April and the end of June.
The best performing group was the Morningstar Commodity Index -- up 21 percent for the quarter. And bonds provided no safety as interest rates rose on inflation fears, cutting bond prices by 1.3 percent on the Morningstar Core Bond Index.
Just for perspective, the average duration of a bear market is 17 months, and the longest ran for 42 months, from November 1938 through April 28, 1942.
Hope: elections, the market
So where is the traditional election year bullishness? The first six months of this election year posted the largest stock market loss -- a 12.6 percent decline based on the S&P 500 stock index -- of any presidential election year since 1940, according to Jim Stack of Investech Research. His company keeps track of those historic market relationships at www.Investech.com.
Stack notes that the only other double-digit losses in the first half of a presidential election year came in 1940, at the start of World War II when Germany invaded France, and in 1932, at the depths of the Great Depression!
Now here's the optimistic part of Stack's statistics: Those two years -- 1932 and 1940 -- with double-digit stock market losses in the first half, each rebounded for double-digit gains in the second half from July through Election Day!
As of Friday's close, Stack sent word to his subscribers that he's still waiting for confirming signals from his indicators that it's time to buy. His Friday comment: "There is no confirmation that a market bottom is at hand, or even near."
The most bearish case
Perhaps the best-stated bearish case is made by Bert Dohmen, who has written the Wellington Letter for 30 years, and whose latest book, Prelude to Meltdown, was reviewed in this column last year.
Dohmen called the market top last October. He now says the "first good support" for the Dow could come at 9,750 -- but he implies that won't be the ultimate bottom!
Dohmen's advice is to use any current rally to liquidate stocks globally.
How to react
While bulls and bears debate the market direction, individual investors have a more immediate issue: How to position their investments for future growth, inflation protection, and some degree of financial security.
To answer that, you have to examine your own situation and risk tolerance. This isn't a question of calling market turns; it's an assessment of your own changing financial situation, your goals -- and your financial and emotional ability to ride out a long-term decline (if there is one) in the stock market.
As you get closer to retirement, your priorities will change -- and so will your ability to watch your retirement nest egg gyrate in value. It's best to do that kind of thinking in the calm period before panic erupts. That may not be long now. And that's The Savage Truth.
Terry Savage is a registered investment adviser. Distributed by Creators Syndicate. Copyright Terry Savage Productions Ltd.