I believe that the large stock market correction – yes, that’s what I’m calling it – we experienced this week, beginning with the 416-point slide in the Dow Jones Industrial Average on Tuesday, should not be cause for significant concern.
The correction in the market may be the foreshadowing of the economic slowdown we are supposed to get later this year, and this means you probably should be a little more selective with your portfolio by buying large, well-known companies that can weather a slowdown. However, that doesn’t mean you should cash out your stocks and run for cover.
Since the beginning of the year, I have anticipated a correction in the market, not because I believed the market was highly overvalued, but because the market had a nice run-up from the summer into the new year. And what goes up must invariably come down.
I was actually hop-ing for a correction to buy some good stocks at attractive prices. I’m frugal when I purchase stocks – I never want to pay full price.
But for the people fully invested and hoping for another good year, the huge decline on Tuesday was painful. That’s why it’s important for investors to understand what happened.
The catalyst for the selloff was a 9 percent decline in China’s Shanghai Composite index, after Chinese authorities said they would institute measures to curb market speculation.
The China downturn was compounded with weak durable goods data and former Federal Reserve chairman Allen Greenspan’s comment about the possibility of a recession. You may remember Greenspan for his famous “irrational exuberance” speech.
The China selloff, weak durable goods data and the words of Greenspan set off a panic, as investors became nervous about the possibility of a global slowdown and fears that a recession may be imminent.
Remember, I said that the market was irrational sometimes. Well, that is exactly what happened on Tuesday.
While fears of a global slowdown and recession are possi-bilities that shouldn’t be taken too lightly, the 416-point decline in the Dow Jones on Tuesday was excessive. We got no news on Tuesday that should have made the stock market worth 4 percent less than it was the day before.
But fear and panic are going to happen in the market. Wall Street is finicky, so you have to anticipate that things like this may happen.
I think that psychologically the selloff by investors was also driven by fear that they were going to lose all of their gains from 2006. I think it snowballed from there, as more and more people took the huge dive in the market as invitation to lock in their gains.
So, while this week’s selloff was a correction to better reflect the anticipated economic slowdown, it was exacerbated by panic. But market hysteria is not necessarily a bad thing. Personally, times like these allow us to pick up some stocks at discounts.
I really like the market right now – despite the panic and volatility.
Overall, I think the market is undervalued. Many big-cap stocks I’ve been watching are trading at lower multiples (price-earnings) than they have for the past 10 years. The lower the multiple, the cheaper the stock in relation to its earnings. This tells me that a slowdown is already priced into these stocks, so this week’s declines make these stocks even more attractive to own.
The big caps are the ones you want to be owning: companies like Johnson & Johnson, Procter & Gamble, Altria, General Electric, AIG, Citigroup and Pepsi. These are the companies that will be better able to withstand a slowdown because of their size, diversified portfolio of products and global presence. And they are cheap.
Right now, I would be careful with the small caps and midcaps. I don’t see them holding up well during a slowdown. I would try picking them up during a market downturn, where they are more attractively priced.
So, while I like the valuation in the market right now, especially after this week’s correction, we could see future volatility in the market. And if we do get a slowdown or recession, you want to have a diversified portfolio of quality large caps to weather the storm and maybe even make a little money.