Why Stocks Keep Plunging and What to Do Now

The news is glum on several fronts, but the prospects for a recession remain slim. It’s important to stick with your plan.

(Image credit: Getty Images/iStockphoto)

Take a deep breath and repeat after me: “It’s not 2008. It’s not 2008. It’s not 2008.”

Yes, volatility, especially volatility to the down side, can be frightening. Losses, occasionally big losses, come with the turf when you invest in stocks. But there’s no reason to think that the current pullback will be anything like 2008, when the stock marketed plummeted 37%. So this is not the time to panic and make drastic changes to your portfolio.

Following today’s plunge in share prices, the broad U.S. market is within shouting distance of its first correction—a drop of at least 10%—since 2011. With Standard & Poor’s 500-stock index sinking another 0.8% today, the market is now 7.8% below its record high, set on September 18. At one point today, the index was down as much as 3%.

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What’s behind the market’s rapid deterioration? Here are five driving factors:

1. Concerns about a global economic slowdown and its eventual impact on the U.S. economy. Analysts are especially worried about weakness in Europe, where some economies are on the verge of descending into deflation. They worry, too, that China’s growth may be decelerating at a much more rapid pace than had been expected.

2. Jitters over a super-strong U.S. dollar. Although a strong greenback is positive in some ways (for example, it makes imported goods cheaper for Americans), it can be problematic for U.S.-based multinational companies because it makes their products and services more expensive to foreign customers. Plus, money earned overseas gets translated to fewer bucks as the dollar gains.

3. Plunging oil prices. While lower prices at the pump are a blessing for motorists, they harm many energy companies and their stocks. Moreover, the drop in crude raises questions about the stability of countries, such as Russia and Venezuela, whose economies are closely tied to energy.

4. Geopolitical instability. Investors worry about the rise of ISIS, fears of Russian expansionism, and the potential for an explosion in Hong Kong.

5. Ebola. Says Bank of America Merrill Lynch: “The Ebola crisis is rapidly bringing to the world’s attention the growing risk of a pandemic….The economic fallout from a severe pandemic could cause global GDP [gross domestic product] to fall by almost 5%.”

Put all of these factors together and you have the ingredients for a vicious stock market downturn. Note that one item not on my list of concerns is the market’s valuation. Even when the S&P index hit its peak a month ago, it didn’t appear excessively overvalued. This was not a repeat of early 2000 when the S&P 500 traded at more than 25 times estimated earnings. At its most recent top, the market traded at 16 times estimated earnings.

Based on what's known today about U.S. economic conditions, I think stocks are fairly valued – and, in some cases, may be slipping into bargain territory as the market continues to retreat.

Are we merely witnessing a correction or in the early stages of a bear market? That depends on what happens to the economy. Bear markets sometimes occur even as the economy continues to expand. (The late economist Paul Samuelson famously quipped that the stock market had predicted nine of the last five recessions.) But if we're heading for an economic contraction, we're sure to have a bigger decline. Bear markets and recessions go hand in hand. Kiplinger’s does not foresee the U.S. entering a recession. In fact, we see the economy growing a solid 3.0% in 2015.

The alternatives to stocks remain pitiful. Cash still yields nothing. Government bonds have performed nicely since the stock-market correction began, but yields have come down as prices have gone up, adding to the risk of owning Treasuries. The 10-year Treasury bond closed today with a yield of 2.09%, nearly a full percentage point below where it was at the start of 2014. Gold has perked up a bit during the stock-market pullback, but it’s also risky and may not continue to zig while stocks zag.

My best advice: Review your investments, and make sure you can handle additional declines in your portfolio. If you can’t, you probably have too much in stocks. If you're dollar-cost averaging into stock funds (through, say, a 401(k) plan), stick with the plan. You’ll be buying low as stock prices fall. If you buy individual stocks, make a shopping list of stuff you'd like to own at specific price targets. Don't try to time the market.

Manuel Schiffres
Executive Editor, Kiplinger's Personal Finance