investing

Tomorrow's Bull Market

The market could well fall another 10% or 15% from here. But look for terrific returns for years to come after that.

The unrelenting market slide since the start of the year is terrifying. What's more, it doesn't seem excessive: The news flow from Wall Street bankers and from Main Street is equally horrid.

The only real surprise is that it took the market so long to fall this far.

But there's no reason to panic. Bear markets -- a 20% or greater decline in Standard & Poor's 500-stock index -- typically occur every four or five years. They're the price of stock investing. What's more, I think this bear market will set up an extraordinary buying opportunity -- one that will produce superior market returns in the coming years.

Let's start with the basics. A bear market is hardly the end of the world, or even of your investments. On average, the market declines 25% or so in a bear market then goes on to make new highs within a couple of years.

Here's the kicker: We're already down more than 15% from the peak. Odds are, half or more of the damage from this bear market has already been inflicted.

I think that investors have forgotten that fairly benign piece of history, partly because of the market's awful returns this decade. After peaking in early 2000, the S&P 500 lost nearly half its value before bottoming in October 2002. Tech stocks did far worse -- falling roughly 80%.

But the 2000-2002 bear market was hardly ordinary. The S&P's plunge tied the 1973-74 bear market for the worst bear market since the Great Depression. This type of severe bear market has been a once-in-a-generation event. In other words, don't expect it to happen again anytime soon.

What has the market returned since the dawn of the new millennium? Virtually nothing. The S&P finished 1999 at 1469. It closed January 18 at 1325. Even with an annual dividend yield of almost 2%, we've gone nowhere for eight years.

That about equals the total return of the 1930s, the decade of the Great Depression, when the market returned an annualized 0.1%, according to InvesTech Research. Annualized returns for other decades: 1940s, 9.0%; 1950s, 19.3%; 1960s, 7.8%; 1970s, 5.8%; 1980s, 17.5%; 1990s, 18.2%.

We're overdue for some good stock-market performance. At the beginning of the millennium, a lot of smart people suggested that returns for this decade would be subpar because of the terrific returns of the 1980s and 1990s, as well as the record-high price-earnings ratios on stocks.

They were right. But we've more than made up for those outsized returns. And as corporate earnings have surged, stock-market valuations have fallen. Price-earnings ratios on the stocks in the S&P are around 15. That's dead-average compared with the market's history.

Really bad bear markets have always started when P/E ratios were excessively high -- not average. "I think we're in a garden-variety bear market, which meansa loss of 20% to 30%," says James Stack, president of InvesTech Research.

After that, he says, "Investors could see several consecutive years of healthy 15% to 20% returns."

Of course, there's a caveat. If the financial crisis gets out of control, all bets are off. So far, the Federal Reserve shows every indication of doing what's necessary to stabilize the markets. But its powers are limited.

Likewise, if housing markets fall too far too fast, the economy will worsen significantly, crippling stocks. Consequently, Stack is keeping his powder dry.

But I'd bet against either of those nightmare scenarios. And the stock market always has risks. That's why patient investors get such healthy returns from stocks.

For now, you should keep putting the bulk of your money into stocks and funds of large, growing companies -- and of developed foreign economies. I'd be trimming natural-resources stocks and funds and emerging-markets stocks and funds.

For large-company growth stocks, look to Marisco Growth fund (symbol MGRIX) and Vanguard Primecap Core fund (VPCCX). For overseas exposure, stick with Dodge & Cox International fund (DODFX).

But once this bear market ends, you'll want to change your allocations quite a bit. And the stock market should soar.

Steven T. Goldberg (bio) is an investment adviser and freelance writer.

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