Blue Chip Average Down 6.9% for the Year
Still Up 1.4% for the Last Week

Nationa, Local Media Seems Focused on Negative News

February 17, 2008
By: Jerry Cole - Retirement, Investment

Despite a performance in the red the last two days, the Dow Jones Industrial Average still gained 1.4% for the week. The gains in the early part of the week came on hopeful news that bond insurers would be able to keep their AAA ratings and a better-than-expected retail sales report. Then the news turned negative led by the University of Michigan's measure of consumer sentiment, which plunged to its lowest level in 16 years. Thus, at 12348.21, the blue chip average is down 6.9% for the year.


In the face of a plethora of bad news in the first month and a half of this year, the Dow has resisted falling into bear territory (down 20% from it recent peak which was 14164.53 set on Oct. 9, 2007). However, there also has not been a total capitulation by investors resulting in a massive sell-off which often brings the market into bear territory. When that happens, it is a signal to some that it is time to buy. But waiting for that massive sell-off can be folly because it doesn't have to happen.

To be sure, the media has done its darnedest to report only the negative news. It seems that's what sells, but let's hope it doesn't become a self-fulfilling prophecy. The 20th-century sociologist Robert K. Merton coined the expression "self-fulfilling prophecy." Examples can be found as far back as ancient Greece. It is described as a prediction that directly or indirectly causes itself to become true. If we believe long and strong enough something will happen, it usually does. This can be both positive and negative.

A common mistake investors make is improperly judging risk. Generally, the longer the time horizon an investor has, the more risk they are able to take on. However, many investors end up taking too little risk. By focusing on short-term volatility rather than the long-term horizon of their assets, investors become short sighted and inevitably ignore the various probabilities of achieving their objectives. Consistently investing in CD's or Treasury bonds for fear stocks will drop in the short-term can result in barely keeping ahead of inflation. This reduces the odds of achieving a long-term goal of growth.

On the other hand, investors with a short-time horizon are often overly exposed to risk and in danger of asset loss during a short-term period of volatility. If you have just retired, you do not want to invest in a new start-up company engaged in producing a product that has yet to be proven useful.

An example of irrational selling this past week could be found in closed-end municipal bond funds. The rush to sell shares in some of these funds sent values tumbling to 90 cents for each dollar of underlying assets. This in turn produced yields above 5% that are largely free of federal tax.

Closed-end funds are like ordinary mutual funds, except they issue a fixed amount of stock that trades like a regular share. Closed-end muni funds are often held by private investors seeking security and income. These are the investors most likely to get alarmed by volatility. The panic can start feeding off itself. It can become a self-fulfilling prophecy.

At some point the domino effect of the credit crunch started by defaults in subprime loans will come to an end. In the meantime we can expect volatility. So remember to keep your risk within your tolerance and keep ahead of inflation.

I invite your questions.

(The opinions expressed are solely those of the author and not Gen worth Financial Securities Corporation.)