Time For Investors To Put Cash In The Bank?

Jul.25.07 | About: SPDR S&P (SPY)

When stock market indexes are at record highs, investor sentiment can swivel faster than a weather vane in a wind storm. Now that that sentiment is pointing toward panic, should you be eying a safe haven?

There is certainly reason to be concerned. The S&P/TSX composite index suffered its worst one-day plunge in more than three years Tuesday. It ended the day at 14,068.16, down 400.17 points, or 2.8%. In point terms, rather than percentage terms, this decline was worse than the one-day swoon following the 2001 terrorist attacks.

Tuesday's decline was widespread, with all 10 sectors taking a beating of some form or another, led by information technology (think Research In Motion Ltd. (RIMM), which fell nearly 5%), energy and materials.

Some observers are even wondering if markets are poised to repeat 1997, when currency and credit gyrations in Thailand and Russia spread to the rest of the world, leading to steep stock market losses. Today, similar gyrations are emanating from the United States, where the dollar is in free fall and the subprime mortgage market is in trouble. It might be tempting to take these observations as a strong hint that now is a good time to hit the "sell" button on your equities -- which have done so well over the past four years -- and take your cash to the bank, where at least you will not lose any more money.

That would likely be the wrong choice, though, at least in the longer term. During recent pullbacks, investors have done far better by buying on the dips rather than selling in frustration. After the index fell 2.7% in late February, stocks began an impressive rebound that took the market 12% higher by last week. When the index dipped sharply in May, 2006, it went on to rise about 30% over the next 14 months.

The last time the index suffered a worse decline -- that would be April, 2004 -- the reasons behind the decline seem almost quaint from today's perspective. Nortel Networks Corp. (NT), close to an irrelevant stock now, crumpled. And there were concerns about China's economy, which sent jitters through a commodities market that was just beginning its startling ascent.

No one is suggesting that Tuesday's head-spinning decline, which hit most of the world, is a one-off event. But with reasonable stock valuations, decent earnings growth, a strong global economy and a U.S. Federal Reserve that believes the subprime mess is contained, the odds of a protracted downturn seem slim. Even after Tuesday's decline, the Canadian benchmark index is still up about 9% this year, which is close to an average return for an entire year, let alone seven months.

"We're in an evolving environment, in which interest rates are generally higher -- whether by central banks or by higher government bond yields --and earnings are growing more slowly. So the forces were at work here for some kind of material pullback," said John Johnston, chief strategist at The Harbour Group at RBC Dominion Securities. "My suspicion is that it's probably not that bad, but it could get a lot worse before it gets better."

He sees the potential for a 10% pullback before the index bottoms out. In other words, you might feel some pain in the days ahead--but there is opportunity there too.