Gaining Financial Confidence

• Understanding Market Corrections

Understanding Corrections, or, "De-nial" Isn't a River in Egypt!

Considering the number of phone calls, e-mails and occasional drop-in visits we've been getting, I'm thinking most of you have been watching the last few weeks of market "correction" with varying degrees of consternation. So, with the Dow down over 8% since May 10th,* and some overseas markets more than twice that, it feels to me it's time to take pen in hand.

Let Me Share What I've Learned…

Here's what I've learned about "corrections:"

(1) A correction lasts until "everyone" is positive it will never go up again! Of course, I'm using hyperbole but it contains the essential point that I feel the nature of corrections is to "shake out" weak shareholders (those driven by emotion or lacking conviction) and those who have arrived late (and may have bought at the top);

(2) 10%, for some unknown reason, can very often be what it takes to scare people …if it happens quickly enough;

(3) If "Bad Old Mother Market" senses too much confidence, she may go for a full blown bear market, or do whatever it takes to "shake people up and out."

So You See Things Differently…

Keeping those things in mind, I think it might be helpful to give you another viewpoint. Instead of looking at this correction with dread, see it as we do: As a potential opportunity!

Opportunity?

Yep, opportunity.

Opportunity in what way?

Consider 1998: From January to July, the S&P 500 rose from around 935 to around 1190. It then proceeded to drop to an intraday low of 920 in October, a "correction" of 270 points or 22.7%. Bottoming in October, by year end the Index was back over 1200 and ended 1999 at 1469.25, a rally off the low of almost 60%*. Is that what will happen this time? We have no idea. What we do know is that in a pullback, there are good things to buy, opportunities presenting themselves.

Consider Apple Computer: In May of 2004, Apple was about $13 a share; by February 2005, it was over $45. By May it had "corrected" back down to $32 before rallying to a high this past January of $85.59*. Once again, opportunity in the "correction" is the point I want to make.

Opportunity (Hard) Knocks…

I believe "Correction equals Opportunity": because of the ways we seek to manage risk: Relative Strength, Using Stops and appropriate asset allocation all are why we are confident that we can navigate through. And, believe it or not, one of the most important ways we, and you, can manage risk is to keep reminding each other and ourselves that the process works and that staying with it is the key.

According to a June 12, 2006 story in Investment News¹ the S&P 500 earned almost 12% per year from 1986-2005 but the average person who invested in similar funds only earned around 4%! What?! That's right: 12% for "the Market," 4% for investors! Why? Here's what Dorsey Wright & Associates, one of the research groups we read, says about it: "It's not that the market itself is beating [investor's] brains out - [they're] doing it to themselves"! How? "…most investor mistakes are made in attempting to avoid loss! Managing risk is a good idea, but believing you can somehow eliminate it - which is what investors secretly desire - is nuts…"²
Put another way, after 25 years of doing this, I am convinced that people secretly want accounts that go up all the time and never go down! Does that sound appealing? Sure, until we realize that the way to do that eliminates any real chance of earning much on the upside!

Maybe I'll Wait This One Out…

One variation that doesn't work is "Why don't we just go to cash?" Believe me, I've checked it out and cash ain't all it's cracked up to be!

I'm finishing up the work on the Sector Relative Strength Model we have been talking about for the last couple of quarters (Blame Ed for the delay! I do. Actually, I blame Ed for everything. In case you didn't know it, we have a basic rule: "When the market goes up, it's my work; when it goes down…ED DID IT!) So, as I say, I came upon a chart of investment sectors ranked "best performing to worst" each year 1990 through 2004. This chart was a little rarer in that these charts don't usually include "Cash" in their analysis. This one did. Guess what I discovered? Better yet, here's a quick quiz: How many times was Cash the best performing style-group or sector during that period of time? Once? Four times? Six times? How about "None!" "Nada!" "Nil!" "Never!" **

Interestingly, Cash did come in second in three years (1990, '94 and '02) but in two of those three years Bonds were the top performer. And, in the three years where Cash came in second, the return in the following year of the top four sectors was never less than 34%! So the next time the market has a really bad day, and while the correction continues, think of that hackneyed old adage to "make lemons into lemonade!" And if that doesn't work, add a little vodka!

*-Source AIQ technical Analysis Software 2006
**-Source: Lipper Analytical Software 2005
Note: Apple Computer traded at its high on 1/17/06- current price 6/21/06-57.86

¹ Quoted by Dorsey Wright & Associates' Daily Equity Report, June 19, 2006, "Karma Boomerang or How To Enjoy A Correction."
² Ibid.

This column is provided by Neal Dietz, Senior Vice President & Investment Officer, Dietz & Lynch Financial Strategies Group of Wachovia Securities in Newburyport, Massachusetts. 978-462-7975 or www.dietzlynch.wbsec.com.

Wachovia Securities does not provide tax or legal advice. Please consult with your own tax and legal advisors before taking any action that would have tax consequences.