In an effort to understand why the stock market has pulled back, I urge you to revisit 1996 for some clarity. The Dow Jones Industrial Average reached 6,000 in November 1996. What people have forgotten is that the top analysts from Morgan Stanley up until that time had been predicting a 1,000-point sell off to occur in the fall. Even then there was concern that stock prices had become inflated and that corporate earnings wouldnt be strong enough to support higher share prices. What the average investor misses is that now that the economic environment is confirmed to provide lower earnings for the foreseeable future and if there is no expectation of better earnings, of course share prices fall, remain depressed and can decline further. So, in 1996 when the top analysts believed the economic environment might not be so good they guessed the DJIA would decline to around 4,000 to 5,000. And if those same analysts had todays information as their economic forecast my guess is that they would have reduced their expectation for the DJIA to 1,000 to 3,000. Heres part of the commentary that appeared in The Red Herring magazine, January 1997, page 106:
The overall feeling that was that the economy was beginning to slow down which would result in lower corporate earnings and investors would in turn begin to sell off part of their portfolios. But it hasnt played out that way. So what happened? Well for one thing, the market continues to be driven upward by relentless waves of new money washing into equity mutual funds specifically, a staggering $178 billion in the first nine months of 1996, far beyond the previous full-year record that was set in 1993.
What you get out of the above paragraph is that two things fueled higher share prices:Although the economic climate was in question, it was not determined to be negative, so investors believed earnings still had a chance for growth and huge sums of new money was flowing into the stock market. In this environment those two elements are gone, earnings growth has disappeared and there is a lack of suckers pouring money into the market. Now it becomes obvious why share prices in the stock game decline there isnt any reason to believe that the economic environment will change for the better and get back to the glory days for a very long time. Now, recall that mutual funds promised you wealth by suggesting compounded returns of perhaps eight to fifteen percent and financial advisors preached diversification as a safety mechanism, and that mutual funds spread the risk among various stocks so that your money will be safer. Now you see that is not true. The mutual funds didnt make you rich over the years and in a downturn the concept of spreading the risk didnt protect your holdings so your money was still at risk.