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US Stocks: Buying the Bounce

Wanna buy US stocks now they've already crashed...?

SOMEBODY CHANGED the channel, writes Eric Fry for the Rude Awakening.

For the last two years, every time I walked into my local Bank of America branch, all the television monitors stretched along the bank's walls displayed Bloomberg TV, a financial news station. But today, when I strolled into the bank to make a deposit, Bloomberg had been replaced. A home improvement show had taken its place.

Apparently, the management decided that stock quotes are bad for business...or maybe just depressing. So why not change the channel? But if only investing were as simple. Many of us would have reached for the remote months ago.

We would have preferred to watch almost anything other than falling share prices. "Hey, I haven't seen THIS Mexican game show before!" we might have said to ourselves. Sadly, however, we cannot change the channel. If we don't like what we see, we can either leave the room...or continue watching, while hoping that the story line becomes more entertaining.

The story line has become slightly more entertaining as the Dow Jones recoups a chunk of its recent catastrophic losses. Investors have been grateful for each and every one of those points reclaimed. Triple-digit performances have become almost blasé on Wall Street these days, but the performances have rarely included a plus sign.

Now the Dow's just enjoyed its best one-week advance since 1982...even while closing the month of October 14% down. But just for kicks, it's also worth noting that the recent 9.6% gain inside one week would also rank as the Dow's third best YEARLY gain since 2000.

In other words, the stock market rarely rises 9.6% in a single year, much less in a single week. So how much more can investors expect...and how soon can they expect it? The answers to these questions are utterly unknowable, of course, but history does provide some interesting insights.

First, the good news. Stocks always bounce after a severe selloff. After the Wall Street Crash of 1929, for example, stocks rallied a whopping 48% from the post-crash low to the recovery high six months later.

Now the bad news: Those post-crash bounces don't sprout roots and blossom into new bull markets. On the contrary, these illusions of recovery deceive investors into believing that a new bull market is underway. Let's consider a couple of troubling precedents...

Let's imagine that you bought the Dow Jones Industrial Average in 1929, but you waited until AFTER it had already fallen 42% from its high. Why 42%? Because that's the amount that the modern-day Dow just fell.

How do you think you would have fared? Do you think you would have made money very quickly or very slowly? The answer is "both" – you would have enjoyed a quick bounce. But if you did not sell into that bounce, you would have lost 80% of your capital during the next two years. If you had held on, however, you would have recouped your original investment...22 years later!

You think that's bad? Check out Japan's Nikkei Index, using the same assumptions.

If you had purchased the Tokyo index after the first 42% drop from its record high of late 1989, you would have made a little money during the first two months. But woe to you if you did not sell!

Your purchase would STILL be under water to this day...almost 20 years later. In fact, you would be nursing a loss of more than 60%!

What's the point of this discussion...other than to depress stock-market bulls? Merely to emphasize that the recent past is not necessarily prologue, but the ancient past might be.

Only a fool would dare to predict that share prices will collapse like they did during the Great Depression. But only a greater fool would dare to rule out the possibility. We Americans have entered a very precarious chapter in our financial history. Hopefully, we will emerge from the current crisis with nothing more than a few scrapes and bruises. But we might not be so lucky. Serious, debilitating financial injuries are entirely possible.

Life here in the States could become noticeably less comfortable for a while...and share prices could continue to reflect this new reality. So why not err on the side of caution? Why not insist on buying ridiculously cheap stocks, if you buy any stocks at all? And why not insist on receiving very high dividends, if you attempt to receive dividends at all?

We're just asking questions? We wish we knew the answers. We have no idea what will actually happen; we only know what MIGHT happen...and that's why we are more than a bit worried. We are worried because the American economy is poorly prepared for economic weakness.

Eric J.Fry has been a specialist in international equities since the early 1980s. A professional portfolio manager for more than 10 years, he wrote the first comprehensive guide to American Depositary Receipts, International Investing with ADRs. Today he reports on Wall Street from California for the renowned Daily Reckoning email service.

See full archive of Eric Fry articles

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

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