A Market Crash Is Coming

By Selena Maranjian February 12, 2008 I hope this doesn't surprise you: Another stock market crash is on its way. That's the bad news. The good news is that it probably isn't right around the corner. Many financial prognosticators on TV will offer opinions on when the next big crash is due, but I don't feel I'm shortchanging you with my opinion: I don't know when it will happen. This is the best, most honest answer anyone can offer because the stock market's short-term movements are extremely unpredictable. (In the long term, the arrow usually points up.) There are many things we can learn by looking at past crashes. At about.com, I found Dustin Woodard's review of the United States' 10 worst stock market crashes: Began Ended DJIA Fell ... Change 6/17/1901 11/9/1903 57 to 31 (46%) 1/19/1906 11/15/1907 75 to 39 (49%) 11/21/1916 12/19/1917 110 to 66 (40%) 11/3/1919 8/24/1921 120 to 64 (47%) 9/3/1929 11/13/1929 381 to 199 (48%) 4/17/1930 7/8/1932 294 to 41 (86%) 3/10/1937 3/31/1938 194 to 99 (49%) 9/12/1939 4/28/1942 156 to 93 (40%) 1/11/1973 12/6/1974 1,052 to 578 (45%) 1/15/2000 10/9/2002 11,793 to 7,286 (38%) What to learn from thisHow can this information help you? Here are a few key lessons: Regrettably, some of the crashes followed one another closely. For example, while the Dow sat near 400 in 1929, it remained below 100 by 1942. One could argue that in this period there was one long crash instead of several small ones. A big question the data raises is this: What caused the carnage? Reasons have varied over time. The Depression years included several crashes, and there was one during and one soon after World War I as well. Other factors tied to crashes include inflation, speculative trading, insufficient regulation of the market (which has been strengthened over time), automated trading, and trade and budget deficits. Sometimes crashes occur without clear reasons. The 1987 crash, which featured a one-day 23% drop, for example, has many alleged causes, but no single, definitive trigger I could find. A last thing to notice is that there have always been recoveries, and the market trends upward in the long run. You sometimes have to wait a long time for a full recovery, though. This is especially true for those who invested in market darlings that soared, often unreasonably, prior to crashes. Sun Microsystems (Nasdaq: JAVA), for example, soared from roughly a split-adjusted $24 to more than $200 between 1998 and 2000, and remains well below 1998 levels today. What to do about itLet this information shape your investing, reminding you that anything can happen in the coming five or even 10 years. You should only have your long-term money in stocks. You don't want to lose that sum you've socked away for a down payment on a house or for college tuition. Here are a few takeaways: If you're frightened of any kind of significant drop, you might want to place stop-loss orders for your holdings with your broker. (Learn more about brokerages in our Broker Center.) You can, for example, specify that if Stock ABC falls 10%, you want it sold ASAP. This can protect you, but it can also evict you from some great performers that slump temporarily. (Read Jim Mueller on the dangers of stop-loss orders.) Look for opportunity in crashes. If you have some cash on the side, or can generate some, you might be able to take advantage of some first-rate bargains -- although, again, it might be a few years until you're rewarded. For example, on "Black Monday" in 1987, JC Penney (NYSE: JCP) stock fell 19%, from about $29 to $21 (which in today's split-adjusted terms would be a drop from $6.24 to $5.04). It gained back that ground within a few months, and it had more than doubled within two years. Recently it was trading around $48 per share, representing a nine-bagger for 1987 investors. Look at Adobe's (Nasdaq: ADBE) chart, and you'll see that investors who bought after the recent Internet bubble popped have done well, as have patient Qualcomm (Nasdaq: QCOM) investors. Consider investing in certain kinds of companies -- stable growers that pay significant dividends, which you'll receive no matter what the market is doing. Look at this chart of Colgate-Palmolive (NYSE: CL), for example, and see how rocked it was by the 2000 to 2002 market crash. Wells Fargo's chart also shows the value of hanging on to steady growers. Over the past decade, through market ups and downs, Colgate-Palmolive's dividend has grown by a compound average rate of 10%, and Wells Fargo's has grown by 14%. (One other high-yield company worth a closer look is Dow Chemical (NYSE: DOW), recently yielding 4.4%.) If you're interested in adding some (or many!) significant dividend payers to your portfolio, I invite you to test-drive, for free, our Motley Fool Income Investor newsletter. Its recommendations have been beating the S&P 500 by nine percentage points on average. A free trial (with no obligation to subscribe) will give you full access to every past issue.