I keep seeing articles in the financial media about what a great buying opportunity this is for investors because the markets have lost so much value since peaking in October 2007. One article I read this week encouraged investors to increase their 401K participation levels because of the great discount they are getting by investing today compared to a year ago.

Here is an illustration from that article: “It’s like walking into a retailer and you’ve got a nice plasma TV up there, and six months ago you’d have had to pay 100% of retail, and today you get to pick it up at a 40% or 50% discount. That’s a pretty good deal, and it’s the identical piece of merchandise.”

While that sounds good, it is not a completely accurate portrayal of the current situation. Most of these articles ignore the real possibility that market values could still go much lower. Although many investments have declined by 40% or even 50%, there is no guarantee that this is the bottom. 

In other words, to continue with the hypothetical illustration above, what if you purchased that plasma TV today at a 40% discount only to discover that the price dropped another 40% the day after your purchase? You might still be glad you did not pay full price, but you would undoubtedly wish that you had waited a little longer and obtained the additional discount.

As I write this, Bank of America stock (BAC) is trading at $5.78 a share. Is that share a better deal today than it was a year ago at $50? Not necessarily. That represents a loss of about 89%. If Bank of America were to drop another 89%, the share price would be 63 cents. Is it possible that BAC could drop to that level? Given the current economic situation, it is quite conceivable. 

On the bottom line of an investor’s balance sheet, there is no difference between an investor who starts with a share price of $5.78 and loses 89% or one that starts with a share price of $50 and loses 89%. 

I have a feeling that many investors are hearing comments from their brokers or advisors that go something like this: “The Dow lost 34% in 2008. The last time that happened was during the Great Depression. You don’t want to pull your money out of the market now. You’ll miss out on the rebound. What are the odds that the Dow is going to fall another 34%? Sure we’ve seen some individual positions with those kinds of losses, but a major index is more diversified.”

In case you have forgotten, after peaking in spring of 2000, the NASDAQ lost almost 75% of its value before bottoming in the fall of 2002. Not only is it possible for a major index to lose more than 30% in consecutive years, it has already occurred once less than a decade ago.

Please don’t mistake my caution at this juncture for a market forecast. I hope that the market does not fall another 30% from this level. But right now it certainly seems possible. Economic fundamentals are too weak to say that additional downside risk is insignificant.

The mere fact that the price of something has gone down–even significantly–does not mean it has become a better buy. A couple of years from now, it is possible that we could look back and identify this point in time as the bottom of the financial and economic crises. For now, however, we cannot determine where the bottom lies and it is irresponsible for advisors to tell investors that this is a good time to buy simply because stocks have suffered a significant downturn.
F.S.

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