The Dow Jones Industrial Average has declined from nearly 10,400 in mid-May to less than 7,800 by mid- July. The market rallied a few times during this period, but bear market psychology has persisted. The financial press is filled with stories of early retirements gone awry because of the stock market collapse. One also finds advice: Buy bonds! Buy gold! Buy and hold! Sell now to avoid insomnia!

There is no doubt that the recent collapse is disconcerting, perhaps more so than the break of the bubble in 2000. During those declines the investing public smelled a bubble, but these declines are coming during an economic recovery. Perhaps history will tie today's losses together with the millennium's losses as a single bear market. Thanks to 401(k) company-sponsored pension plans, the last 10 years have seen sharply wider participation by regular folks. But many of these new investors, as well as many of the younger financial professionals, have never struggled through a bear market before, perhaps another factor in the severity of the current downturn.

Investors always want to buy low and sell high in order to make a profit, but they mustn't forget that the best time to buy low is during a bear market. Yet buying low to sell high isn't so easy given investor anxiety, if not general depression! But there are opportunities. A Wall Street Journal article reported that 40 percent of stocks have actually risen since the market burst in 2000. Furthermore, last week's severe drop, that included a 7.6 percent tumble in the Dow Industrials, was accompanied by 179 stocks hitting 52-week highs.

New investors view
It is said that investors have short memories. The market lost one-quarter of its value on Black Monday 1987, but within a year it had recuperated entirely. The stock market drop associated with the 1990-91 recession is just a blip on the chart below, although the 1998 tumble associated with the Russian financial crises is more noticeable. Nevertheless, the recoveries were quick and sharp and the bull market managed to climb higher. Considering that it took roughly 8 years for the DJIA to double from 2000 to 4000 and then only 3 years to double again to 8000, it is no wonder that price appreciation may be looking for a respite right now. Basically we're back to 1998.

Old investor view
The picture surely looks very different when looking at the 20-year period from 1965 to 1984. Granted, this period does include four recessions (1969-70, 1973-75, 1980, 1982-82), nevertheless, the stock market wasn't always climbing. For instance, the market tumbled in 1966 when a credit crunch softened the economy without pushing it into recession. The market also dropped sharply between 1976 and mid-1978, a period of accelerating inflation. But quick recoveries were the rule, leading to volatility premiums that investors accepted. Stock market returns were good, but they weren't associated with a free ride in the same way as they were in the 1990s. Incidentally, while the recovery beginning in 1983 (following the 1982-82 recession) certainly was accompanied by a stock market rally, the DJIA peaked in 1984 and the market retraced its steps for several months even as the economy continued to expand. This is just one example supporting the quip that the stock market has "predicted" nine of the past five recessions.

In the 1980s and 1990s, stock market crashes were V-shaped. These are psychologically less stressful because investors can feel the bottom and can begin bargain hunting with confidence. The bear market surrounding the 1973-75 recession was akin to Chinese water torture as the market declined for nearly two years (peaking December 1972) before reaching bottom in September 1974. The DJIA peaked in the current cycle in January 2000; water torture certainly applies here.

The Long Term Perspective
The chart below depicts the year-over-year change in the DJIA back to 1946. Every upturn was followed by a downturn and vice versa. The 1990s experienced a particularly long upturn that has been justly labeled a period of irrational exuberance. The current downturn shouldn't have been unexpected, nor does it appear out-of-whack with historical trends.

It is easy to get caught up in the frenzy of the financial media. The news on the stock market seems almost always negative these days. Since we have no real knowledge of when stock prices will bottom, analysts find comparisons to other historical periods and come up with a conclusion about where the market will go next. In fact, our analysis may seem to fall in that category. Actually, the point of this exercise was to show that equity prices can move up as well as down at any given point in time. The only true statement that can withstand the test of time is that the market will overshoot on the upside as well as the downside. Remember the irrational exuberance in the face of bad economic news? Now we are seeing the flip side and getting irrational depression in the face of relatively good economic data.

The chart below shows annual rates of return coupled with the 10-year moving average of the Dow. Assuming that we end 2002 at today's levels, the Dow would still show a 10-year average yearly return of 10.4 percent. No, it isn't as good as the 33.5 percent rate of return posted in 1995, but it isn't bad for the long haul.

Bottom Line
There are some key points to remember these days. Financial pundits might tell you to sell your stocks in favor of bonds or gold or real estate. Actually, it is a good idea to always be diversified. Stocks, bonds, and real estate are good investments for the long run. We don't know when the market will bottom in this cycle. Investors who need some liquidity in their portfolios might want to sell some stocks. However, panic selling is a result of panic, not reason. Selling at the bottom of the market is just as bad as buying at the top. Remember, even though the Dow may be down these past three years, 40 percent of stocks have still risen since 2000.

Am I scared that the stock market will fall further in coming weeks? You bet! Will I be bargain hunting in the next couple of weeks? You bet! For the careful investor, opportunities are always to be had in both good and bad environments.

Evelina M. Tainer, Chief Economist, Econoday