The Wall Street Journal-20080123-Common Sense- January-s Plunge Has Been Dizzying- Now- the Good News

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Common Sense: January's Plunge Has Been Dizzying; Now, the Good News

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SmartMoney

Forget the "January effect," the traditional boost stocks got from new money flowing into the market after the new year. The few weeks of trading in 2008 have turned out to be among the worst ever for the stock market. And Monday's plummet in the global markets and yesterday's scary opening hours in the U.S. would seem to test the theory. But the day ended with U.S. stocks showing just modest declines.

To be honest, I've never thought the January effect made much sense. Supposedly, stock prices are depressed by tax-loss selling before Dec. 31, and then bargain hunters rush in after the new year. But what about years in which there were few losses, and hence not much tax- loss selling? And why did stocks with big gains rise as much as those subject to tax-loss selling?

Perhaps 2008 will also test the theory that stocks rise in election years. But with Election Day still more than 10 months away, and Congress rushing to enact an economic stimulus package, it's far too soon to tell.

As for January, the plunge has been dizzying. The Nasdaq Composite, having crossed my latest buying threshold of 2575 just two weeks ago, was hovering just over another buying threshold this week, representing a further 10% decline. At about 2300 the Nasdaq will be in bear-market territory for the first time since August 2002. Other averages are similarly close to bear markets, and the battered small caps are already far into bear territory.

From a purely technical perspective, this sudden plunge feels more like the kind of selling climax that typically ends a bear market rather than the slow but steady grind that investors endured after the tech bubble collapsed (though there were some steep falls then, too). The theory is that when selling mania sweeps the market, it flushes out all the sellers, leaving mostly buyers in their wake. This sets the stage for a recovery. But I never set much store in market technicians.

I rely instead on my Common Sense system, which never tries to predict the direction of the market. I rely on where it has been, which is knowable. This is the first time since 2002 that back-to-back buying opportunities have presented themselves: successive 10% declines without an interim selling opportunity. Back in the dreadful 2000-02 bear market, there were many successive buying opportunities.

When this happens, you realize that your earlier buying was premature. If I knew the Nasdaq was headed to 2300, I naturally would not have bought stocks at 2575. But neither I nor anyone else could have known that. And consider the alternative. If I bought only at 20% declines, or in bear markets, I wouldn't have had a single buying opportunity for the past five years. As it is, I was able to commit cash to the market at what turned out to be opportune times. This time I may have bought early, but I didn't buy at the high point of last October.

In my experience, and history bears this out, sudden drops like these represent opportunities for patient investors. This may be your chance to buy stocks you never thought would be cheap. Take tech darlings Google and Apple. Both are about 20% off their highs. Commodities and raw materials? BHP Billiton is down around 30%. Emerging markets? Off nearly 20%. For months they've all been too expensive to consider buying, in my view. But now even the most sought-after stocks are much cheaper. And the rationales for buying them, from technological innovation to strong demand from developing countries, are still intact, even if there is a recession that slows things down.

Bull markets are great, but they breed complacency. Bear markets can be energizing. Instead of fretting over the decline in your net worth, think opportunistically about all those bargains -- and the potential gains when, inevitably, a bull market returns.

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James B. Stewart, a columnist for SmartMoney magazine and SmartMoney.com, writes weekly about his personal investing strategy. Unlike Dow Jones reporters, he may have positions in the stocks he writes about. For his past columns, see: www.smartmoney.com/commonsense.

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