Forum Archive Index - April 2000

["Rob Henderson" <robhenderson@paradise.net.nz>]

Market Drop Signifies Nothing

http://www.fool.com/portfolios/rulemaker/2000/rulemaker000417.htm

By Rob Landley (TMF Oak)
April 17, 2000

"It is a tale told by an idiot, full of sound and fury, signifying
nothing." -- William Shakespeare.

Okay everybody, take a deep breath and repeat after me:

Taxes are due today. Day trading is at record levels. Day traders have to
pay short-term capital gains taxes. All in a lump sum. Right about now.

This is one reason we don't do a lot of trading in the Rule Maker portfolio.
We do a lot of buying, but not much selling. In fact, our only sells to date
were forced by share splits that caused us to have partial shares that were
delivered to us in cash. We're lazy procrastinating sods who don't like to
do the tax paperwork. Our tax bill for 1999 came to only $55.39. Most of
that amount is due to the $188.08 of taxable dividends which we received
this past year. And yes, here in the Rule Maker Portfolio, we actually
deduct taxes from our reported returns. Since we started this gig over two
years ago, our portfolio is handily beating the S&P 500 on an after-tax
basis -- check out the numbers.

I feel sorry for day traders who had to fill out page after page of Schedule
D's. It may only take a click of the mouse to trade these days, but every
single trade still has to be reported to the IRS. And then to suddenly find
out that those day-by-day gains they've been living off of for the past year
add up to one big tax bill forcing them to sell a bunch of stock right when
everybody ELSE had to sell too...

Tragic. Simply tragic. But all of this definitely falls under the broad
category of "things that should not be news." Maybe a human interest story,
but a business section headline?

How about the Saturday front-page headline in the Courier-Post in southern
New Jersey? I pick on them merely because I happened to buy a copy. The
story itself was from the Associated Press, and proclaimed a record breaking
6% drop in the Dow Jones Industrial Average. The first line reads, "The
nation watched agape Friday as the stock market suffered a history-making
collapse that shook professional and armchair investors alike." It was a
"semi-panic," says the article, "almost a full cascading deterioration." (I
don't know what that means, but I assume it would cause the markets to
suspend trading until they could administer Valium to everybody on the
trading floor.)

Why are people getting hysterical about a 6% drop? Because now that the Dow
is 10,000 instead of 2,000, a 6% drop is 600 points rather than 120 points.
That's a lot of points; a record number. But it's still 6%. Deal with it.

We have a record number of day traders, but hopefully they'll have learned
something from this. Day trading is a zero-sum game, no matter how easy the
Internet makes it and how many commercials Internet brokers run on
television urging people to do it. Zero-sum means it's like poker, where all
the players come to the table with money, and that's all the money there is
in the game, and if anybody gains any money they win it off of one of the
other players.

Except day trading is worse, because every trade costs you a commission that
goes to the brokerage, and a spread that goes to the market makers. (If you
don't know what those are, try the Fool's School Investing Concepts
section.) And at the end of the year, of course, Uncle Sam gets his cut.

Here in Rule Makerdom, we're looking at the future earning potential of
companies. We're looking at how growing companies can become more valuable
and profitable and return cash to their investors through dividends and
stock buybacks. And we revel in the fact that we don't have to pay taxes on
unrecognized gains, so increases in stock price don't result in a tax bill
until we sell stock.

The Associated Press article was by no means the only one. Reuters has a
headline, "Stocks Suffer Historic Losses as Inflation Rises." Oooh. They're
historic now. Hands up everybody who thinks this will go down in history
along with the "Asia Scare." (Two years ago. Remember?) How about this
headline, "Technicians See Further Damage in Nasdaq." It sounds like
somebody spilled a Coke into it and shorted the electronics out. I love the
first line of that article, too: "Technical analysts surveyed the bloodbath
in the Nasdaq... Friday as key support levels were once again easily
violated." Sounds like a Victorian horror novel involving vampires and
scantily clad women. And here's another article looking for comments from
the White House, Secretary of the Treasury, Federal Reserve, AND the
Securities and Exchange Commission, and finding the fact that they
collectively didn't really have anything to say -- in and of itself
newsworthy! That's almost Zen.

The reality is, April's tax hit caused enough selling to trigger margin
calls. People who borrowed money using their stock as collateral, and used
that money to buy MORE stock, suddenly found that their collateral had
shrunk to the point where their loans were being called in. Oh dear, you
mean they have to sell some stock (to pay off the loans) at the worst
possible time, AFTER the stock has gone down? Of course, that's how margin
loans always work.

Will the market continue to go down? Entirely possible, the herd has been
spooked into momentum trading. Is this a "justified market correction"?
Maybe. Dunno. Will the market come back up at some point? Barring nuclear
war or a comet crashing into the Earth, of course. When, exactly will this
occur? Beats the heck out of me.

What I do know is that if I considered a stock to be worth buying at a
higher price, and the company I'd be buying stock in hasn't changed, then
the lower price is a good deal for me as a buyer. It's a fire sale on
stocks. Does this mean I should buy something I wouldn't have wanted to own
otherwise? Probably not.

But whether or not anything useful can be learned from the situation, you've
got to admit the amusement value of all this for a long-term, buy-and-hold
investor who isn't relying on margin is just awe inspiring.

Finally, if you're not sure what to make of all the recent market movement,
check out the Fool's Market Craziness special.
- Oak



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