|
Because most investors ignored some basic observations about economics in the late 1990s, they lost trillions in their stock portfolios. In the late 1990s, the United States experienced the greatest expansion of debt in history, coupled with a record expansion of the money supply. (Both are controlled by the Federal Reserve, the U.S. government central bank referred to as the Fed.) This growth of debt and money supply resulted in more consumer (and corporate) borrowing, spending, and investing. This activity hyperstimulated the stock market and caused stocks to rise 25 percent per year for five straight years. Sounds great, but such a return can't be sustained and encourages speculation.
This artificial stimulation by the Fed resulted in more and more people depleting their savings, buying on credit (it's cheap — why not?), and borrowing against their homes. All this spending (on big ticket discretionary items, vacations, and so on) prompted businesses to expand (by borrowing money, of course, or by going public). But such high-level spending can't go on forever.
When the inevitable slowdown came, companies were caught in a financial bind. Too much debt and too many expenses in a slowing economy mean one thing: Profits shrink or disappear. To stay in business, companies cut expenses, and the biggest expense in a company is payroll. So companies started laying off employees. And when you don't have a job — or are afraid of losing one — and you have little in the way of savings and too much in the way of debt, you start selling your stock to pay the bills. This was a major reason that stocks started to fall in 2000. Earnings started to drop because of shrinking sales from a sputtering economy. As earnings fell, stock prices also fell.
The lessons from the 1990s are important ones for investors today:
- Stocks aren't a replacement for savings accounts. Always have some money in the bank.
- Stocks should never occupy 100 percent of your investment funds.
- When anyone (including an "expert") tells you that the economy will keep growing indefinitely, be skeptical and read diverse sources of information.
- If stocks do well in your portfolio, consider protecting your stocks (both your original investment and any gains) with stop-loss orders.
- Keep debt and expenses to a minimum.
- Remember that if the economy is booming, a decline is sure to follow as the ebb and flow of the economy's business cycle continues.
|
