A Good Bad Quarter

Story Notes

• Much like Q2 2006, this year's third quarter market fears turned out to be much ado about nothing—a classic bull market correction
• "Sell in May and go away" would have been a bad strategy this year (as it is most every year)
• Bull market corrections happen too quickly to avoid—it's best to stay fully invested and wait them out

The third quarter of 2007 was a tough one, wasn't it? It sure felt bad. Common headline adjectives included "turmoil" and "crisis." We worried over subprime meltdowns, credit crunches, dollar devaluations, inflation resurgences, roaring bear markets, and recession doldrums. The sum of these worries resulted in a global stock correction (as measured by the MSCI World Index) to the tune of 11%. Yet here we are, in the first days of the fourth quarter, once again near or surpassing all-time highs for stocks throughout the world.

We've written extensively on the correction. If you'd like more detail, see our past commentaries:

• Corrective Measures, 08/03/2007
• Blood in the Alleys, 08/09/2007
• Pray for Panic, 08/10/2007
• Bad Connation, 08/13/2007
• Are We There Yet? 08/20/2007
• Best Credit Crunch Ever! 08/23/2007

At MarketMinder we know the only way to forecast stock returns is by understanding what's likeliest to happen looking forward, not by agonizing over the past. But history can be very instructive—some important lessons investors can learn from recent history include:

• Bear markets don't announce themselves—this was a classic bull market correction
• Incorrect psychological beliefs, given time, are ultimately trumped by fundamental truths
• The best way to navigate a correction is to do nothing

So recent market fears turned out to be bogus. But still, the old adage, "Sell in May and go away" had to be right this year for stocks, didn't it? Actually, no. If you sold out of the S&P 500 on May 1 and didn't reinvest until October 1, you'd have lost money on the deal. During that period US stocks gained 3.8%. Not a huge expansion, but consider the transaction costs and taxes associated with inning and outing—likely hacking off another couple of percent. Suddenly, you've cost yourself big bucks by panicking with the herd.

And what about September? Many folks believe it to be one of the worst months for stocks! But the S&P 500 roared this September—returning 3.7% for the month.

We heard a pundit on CNBC today say, "It's a new quarter and the market is starting to get a hold of the subprime and credit issues." That's almost exactly wrong—the market figured out these were bogus worries much earlier, rallying hard in the latter portion of August into September. Had you hit the sidelines for those months while journalists sowed fear, you'd have missed a ton of upside.

Much like the second quarter of 2006, this year's third quarter was a classic bull market correction: A short, sharp, steep, and scary downward shock fueled by baseless fears that ended as quickly as it began.

We remain optimistic about stocks for the rest of this year. As investor psychology begins to meet reality, expect the familiar bullish trends of 2007 to resurge—specifically big M&A and share repurchase activity, stronger than expected global economic growth, and solid corporate earnings growth. It's still a great time to buy stocks.