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The value of my investments has dropped 35 per cent in just six months. Should I consider this lost money?

Chances are that most Canadian equity investors can relate to the loss of value on their recent portfolio statements. Whether you're an active stock player or a passive retirement- fund holder, the fall of many stock prices, coupled with economic turbulence, has played havoc on the bottom line.

Despite the unpredictable repercussions of a terrorist-stricken market, the stock market follows the ebb and flow of economic cycles and will continue to do so.

While these cycles are normal, no one can time the market and that's where novice investors get into trouble. There's speculation, and then there's investing.

The Power of the Market Cycle

The best way to visualize the normal ebb and flow of a stock market cycle, is by picturing a roller coaster. There are basically six stages to the cycle or roller coaster swing:

  1. The first is the accumulation phase. It actually begins at the end of the last stage of a bear market. At this point, prices are depressed and financial reports are negative. Farsighted investors use this period to take advantage of low prices and buy shares from discouraged and distressed sellers. This phase is characterized by aggressive buying by informed investors in anticipation of an economic recovery and long-term growth.
  2. In the second phase, corporate earnings begin to increase as economic conditions improve. The stronger tone of business and the rising trend in corporate earnings generates positive business reports that begin to attract attention in both the public and the media. The buying public begins to amass stock. In this phase, stock prices begin to rally strongly.
  3. A market rife with activity characterizes the third and final phase of the bull market, as the public has now become heavily involved. Record corporate earnings and peak economic conditions are bandied about in bullish stories and newscasts. Speculative volume increases in the market since the public has all but forgotten the last time the market was bearish. A buying frenzy is often seen as investors become convinced that the market is unstoppable. Those who bought during the initial accumulation phase, however, begin to sell their holdings in anticipation of a downturn. History has shown that the spring of 2000 marked the final phase of the bull market.
  4. The first phase in a bear market is the distribution phase (this phase actually begins at the end of the last stage in the bull market). Farsighted investors observe the euphoria and begin to sell their holdings at an increasing rate.
  5. The second phase of the bear market is characterized by aggressive selling. Buyers become increasingly harder to find as sellers become more desperate. Prices begin to strongly accelerate downwards as more people begin to try to liquidate their holdings.
  6. The final phase of the bear market sees discouraged investors who held their stock throughout the panic in the second phase finally capitulate and sell their shares. This leads to further weakening and erosion of prices. The media is teeming with bearish headlines and news stories as the markets continue to fall from distressed selling by those needing to raise cash. The bear market ends when at least most of the bad news is finally discounted by the market. This paves the way for the start of the first phase of the bull market.

When the sun comes out again…
Despite the profusion of doom and gloom news, the October 13 issue of The Economist offers investors a level-headed perspective on the current economy (The uses of adversity, page 15):

"For downturns provide opportunities as well as hazards. Recessions do not last forever. This one will probably be on a retreat a year from now. If (companies) are not too disoriented to take some risks, they will benefit when the sun comes out again. New ventures launched today will be designed to cope with the rough as well as flourish with the smooth. It is in the early stages of an upturn that fortunes are most easily made. This is the moment when companies should be preparing to make them."

Investing during economic cycles
No one can predict the bottom of the market or economic cycle, so prudent investors don't try to time the market.

Many inexperienced investors who jumped on the technology momentum train less than two years ago are now reacting with fear and selling their investments, just adding to their losses. It's human nature to react during both the greed and fear stages of the stock market.

Experienced investors brace themselves for the market cycles, while keeping a cool head. Investors who do not react emotionally, and who chose to invest in fundamentally sound companies, ride out the roller-coaster swings.

Unless you invested in poor companies that will only continue to weaken your portfolio, financial professionals stress that this is not the time to sell your investments. Doing so will remove any opportunity for fundamentally sound companies to recover in the next economic cycle.

Quality companies are not averse to market swings. Give them time and they generally recover and experience growth in the long term. As well, by buying and holding on to quality companies, investors limit the cost of trade commissions.

It is during economic uncertainty that diversifying among different investment areas such as short-term cash or money market investments, and stocks and bonds really comes into play to smooth out market volatility.