Finally, a stock market test

After months and months of smooth sailing on the markets, we finally got a little test yesterday with the Dow falling 546 points at one point.

I don't receive CNBC-TV, but I don't sense any fear in the air. The market simply corrected a bit from a massive months-long run-up. Unlike other big corrections over the past 10 years, this one generated almost no water cooler talk. My co-workers didn't talk about it. The 30 guys I played basketball with last night didn't talk about it. The local news focussed more on weather than on the stock market decline. It didn't get much attention at all. I don't even see much mention of the correction in all the PF blogs, which seem more interested in real estate deals. My personal feeling is that more declines are ahead, but also that the market won't take too long to recover. Unlike during the post-2000 correction, people aren't overly invested in the stock market, and seem adequately diversified into other investment areas (heavily overweighted in real estate), which should keep any large corrections from turning into a disaster. This is just my personal feeling, not based on any statistics, so please don't make any strategic decisions based on it.

I happened to see the bottom fall out of the market at Dow down 500+ and went in for a trade of DIA, QQQQ, and a couple of foreign ETFs, expecting a technical bounce after that massive 200 pt afternoon spike down in the Dow. I sold most of those positions already today for a quick 5% gain, since I'm expecting further large corrections in the not-too-distant future.

Yesterday was an excellent test of diversification strategy, so I reviewed the reactions of my various diversified holdings. I mentioned in an early post that I believe diversification doesn't help as much as one might expect, and this certainly seemed to be the case yesterday. Everything fell in concert - small cap, mid cap, large cap, value, growth, dividend plays, technology, domestic, foreign - European, Japanese, Asian ex-Japanese, emerging markets - Brazil/Russia/India/China, real estate funds, commodities, energy. EVERYTHING fell, except for bonds. I think that so many trading vehicles have been developed for every investment under the sun, that diversification just doesn't get you what it used to. You couldn't readily invest in gold a few years ago, but now that you can do so easily through the exchanges, gold has started tracking stocks. With all of the ADRs and foreign ETFs available now, the same has happened with foreign and emerging market stocks - they seem to be more correlated with US stocks and vice versa. What's the point of investing in gold if it falls even more than stocks during a stock market crash?

I am underweighted in commodities/gold, but the action yesterday is leading me to think it's not worth bothering to increase allocation in this area. However, bond/stock diversification seems to be a valid strategy. Currently, I have bond investments in individual munis, LSBRX, RPIBX, and some other miscellaneous bond funds. I'm looking to move more cash assets into bonds.

And still waiting for further market corrections to increase my diversified stock holdings in a more permanent manner.