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Last Straw for Small Investors?

Stocks: Analysts fear corporate scandals could drive out those hanging on through bear market.


The stock market peaked 27 months ago, and with every new decline since then the same question has been asked about individual investors: How much can they lose before they can stand to lose no more?

For some Americans whose trillions of dollars in savings helped drive the great 1990s bull market, the threshold of pain may finally have been crossed.

Bob Friend, a Redondo Beach aerospace engineer who has invested in stocks for 20 years, says he plans to move more of his investments into interest-bearing bonds, or perhaps gold, in the next month.

Stung by his portfolio losses and disheartened by mounting revelations of corporate fraud--the latest WorldCom Inc.'s bombshell last week of $3.9 billion in accounting irregularities--Friend says his faith in the market has waned.

"There's a complete lack of trust in corporate leadership," he said. "I think the lack of ethical behavior has destroyed investor confidence."

Comments like those are sending a chill through Wall Street. Individual investors were a big source of fuel for the stock market's unprecedented gains in the 1990s, a decade in which the total value of the 5,000 largest U.S. stocks soared from $3.4 trillion to $14 trillion--a wealth boom that, in turn, helped power the economy.

Perhaps more important, the public's willingness to largely stay in the market through the devastating decline of the last two years may have kept stocks' losses from becoming far worse.

Now, some analysts fear that many small investors are on the verge of giving up on the market.

"The new concern is that we have lost a generation of individual investors, much the way we did after the Great Crash" of 1929, said Edward Yardeni, market strategist at brokerage Prudential Financial in New York.

Souring on Stocks

Investors also soured on stocks en masse in the 1970s, after the market plunge of 1973-74. Measured from 1972 to 1981, the net gain in the blue-chip Standard & Poor's 500 index was a minuscule 3.8% as investors stayed away.

The worries about another lost generation of investors may yet prove to be overblown. What's more, even if Americans have had their fill of stocks, it isn't clear that the implications would be dire. The economy doubtless would survive without a rising stock market. Savings that might have been earmarked for equities would simply flow elsewhere--into banks, for example, or the real estate market.

The housing market, red hot this year while stocks have fallen, already appears to be luring money that might otherwise have gone to Wall Street.

But an equity market that stalls out, or declines further, could make it far more difficult for U.S. companies to raise capital needed to grow. Likewise, poor returns in the stock market would change the financial outlook for the tens of millions of people whose retirement nest eggs still are locked up in stocks.

Even now, many older Americans must rethink their retirement spending plans as share prices have tumbled. The S&P 500 has dropped 35% from its record high in March 2000. That is the deepest sustained decline in the index since it dived 48% in 1973-74 amid the Arab oil embargo, surging inflation and President Nixon's resignation.

An investor whose retirement portfolio has tracked the S&P 500, and who had $500,000 at the market peak in 2000, has $325,000 now.

More exasperating for investors has been the duration of this slide and the volatility along the way. Twice in the last 15 months, stocks staged sharp rallies that appeared to mark the end of the bear market. Instead, the rallies quickly gave way to renewed downturns.

The S&P 500 hit a three-year low on Sept. 21 in the aftermath of the terrorist attacks. The market then rocketed in the fourth quarter as investors bet that the U.S. military would prevail in Afghanistan and that the economy would soon emerge from recession--both correct bets, as it turned out.

But as 2002 dawned, many stocks crumbled anew. And last week, long-distance titan WorldCom's revelation that it understated expenses by $3.9 billion over the last five quarters, effectively hiding a sea of red ink behind phony profit statements, triggered a wave of selling that drove the S&P index briefly below its close on Sept. 21.

There are various ways to measure "bull" and "bear" market cycles. But if the S&P 500's dip last week below the September low means the bear market didn't end after the terrorist attacks, it is now 27 months old. For the S&P index, that would be the longest decline since the 1940s.

A Third Year in the Red

The harsh financial reality for many buy-and-hold investors is that their portfolios are deep in the red for a third straight year--a rarity in modern market history. If the trend holds through December, this will be the first time the market has fallen three consecutive calendar years since 1939-41.

Investors in the giant Fidelity Magellan stock mutual fund, for example, lost 9.3% in 2000, 11.7% in 2001 and are down 14.6% this year.

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