MARRIED TO THE MARKET

By Daniel Kadlec

Worried about retirement? Don't be. Little Biff and Betsy are just a few years from college? No sweat. Vacation house? Go ahead. Heck, chuck all your financial concerns, including those about social time bombs like a deficit-ridden federal budget and the financial squeeze on Social Security. Omnipresent and omnipotent, the stock-market god will take care of all.

You just need to keep the faith with your fellow believers: the stock-obsessed masses in mutual funds and investment clubs, trading online and standing in line a dozen deep at the corner Fidelity or Schwab office. Only 10 years since the most devastating one-day plunge in history, Americans are married to the market in confounding degrees. They have the trust of a newlywed that stocks will be a lifetime mate. The average person has more invested in the market than in the house that shelters him. Stocks account for more than 40% of the average household's financial assets, more than in any period in history. The percentage of adult Americans who own stock has risen from 10.4% in 1965 to 43% today.

Stock ownership isn't just a way to better your lot in life; it's a religion that seems ready to unify the planet with a single Almighty. In Wall Street we trust, and trust, and trust some more. Patricia Horst, 62, president of her own business-forms company in a Cincinnati, Ohio, suburb, says every dime of her portfolio is in the market. "Every night when I download the prices on my holdings, I just sit there in awe of all the money I'm making," she marvels. The benevolent stock-market god--the true promise keeper of our generation--is paving the way in green for her to retire in a few years and fulfill a lifetime fantasy of spending six months a year in Europe.

Patricia, do you remember--does anyone?--Oct. 19, 1987, that lose-your-lunch Monday 10 years ago this week when the Dow Jones industrial average plunged 23% and sent shrieks issuing from the canyons of Wall Street? A similar crash today would take the Dow from 8000 to 6160 in a single day. It would hack your mutual-fund balance from $50,000 to $38,500.

As it turned out, the '87 carnage was quickly repaired and never did ripple in a way that would curb consumer spending and dampen the economy, as many feared might happen at the time. Just two years after the crash, the Dow was setting records again and the investing public had learned, rightly or wrongly, to buy when the market drops. The bigger the decline, the greater the opportunity. So goes the dogma of the day, and it is ironic that the greatest one-day plunge ever--the 1929 crash was a mere 12%--was the springboard for today's equity culture, which professes one elixir for every financial ailment: buy-and-hold.

Clearly, the market is a proven wealth builder that can and should benefit all participants in a free-market economy. It's only right that everyone should be entitled to a piece of the action. Scott Sorochak is a 30-year-old Internet entrepreneur in San Ramon, Calif., who has been buying stocks since he was 16. His portfolio today is worth $1.8 million, and he plans to retire at age 40. "We literally go to bed every night laughing at each other over this," he says. Is he taking any chips off the table? Nothing much. "I'm still very bullish."

Sorochak's dreamy success notwithstanding, investing in stocks isn't the sure thing that today's equity culture assumes. Even in up markets, some stocks go down and stay down. Ask anyone who owned shares of U.S. Surgical in 1991. Johnson & Johnson invaded the little company's niche in surgical supplies, and the stock, once worth $120 a share, is now below $30. U.S. Surgical is hardly an isolated case. Biotechnology stocks fell 80% in a 1992 bloodbath, and many have not fully recovered. This year scores of stocks are down in an up market.

Sure, buy-and-hold is all but foolproof for those with diverse portfolios, an endless time horizon and supreme confidence that they'll never need to raise money in a pinch. But how about the other 99% of humanity? For them, the market holds risk, and some sense of that risk is precisely what's missing today and, oddly, what may make the market riskier than ever.

Contrary to cult thinking, outsize returns year in and year out are not a birthright wholly detached from the possibility of getting wiped out. Only curmudgeons like Federal Reserve Chairman Alan Greenspan, who last week sent up his third warning flag in 12 months, and gray-haired money managers who lived through the tough '70s markets speak of such things. Everyone else goes on merrily leveraging his or her financial future to an institution that has demonstrated through history a penchant for stomping on anyone who dares to take it for granted.

Practically everyone has a bull-market story, and collectively these tales illustrate the depth of the market's penetration into our social consciousness. Barton Biggs, the veteran investment strategist at Morgan Stanley Dean Witter, recalls a party at his summer house last month. The septic system backed up, and the plumber who came to save the party did so in more ways than one. The plumber recognized Biggs from his TV appearances and immediately commenced quizzing him on the market. "I told him I would be cautious at this point," Biggs says. The plumber begged to differ. To the amusement of all within earshot, "he told me I was as full of it as my septic system." The plumber went on to say he was plumbing part time now because he made more money trading stocks.

Ray DeVoe, who writes the DeVoe Report, an investment newsletter, conducted a series of interviews this summer at small-town grocery stores. He found that late in the month an increasing number of shoppers were buying as little as $20 worth of groceries with a credit card. Many were cash short because they were having $100 or $200 a month automatically debited from their checking account and plunked into a stock fund.

"Look on top of the Morgan Stanley building at Times Square," suggests James Grant, editor of Grant's Interest Rate Observer. "There is a continuous electronic display of the most obscure and arcane financial information imaginable, and the crowds on the street look up and don't seem to think there's anything odd or misplaced about it." Ticks, euros, LIBOR, basis points--a new language for a new era.

Plenty of hard numbers confirm this love affair with stocks. There are more financial newsletters, books, personal-finance magazines. A total of $2.2 trillion resides in stock mutual funds, 12 times the $186 billion that was there in 1987. Net inflows are about $20 billion a month. New funds are forming at the rate of three a day. In the U.S. there are more mutual funds that own stocks than there are stocks listed on the New York Stock Exchange.

Society as a whole, not just individuals through mutual funds and 401(k) plans, has placed a gargantuan bet on the stock market. Even governments see the market as a means to an end. The state of Louisiana recently passed a law allowing its pension-fund managers to put as much as 65% of their assets into the stock market, up from the previous cap of 55%.

And of course there is the controversial debate over whether the Social Security system should begin owning stocks rather than government bonds exclusively. Proponents such as Democratic Senator John Kerry of Massachusetts and Republican Congressman John Porter of Illinois say the higher returns are the best way to fix the Social Security-funding problem. (Without changes, the system will be broke by 2029.) "It would give every American worker control over his or her retirement destiny," Porter maintains.

The immense faith in stocks led Washington to cut the capital-gains tax rate a few months ago. The cut had been in the works for years. It didn't become feasible, though, until enough voters owned enough stock (which they implicitly believed would deliver capital gains) to conclude that such a cut would be good not just for the rich but for everybody.

Is it all misguided devotion? Hardly. Since 1926, the Standard & Poor's 500 has risen 10.9% a year on average, beating bonds, money-market funds, gold, collectibles, tulips and most other things. That long-term statistic is the holy scripture for today's investors, the thing that gives them faith when they fleetingly wonder how much higher their stocks can go.

There is no reason to suspect that the long-term growth rate will change much--and you should be terrified by that thought. If the 10.9% figure is reliable, as everyone assumes, then a period of grossly subpar returns must be coming. The S&P 500, including dividends, has returned an average 33% annually since 1994. To revert to the long-term trend line over, say, the next four years, the S&P 500 would have to register no gain. Indeed, a handful of Wall Street pros sees something on that order starting. Charles Clough, chief investment strategist at Merrill Lynch, expects total return from stocks to be 4% to 6% a year in the next five years. Biggs says the market might return nil to 2% a year in the next five years and 5% a year in the next 10.

But that's not at all what Wade Brown, a 31-year-old financial manager in Lindon, Utah, has in mind. "Every time I've lost on a stock it's because of impatience," he says. "As I look back, the stock has always gone back up." He's banking on a run to get his portfolio to $1 million in four years. "Age 35 is what I've been thinking," he says matter-of-factly. "That's the only milestone that has crossed my mind." Age 35? A million dollars? Where does such confidence spring from? Lots of places, and most of them quite valid. Baby Boomers are saving for retirement, not spending their hearts out. The fall of communism is opening the door to global trade. Technology is making everyone more efficient, which keeps inflation and interest rates low even as corporate profits mushroom.

That, in a nutshell, is the new era you have heard so much about, and it's real, at least for now. Such perfect economic conditions have persisted through most of the '90s and led to a uniquely placid period in the market. As a society in love with stocks, we've never quite been here, so no one can be sure what to expect. When pushed, market veterans liken today's fervor to 1929 or 1968, both bull-market peaks. Because of key differences between now and those periods, however, few predict imminent disaster. But it's worth noting that after the '29 crash the S&P 500, excluding dividends, didn't fully recover for 25 years. And the '68 peak was part of a sideways market that lasted 18 years. Some believe a long dry spell like the one after the '68 bust, which included a 46% decline in the market in 1973-74, will be our model. Others say the model will be the even more disturbing decline of stocks in Japan since 1989. There, the market has fallen 63%, and assets in mutual funds have plunged 93%.

Such a turnabout would offer a stiff test for this equity culture. "If you're 30 or 40, it's nothing to worry about," says Biggs. The market always comes back. But if you're 55 or 60 and letting bills pile up while you buy stocks, the risks are acute because you have less time. Minuscule returns over a long period could mean that you won't have as much money in retirement as you thought, or that you'll have to work longer, and if you need money during the worst of the drought, you'll have to sell at the bottom. A serious market dive of 40% could sap consumer confidence and bring on a recession, always tough on those who have been taking on debt.

But the biggest risk is the one that has trampled investors so often in the past. With a big market drop, the equity culture--the faith--just dies out as investors see other assets start to zoom higher, as gold and real estate did in the '70s. They shift to those asset classes and end up missing huge initial gains when stocks eventually, inevitably, bounce back. That kind of behavior destroys any argument for the public's easily attaining the long-term average annual returns that stocks offer.

For the equity culture to be true Nirvana, it must be permanent. Buy-and-hold means buy and hold a diverse portfolio through thick and thin. But where money is concerned, the age-old forces of greed and fear will always rule. Most investors won't stick with their stocks through years of drought any more than baseball fans will keep filling the stadium for a last-place team. And that's the risk.