Gyrations Will Separate Investors From Traders

These are times that test the resolve of millions of small, inexperienced investors, determining whether they hold against the tide of selling or join the frantic herd.

It is a time when traders are separated from investors, when those with long-term goals are differentiated from the short-termers, when the money-wise with clear goals distinguish themselves from those who live on hope.

These are important distinctions. History shows that investors who choose stocks prudently and hold them until changes occur in their goals or those of the company outperform those who trade in and out on the news.

It might not seem that way, but it is. The real winners in stocks, such as Warren Buffet, are as slow to sell as they are to buy. They invest only after studying a stock. They sell for profound reasons rather than headlines.

The point of this is that millions of small newcomers have joined the pursuit of equities in the past few years, mainly through mutual funds, of which there are now thousands. Will they bolt on bad news or will they hold?

How they will act really isn’t known, because never to this extent have so many of them been in the market.

If they resist the negative comments and the scary news and the price volatility they can be a market stabilizer. If they withdraw from their mutual funds they could create a turbulent financial whirlpool.

In this way: Withdrawals force funds to raise money, which they must do by selling shares they own, putting additional pressure on prices and perhaps causing others skittish owners to withdraw.

Forgotten in such a scenario is that fundamental values might change very little. Companies might have good earnings, fine prospects and competent managements - the very qualities that justified high prices for their shares.

At perhaps 10 percent corporate earnings growth, roughly a third of 1995’s, some popular ratios of earnings to price could support a Dow Jones industrial average at its current reading - higher if interest rates fall.

This is the verdict of Arnold Kaufman, editor of “The Outlook,” Standard & Poor’s weekly investment advisory newsletter, published just prior to the latest correction:

“We don’t at this time see any major problems, either from a fundamental standpoint or on a technical front. Greed or fear will gain the upper hand at some point, but for now, the bull market remains intact.”

Still, he and most other forecasters have found it wise to attach caveats to their assessments, the two most common being that a short-term correction is likely and the year’s gains will be far below those of 1995.

Almost as common is the reminder of that most basic of market truths, that nothing rises in an uninterrupted line, and rarely for the five straight years this market has been at it. That’s too much to expect.

Other factors also are involved. How will the Bosnia peacekeeping mission turn out? Will a budget agreement be reached? Will the Federal Reserve blunder in its monetary mission?

For now, though, the question is whether small investors will hold firm or go to pieces.