Fear Has Its Way in the Stock Market

In 1999, a couple of fellows wrote a book called Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market. They wrote that given stocks' long-term outperformance, equities were one of the most risk-free investments one could make. Stocks were safer, even, than bonds.

Alas, stocks don't look so safe anymore. Well before the events of Sept. 11, shares' steep decline from their 2000 highs showed that investors were reassessing the stocks-are-safe thesis. Even so, price-to-earnings ratios remain above historical norms. And in the wake of last week's terrorist attacks, it's difficult to convince investors that they should embrace any kind of New Math.

Indeed, stocks have come to be perceived as far riskier than they were just over a week ago. Investors once thought they could handle the stress of having a big chunk of their finances in the stock market. But in an uncertain and frightening world, taking on risk like that doesn't make as much sense.

"People are realizing what risk is all about again," says Merrill Lynch chief quantitative analyst Rich Bernstein. "But I still don't think we've gotten to the point where the risk premium is at the correct level." Bernstein has long advocated a conservative approach to the market, encouraging clients to diversify investments across different asset classes and to keep their stock investments focused on defensive areas, like consumer staples. He's sticking by that now, though he counsels against going whole-hog into anything at the moment. ...