Week of 10/02/2008

A Nasty, But Not A Calamitous, Stock Plunge
Our Contrary Opinion
A Cure For The Crisis Is Already Being Applied
It's Time To Do Some Cautious Buying
Stock Buyers Should Sip, Not Gulp
The Bottom Line This Week

People who enjoy excitement must envy investors right now. Not even thrill seekers who travel to New Zealand for the world's highest bungee jump have anything on us. When it comes to big bounces, Wall Street is the place to be.

On Monday of this week, we completed the jumping part of the stock market's bungee experience. The rebound on Tuesday was nearly as exhilarating. Wednesday, thank goodness, was a quiet day of recuperation.

Of course the rubber cord could break at any time, in which case the game will be over. However, that seems very unlikely. If a crash was in the works, we think it would have happened on Monday when deep pessimism was rampant.

The market action we are having now is all the more exciting because there was no hint of it last week. The Dow dropped a tepid 2.2% while the Nasdaq just about doubled it with a 4.0% decline. It was barely enough to be a good warm-up for this week's main event.

A Nasty, But Not A Calamitous, Stock Plunge

On Monday, as everyone must know by now, the Dow and the Nasdaq plummeted 778 points and 200 points respectively. Pundits, of course, were quick to point out that the Dow's move was the "biggest stock plunge in history!"

That's true, but as Paul Harvey liked to say, "Heeeeere's the rest of the story:"

In percentage terms the Dow's plunge represented just under a 7% drop. By contrast, the Dow fell 23% on October 19, 1987, which was over three times the size of the hiccup we had this week.

Pundits also gleefully point out that the drop erased all the gains stocks made in the past eight years. Well, that's also true. However, eight years ago was the top of the tech and dot-com bubbles, which was hardly a proper place to begin a measurement. If we start from the market's bottom after the bubbles burst, stocks are up nearly 40%, plunge and all.

Our Contrary Opinion

Many articles about the financial crisis predict it will lead to a near-total meltdown of the U.S. economy. Credit will be unavailable, business will grind to a halt, consumers will stop spending money, and civilization as we know it will end. It's about the darkest outlook possible.

For such a scenario, the Monday-Tuesday stock decline seems mild. If the world is really in as much trouble as so many dire projections suggest, a much larger drop would have been likely. Either the outlook for the economy isn't anywhere near as bad as many writers believe, or investors don't understand the gravity of the problem.

We doubt the latter is the case. On the contrary, history shows that investors have a much better grasp of the future than professionals. That's not surprising because investors put money on their predictions, which tends to focus the mind.

Lastly, if we look at the market action on Monday and Tuesday together, we have another reason not to take poison. Our arithmetic shows the 778 point drop and the 485 point rebound left us with a 293 point decline, which was far from a disaster.

A Cure For The Crisis Is Already Being Applied

We are not in any way suggesting that the financial turmoil isn't serious. It is the most threatening event we have seen in many years. But we think Congress and market forces will restructure our financial system without killing the American dream.

In fact, the process has already started. In January, the Fed arranged for Bank of America to acquire Countrywide. Six months later BOA took over Merrill Lynch. In March, JP Morgan Chase was persuaded to rescue Bear Stearns.

Earlier this month, Uncle Ben Bernanke also paired JP Morgan Chase with Washington Mutual. On Monday of this week, Citigroup took over Wachovia. More "strategic alliances" are undoubtedly on the way, particularly with regional banks that are also having liquidity problems.

Even before the financial crisis hit, banking insiders predicted that a wave of consolidation was on the way. Guess who was expected to lead the charge? The list was headed by none other than Bank of America, JP Morgan Chase, and Citigroup. Recent events simply appear to have accelerated the buyout cycle. It also gave the buyers much better prices.

It's Time To Do Some Cautious Buying

Speaking of better prices, the best time to buy stocks is when everybody else wants to sell them. As uber-investor Warren Buffett once said, "We simply attempt to be fearful when others are greedy, and to be greedy only when others are fearful." He went on to say, "You must have a willingness to do something when everyone else is petrified. You must learn the lesson of following logic over emotion."

With the advice of "The Sage Of Omaha" in mind, we suggest that you consider the following blood-in-the-streets investments:

Financial Services

The low prices the large financial service firms paid for their acquisitions should lead to king-sized profits once the current troubles are over. But, with the financial crisis dominating the headlines, the leading bank companies are currently dirt cheap.

As a result, we are even more bullish on the long-term outlook for the Fidelity Select Financial Services Fund (FIDSX). http://finance.yahoo.com/q/bc?s=FIDSX Remember, this is a managed fund, which means its portfolio will hone in on the winners as they emerge. The fund already holds substantial positions in Morgan Stanley, JP Morgan Chase, Bank of America, and Citigroup. All of them are in the Wall Street doghouse because they also purchased many bad mortgages and ran into trouble. But the surviving banks are now starting to make up for their mistakes.

The Fidelity fund is down 46.5% from its October 2007 high, and it is off 26.2% this year. We think the steep discount makes the fund attractive for long-term portfolios. It should be a particularly good performer in retirement accounts.

Bond Funds

Bond funds also look good. On Monday, market psychologist Brett Steenbarger of TraderFeed (www.traderfeed.blogspot.com) pointed out that the iShares Investment Grade Corporate Bond Fund (LQD) lost 20% of its value over the past three weeks. http://finance.yahoo.com/q/bc?s=LQD Investors are worried that the companies whose bonds are in the fund will not be able to make their interest payments. We think that threat is greatly overstated for investment grade bonds.

To see how irrational bond fears have become, the iShares High Yield Corporate Bond Fund (HYG) is also down 20%. It's ridiculous to price the two very different classes of bonds the same way. It's all the more reason to think the investment grade fund is a classic case of the baby being thrown out with the bathwater.

Multinational Blue Chips

We will also repeat our recommendation of the iShares Dow Jones Select Dividend Index (DVY) that tracks the 100 highest-yielding stocks in the Dow Jones Total Market Index. http://finance.yahoo.com/q/bc?s=DVY&t=1y

When investors start to tiptoe back into the market following a scare, the first place they go is to high-yielding blue chip stocks. As a result, big stocks should be especially good performers at the same time they offer investors a high degree of safety.

Stock Buyers Should Sip, Not Gulp

If you decide to do some cautious bottom fishing, please proceed slowly. The financial crisis is far from over. We may see several more scares in the coming weeks. If you hold some cash back from your first venture into the market, you may see even better prices later on.

In any event, the best investment strategy during times of great turmoil is to buy a little bit after every significant market decline. That will leave your ultimate returns far higher than will be true for people who chase the rallies.

The Bottom Line This Week

The past three weeks have not been much fun. However, Mother Market has a way of rewarding investors who stick with her system over the long term. The greatest returns go to people who find the courage to buy stocks when they are out of favor and they are the least expensive, as is the case today.

Three investments that currently look very attractive are the Fidelity Select Financial Services Fund, the iShares Investment Grade Corporate Bond Fund, and the iShares Dow Jones Select Dividend Index. All of them have been top performers in the past, and they will almost certainly be top performers in the future. 


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Posted 10-02-2008 11:38 AM by Research & Editorial Staff