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July 26, 2007

What To Do As Stocks Go Bust
by Brady Willett

With stock prices plunging around the world today, some value investor tips come to mind.

1) Do not short the market. If you are thinking of going short because stocks must fall further, think again. Not only have bears that have waited for a sharp fall before entering the market short since 2003 had their heads handed to them, but as volatility returns to the marketplace put option premiums quickly shoot-up. In other words, trying to time the plunge can be dangerous, especially right after a sharp sell off.

2) Be careful when buying beaten down issues. As tempting as it is to pickup a beaten down homebuilder or financial stock today, there is the real risk that these issues are entering a protracted bear market. This rule can be ignored if you find a solid company that you are prepared to own for an extremely long period of time. For example, you like Beazer and if the stock price falls by 50% in the next 12-months you will gladly purchase more shares.

While this example may seem far fetched, a lot of 'value' seekers jumped into BZH earlier today when it was down by less than 1%, and a couple of hours later the stock was down by more than 11%...

3) Stay away from gold*. Adding to your gold position solely because equities are declining is nonsensical. Gold is an excellent hedge against monetary inflation, but not necessarily against recessions, stock market corrections, credit crunches, hedge fund blow-ups. etc. Recent history suggests that you would do better accumulating gold when the markets are in a rising/carefree environment rather than during periods of crisis.

*The notable exception: A major financial crisis wherein people simply want out of paper (yes, it has been awhile).

4) Do not make short-term currency bets. If you are looking to win big betting on the Yen, shorting the Loonie, or squeezing another blip out of the pound, understand that you are gambling. While currency volatility looks like it is here to stay, volatility does not necessarily spell opportunity. Ask yourself if you could forget about your long Yen position for a decade before taking the anti-carry plunge.

Incidentally, if you want some protection against a crashing USD own psychical precious metals and seek out attractively priced companies that have limited exposure to USD (and if you happen to know of some attractively priced Japanese companies that consistently throw off high ROE please do let me know).

5) With all of these tips about what not to do, there is one thing every value chaser should continue to do. Keep cash ready. To be sure, if you have the fortitude to ignore all the volatility in the marketplace you will come to realize that cash is fetching a decent return these days...

As for when to put more cash to work, have patience: a four year upswing in investor risk taking is unlikely to be resolved in a few weeks or months.

Brady Willett
FallStreet.com

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