The Best Way to Cope With a Wild Market

By Sep 20, 2008, 6:12 PM Author's Blog  

It’s a bear market…bordering on panic…and most investors have been paralyzed. They feel there is nothing they can do. But that‘s not necessarily the case.

Yesterday two colleagues told me how they are coping with a bear market. I’ll tell you what they’re doing. And then we’ll go over the single best strategy to use now to cope with a bear market.

The first colleague is a friend who has had an incredibly successful run. He was aggressively buying tiny gold stocks back in 2002. The tech crash was in full effect and he took a big bet.

He told me, “You know what; I’m going to Europe for a few months.”

That seemed like a heck of an idea. And yes, in case you’re wondering, he bought an open ended ticket.

Of course, we all weren’t buying penny gold stocks five years ago, and don’t have that luxury.

The other colleague is a hard working commodities analyst who covers mining and energy stocks.

She completely avoided the financial sector because “it seems like banks don’t lend money anymore. I don’t understand how they make such huge profits.”

In hindsight, her instincts were right.

Her bear market strategy is eerily similar to my other colleague’s. “I’m going to learn how to surf…in the Caribbean…just for a few months, until things settle down.”

Again, most of us don’t have the luxury of simply avoiding the problem and waiting for it to go away.

So for most of us it is very important to develop a plan and follow it. That is not as hard as it sounds.We just have to look at what has happened, what is happening, and what will happen. Then make our moves accordingly.

What Has Happened

The world has experienced an unprecedented decade of growth. As the markets surged to new highs, the world side-stepped the Asian currency crisis, Russian government debt default, and the dot.com meltdown. Now the world economy is getting dragged down by the bursting of the U.S. housing bubble and hundreds of billions of dollars of IOU’s from people who can’t afford to pay them.

The financial distress has panicked the pros. All of the Wall Street guys who have been making seven-figure salaries taking mortgages, turning them into debt, slicing them up, and then placing bets on which ones would fail (an oversimplified take of the derivatives) are scared the guy across on the other side of the bet won’t be able to pay his side of the bet.

That’s what is causing the current round of panic. It’s a $63 trillion mess (some estimates put it at $100 trillion) that will need to get sorted out. There’s no transparent market for derivatives and no one really knows how deep that black hole is. That’s going to take some time to work through.

As it has in the past, the U.S. government is reacting to the panic by bailing out the failing institutions. In this case, they are creating as many dollars as possible to keep the world’s largest economy out of a downward spiral.

Like it or not, the moves this week prove that the U.S. government is going to take aggressive action to prop up the system. If Bernanke and Paulson could speak their minds, I’m sure they’d say, “I don’t care if it takes $2 trillion, we’re going to get out of this one way or another.”

What is Happening

So, we’ve got the government bending over backwards here.

The U.S. government has shown its willingness to bail almost everyone out. It has guaranteed the virtually worthless loans created by Countrywide Financial as part of a takeover by Bank of America (NYSE:BAC). It facilitated the takeover of Bear Stearns by JP Morgan Chase (NYSE:JPM). Its latest move has been to essentially buy $85 billion worth of bad debts from AIG (NYSE:AIG). Now, it might even take every penny of bad debt off the books.

On top of that, Bank of America (NYSE:BAC) is set to become a lot more than the Bank of America. By acquiring Merrill Lynch and Countrywide Financial, it will likely become the Bank, Brokerage, Financial Advisor, and Mortgage Lender of America.

That’s good news because we can take the consequences of their actions and turn it into our own profits. But we have to be realistic. As with past financial disasters, where the market excesses had to be eliminated, it’s going to take some time.

What Will Happen

We’re far from out of the woods yet. The current bear market has been a rough one and will likely get worse. But even if it lasts as long as long as the bear market following the crash of 1929 (the longest bear market of the past century), the markets will likely get turned around by mid 2009 or 2010 (hint: watch the unemployment rate, that’s the best economic indicator of them all).

Frankly, I still haven’t recommended a single stock in the financial or housing sectors and I’m not about to. Despite the big rebound over the past two days, bank stocks are still as risky as ever. There will be a chance to buy most of them down the road…most likely at an even lower price. The best thing to do now is prepare for the future. It all hinges on the wild card in all this: the U.S. government. It has already started inflating our way out of this mess just like before.

The 80’s ended with the S&L crisis and real estate crash. The government printed enough money to get out of it.

All those extra dollars eventually led up to the roaring 90’s and dot.com bubble. That bubble was one step higher than the financial turmoil of the late 80’s. To get out of that one, Greenspan slashed rates, created more dollars, and we worked our way out of it.

The current crisis is bigger than both of those and will take just as much time, possibly more.

Inflationary policies have forced the U.S. economy into a cycle of bigger and bigger bubbles. Right now, it looks like the U.S. can probably pull one more rabbit out of the hat. After all, when we’re in a recession, it always feels like “the big one” until we’re about a year out of it. So, as I’ve been recommending for a long time, it’s best to hunker down.

As I’ve been telling my readers since last fall, we should buy very lightly, keep cash on hand, and relish the upcoming opportunity to buy stocks on the cheap.

To be honest, the best thing to do is buy now and buy later. I’ll be buying at regular intervals over the next two years and will surely catch the bottom.

Gold, silver, and oil will likely double (probably triple) over the next few years due to the inflationary impact of the current bailout. With all these new dollars in the world we’re going to have a lot more to spend down the line. Natural gas is probably a quadruple (yes, natural gas will probably hit $30 in the next few years…possibly more depending on how Russia holds up). And I’ll be happily buying stocks in all these sectors over the next two years along with a few other truly great opportunities when the time is right (i.e. Vietnam and Russia).

It’s going to take some time to get out of this and we’ve got to be prepared financially and emotionally. The United States always manages to work out of every hole it digs. There’s no reason not to believe it won’t be able to this time.

It’s never “different this time.”

Just when the markets seem at their absolute worst, it’s time to cautiously buy. After the way this week started, it’s tough to imagine things getting much worse.

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