March 2, 2007
Mind The Gaps!
And keep your portfolio ready for bear
By Brady Willett

Last week was the most interesting in more than four years.  This was the case not only because global stock prices became more attractively priced, but also because investor sentiment may seriously be impacted going forward. In other words, unlike much of the last 4-years – wherein investors increasingly took on more risk in the hunt for returns – last week may have marked the turning point in the opposite direction. The story goes that as investors become more fearful it is time to get greedy – the hope is that this story is now playing out as it did from 2000-2002 (which was an excellent time to make equity investments!)

Investors, or to be more precise fund managers, initially responded to the sell off in the marketplace last week by purchasing shares in companies that had ‘defensive’ qualities (or companies likely to outperform during a recession and/or bear market). However, the influx of capital into these types of stocks proved fleeting as the sell off grew more widespread.

What also made the week very interesting is that selling intensified further on Friday.  In the case of BUD, it closed at its weakest level at the closing bell, which could mean that selling pressures are building rather than abating. 



* Before going any further it should be made perfectly clear that one week does not a trend make.  Quite frankly, there is the possibility that stocks will rebound strongly next week. The following speculations are not a recommendation to short stocks or devote cash to solid companies.

With that out of the way, here are five issues that followed the BUD trend – or shares that opened more stable than most stocks early on Tuesday (BLUE), had succumbed to selling pressures by late Tuesday (RED), and failed to consolidate and struck weekly lows on Friday (Green Circle is weekly low). 


Two defensive issues bucking the above trend – and which could be worth keeping mind during the next min-crash – were Altria and Hawain Electric.  These stocks were able to successfully consolidate after Tuesday’s dump and both have attractive long-term investment qualities.




After this onslaught of charts you may be wondering why any of the above companies are ‘defensive’.  After all, none of them gained on the week.  Here is why: NO GAP!




The company’s that gaped lower last Tuesday were not necessarily ones that are not attractive from a long-term investment standpoint, but they were, in more cases than not, companies that have deeply rooted cyclical qualities.  Given valuation considerations, that the bear is stirring and a recession could be around the corner, it is difficult to be heavily involved in these types of cyclical stocks at this time.

Planning For Bear

Tuesday’s blow-out day in the equity markets was blamed on an assassination attempt against Cheney, the nearly 10% mini-crash in China’s market, spreading subprime fears, computer errors, Greenspan, etc.  Suffice to say, after nearly four years of ‘investors take on more risk!’, the list of topics worthy of discussion has quickly become seemingly infinite. Here are ten quick questions that gained more importance last week and deserve some attention.


But alas, investing is all about time and cash management, and the value investors that have been asleep since late 2004 need to forget about macro questions and get their gear ready to start fishing. What does this entail?

-- Know what you are going to do (i.e. dollar cost average or panic?) with any of your holdings if they fall by 5%, 10%, or more.
 
-- Find and monitor companies you want to purchase for the long-term and set buy targets, and, to reiterate, know before you purchase these companies what you would do if prices fall by 5%, 10%, or more.

-- Keep some cash in the vault because when the bear does return you will have ample opportunity to effectively put it to use.

I apologize if I am preaching to the converted, but I think it is important to point our that there was no magic investment strategy last week and there is unlikely to be one during the next bear.  Rather, investors have taken on more risk for a long-time and as this trend reverses - as it inevitably will - there is no one perfect area of the marketplace to be.

Incidentally, some would argue that precious metals, dividend stocks, or Euros are safe havens.  Perhaps. But perhaps also long-term thinking and planning are the only way to avoid serious setbacks.  For example, being a goldbug myself, last weeks plunge in precious metals was disappointing, but I am fully aware than unless gold can make the jump from inflation hedge to crisis hedge even more serious setbacks could be ahead.

Deploying longer-term thinking, I have some plans today - one being to purchase more shares of Brown-Forman if they fall below $60/share. While the ideas are coming fast and furious (i.e. MO and HE are two to watch during the next serious sell off) purchasing BF at or below $60/share is one platform that I already have set in stone. In other words, if the DJIA crashes by 15% Monday morning and investors in serious panic mode, I buy more BF (if it goes below $60) and sleep very well at night. 

In short, the key difference between the 2000 bear market and the next bear market is that in 2000 you could have parked some capital in high yielding stocks while the tech/internet crowd panicked. Today the only safe area to be heavy in is cash.

Have a great weekend.

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