No two financial crises are exactly the same. There are times to be an observer, watching from the sidelines. And there are times to act.
A week ago Monday, when the Dow Jones Industrial Average plunged 777.68 points, the Nasdaq Composite dropped through my latest buying target, which was 2025. So I stepped in with a list of banking stocks and did some buying. The next day the market rallied, rising above the 2025 threshold. I was pleased by gains in my recent purchases, but hardly euphoric. By Thursday the Nasdaq was below the threshold. My gains were wiped out. On Monday, the index dropped so much that it was time to begin thinking of the next buying threshold, which is 1750.
So why am I buying when the market is plunging? When we're in the worst financial crisis of my lifetime? The answer is simple: That's when stocks are cheap.
Regular readers know that I follow a disciplined system of buying on 10% declines in the Nasdaq, and selling at intervals of 25% gains. These are based on historical averages for corrections (an average 20% decline) and bull markets (an average 50% gain.) The goal is simple: Buy lower and sell higher.
I never try to predict where the market is headed next. This is obviously a long-term approach intended for patient investors like myself. It's important to distinguish this thinking from that of a trader, for whom a day is long term, and months, an eternity. Much as I respect my good friend Jim Cramer of "Mad Money" and enjoy his show on CNBC, we are fundamentally different in this regard. Mr. Cramer recently said that money you need in the next five years should be pulled out of the stock market. I'd say that money with a five-year horizon or less never should have been in the stock market in the first place.
The time to sell isn't now, with the Dow industrials hitting five-year lows. It was last year, with the industrials hitting records. As I said at the end of April 2007, with the Nasdaq above 2515 (my then selling target), selling opportunities "don't happen all that often, and ... are especially satisfying." I sold Goldman Sachs at $250 a share (though I still own some). I cashed out of energy and commodities in May. This is why I have the liquidity to buy now.
That was then. There's no point in bemoaning any failure to act when times were good. The important thing is to take advantage of opportunities now. The last two buying opportunities came quite close together in January, when the market entered bear territory. This past week marks the third 10% decline without an intervening 25% rally, the first time that has happened since the bear market that began in 2000.
With benefit of hindsight, I would have waited to buy, but no one has the benefit of hindsight. Back in 2000-02, when the Nasdaq dropped more than 80%, affording eight consecutive buying opportunities, I followed this system. The purchases made when things looked their worst ended up being the most profitable.
I'm hardly alone in this approach. Surely you've noticed that someone else has been on the prowl for bargains: Warren Buffett. True, Mr. Buffett is getting high-yielding preferred stock and warrants on terms that I can only dream of. As a stabilizing force he's being compared to legendary financier J.P. Morgan.
In my own extremely modest way, I'm supplying liquidity for people who want to cash out. When people I know are pulling cash from bank accounts and putting it somewhere they consider "safe," like a cookie jar, I'm saying I still believe in the system. I credit my late father for this approach, who grew up in the Depression and never lost faith in the U.S. economy or stock market. To those who accuse me of soft-hearted idealism, I can say only that it has paid off over two generations.
James B. Stewart, a columnist for SmartMoney magazine and SmartMoney.com, writes weekly about his personal investing strategy. Unlike Dow Jones reporters, he may have positions in the stocks he writes about. For his past columns, see:www.smartmoney.com/commonsense.
