Prof. Ford,

I just read Mr. Practical's article on debt and credit, How the Bubble Bursts. I appreciated the explanation of the Fed's manipulations of the market. I found the last paragraph most interesting - it's the one I didn't quite understand.

I assume that most investors will have to sell some of their assets to pay off debt; I also assume that this will mean further drops in the market. But that leaves me with some questions:

• Doesn't the liquidation and correction of these bad investments take some time?
• Are stocks really worth holding onto for the next several quarters, while we wait for the market to bounce back?
• Which sectors will be least affected during the credit contractions? (I know it won't be real estate and automotive).

Thanks for your wisdom,
Minyan David


Minyan David,

Glad you liked the piece - I did too. While I'm not Mr. Practical (he's a lot smarter than me and has taught me a ton), I do think I can speak to your questions.

As credit contracts and debt gets wiped clean, stocks will likely decline, perhaps significantly. You mentioned one of the primary reasons for this: Folks will need to pay off their debts and "get liquid."

Many will become increasingly risk-averse, which will make them reluctant to buy stocks - perhaps for a long time. Given that fact, the time horizon you mention may be too short: This deflationary period could last many years (as it did in the U.S. in the 1930s and in Japan in the 1990s).

As for which sectors will power through the crisis, that's really anyone's guess - and I'm not sure that Mr. P would care to speculate on it. Keep in mind that "outperforming" in a bear market may mean "declines less than others.'"

After all, studies show that, during bear markets, at least four in five stocks decline. So, from where I sit, being long anything during a major stock market downturn means that the wind will be in your face, rather than at your back.

For me, this means heeding Mr P's advice about reducing risk and trying to be patient enough to weather the storm.

Easier said than done, I know, and I'm certainly not there yet. But I'm moving in that direction, because I know it's the most prudent move in this unique environment.

Humbly,
-Matt