Playing the Market Among Economic Concerns
By Quint Tatro Dec 17, 2007 9:45 am
It is extremely important during a time like this for an individual to be extremely pro-active and take initiative.
Investors can be easily overwhelmed with all that is going on within the financial world and the broad economic landscape. There are times in life when looking at these matters is like staring at the Mona Lisa; simple, clean, and easily understood. There are other times, however, such as now, where looking out over the landscape is like staring at a Salvador Dali and asking yourself just what is going on. Lines and shapes run together while everyday objects melt or bend as if being warped by some unknown force. It is very easy for an investor to chalk up the fears and uncertainty facing our economy to housing however that is just a start. Furthermore, regardless of what is going on out there, it is the investor's job to navigate the choppy waters regardless and having a plan of action is a must.
What's the Real Deal?
I don't think any would argue that the economic concerns facing the US started with the housing bubble, however all economies are cyclical and regardless of what the catalyst was this time around, investors can take refuge in the fact that normal ups and downs are all part of the bigger picture. The housing bubble can be summarized very simply and you had to be living under a rock not to 'feel' the irrational exuberance. Everyone bought a home, many bought two and still others bought three or more. The moons aligned so that the American dream was available to everyone and once the feeding frenzy started, it quickly ballooned.
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Exotic mortgages were the icing on the cake as people who would have not been able to afford a home under conventional means of financing, were now able to buy due to a low mortgage payment based on a fluctuating interest rate. Everything went along just fine until the interest rates started to reset and many could no longer afford the payment. It may have been 'contained' if that was as far as it went however, mortgages are bought and sold and is where the painting gets a little fuzzy. Mortgages of all shapes and sizes were combined into big pools of investments, and then resold to other institutions again and again. Not only did sellers make money off the difference in interest rates, but buyers used the new pool of mortgages as collateral to borrow more funds for themselves.
It can be dissected much more than this however the simple way to understand it is that banks traded these pools of mortgages between each other as a means of normal financing. They were then resold to other entities such as municipalities, corporations or individuals as a normal interest baring security. It was all fine and dandy until the music stopped. The initial step which made the whole process work was the home owner, who started to see interest rates rise on mortgages and couldn't meet the payments. All of a sudden defaults started to set in which caused a chain reaction throughout the system resulting in a freeze of lending between banks. Unfortunately, this normal lending is an everyday part of a bank's business and in order to keep the general financial system going, must be done.
Now that you know what the 'Credit Crunch' is, which was sparked by the 'Mortgage Mess' there are a few other concerns the economy is grappling with, which centers around the consumer. America is a country built upon excess which keeps not only our domestic businesses going, but also the foreign countries that manufacture much of what we consume. The jury is still out if the downturn in housing or the rise in oil has hit the consumer enough to slow spending. If and when the US consumer slows down or becomes stagnate the result would be felt worldwide. It is why all eyes are on employment data as the common belief is that if people are still employed, they will still buy. No one is sure how it will play out however a glance at a few retail stocks such as Sears Holding (SHLD), Wal-Mart (WMT) and Circuit City (CC) will show you which way so many investors are betting.
What to Do?
Knowing the details doesn't change the fact that so many are still investing in the markets and are relying on growth and income to secure their financial future and is why having a plan in place a must.
Identify your Time Frame
Since the beginning of civilization, economies have been cyclical. Understanding this is half the battle. When looking at your investment dollars, an individual should always first determine when the money will be needed. This sets the stage for what vehicles to use throughout your journey. An individual, who needs their capital within the next five years, should be seeking the safest possible return with the highest yield. This has become tricky since interest rates have steadily declined however there are still very attractive yields being found within the municipal and corporate bond arena if a person is willing to search for it.
For those with a time frame of the next 5-10 years, a balanced approach to capital appreciation is important and large established companies such as General Electric (GE), US Steel (X) and Alcoa (AA) are positioned very well to capitalize on future global growth. An individual may also consider adding a few growth companies that typically do well regardless of the economy. Current favorites include Apple (AAPL), Research in Motion (RIMM) or Intuitive Surgical (ISRG) however for the passive investor I always favor using low cost Exchange Traded Funds (ETFs) or indexed mutual funds to accomplish this goal.
Finally, for those with at least a 10 year time frame, they should be focusing on the longer-term growth of their portfolio adding a combination of larger capitalized companies with other areas such as small growth companies or niche sectors such as alternative energy or biotechnology. In this case, I always suggest an individual utilize a fund rather than picking their own stocks. Diversifying through international investing is also important and one should consider exploring this option also through a low cost fund.
Irrational activity is and will always be what swings the pendulum to extremes in one direction or the other. Investors should remain calm and seek to profit from these swings. While the financial markets remain in flux, there is a high probability a company like Citigroup (C) will not go out of business. Knowing just where a bottom is in stock like this is impossible however a patient investor may consider wading in very slowly and methodically if it correlates with their time frame and risk tolerance. Ultimately, these companies will work through these issues and their stocks will reemerge and move higher. Those that remain calm and take the opportunity to start moving in very slow, will do exceptionally well over the next 10 years.
It is very easy to remain frozen during a time like this and cling onto 'hope.' It is that same frozen fear that will keep an individual from recognizing their goals. It is extremely important during a time like this for an individual to be extremely pro-active and take initiative. It is during these times of chaos where those with formulated plans are victorious. Put a plan in place that fits your needs, execute with intense focus and enjoy your results in the future.
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