Draw up Your Game Plan for the Rest of 2011

by Daniel Putnam | August 9, 2011 9:16 am

Recent events indicate that the markets have entered a phase that is sure to challenge even the most battle-hardened investors. Simply picking good companies with compelling valuations isn’t going to cut it at this point. Instead, investors need to adopt a survivalist mentality and strategy geared toward making it through the rest of this year in one piece. At the same time, however, a focus on capital preservation doesn’t mean you should ignore the multitude of trading opportunities that can arise in a volatile market.

With this in mind, here are a few considerations that may help you survive this downturn and possibly even make some money along the way:

Avoid Companies With Warts, No Matter What the P/E

Distressed investments, turnaround stories and undervalued market leaders always seem to be compelling ideas on the surface — and I’ve been guilty of recommending my share of them in recent weeks. However, any stock with underlying challenges is going to face a tough road now that the market environment has turned sour.

Prime examples are shipping stocks, major banks and weaker retailers. These sectors are sure to present their share of dead-cat bounces in the months ahead, but the odds are better if you restrict your trading/investment list to stocks with only the strongest fundamentals. In short, if you’re leaning toward Best Buy (NYSE:BBY[1]), think Amazon.com (NASDAQ:AMZN[2]) instead. Now more than ever, the old adage “If you wouldn’t want to own it for a year, you shouldn’t own it for a day” is especially relevant.

Recognize a Trading Environment for What It Is

Long-term investing is a great concept on paper, but we’re now in a phase where rallies are likely to meet selling pressure in fairly short order. With the market likely to be weighed down indefinitely by this “crisis of governments,” now isn’t the time to be greedy. This means:

1. Take profits quickly on any rallies.
2. Be even more vigilant than usual about protecting yourself with stops.
3. Keep your positions smaller than normal.
4. Maintain cash on hand to capitalize on a final washout.
5. Wait for evidence of stabilization before buying; there’s absolutely no need to try catching the falling knife here.

Be Ready for the Turn

While the priority right now is limiting losses, the flip side is that an overly cautious strategy might result in missed opportunities. A number of signs now indicate that a trading bottom is approaching. Most notably, technical indicators are massively oversold and the stock market has become the lead story on non-financial news outlets.

This indicates it’s time to prepare the buy list if you haven’t already. A counter-trend rally is likely to bring some of the biggest moves in sectors that you would least want to own with the global economy teetering on the brink of a recession — coal, raw materials, steel, etc. — since this is where the worst destruction has occurred thus far. An incredible number of stocks in these areas are off 30% to 50% just in the past two weeks, meaning an investor willing to bottom-fish in fundamentally sound names may be able to capture some substantial upside.

While there is no shortage of stocks being obliterated right now, a few that stand out as being particularly oversold are: Walter Energy (NYSE:WLT[3]), down 46.1% in the 10 sessions through Monday; AK Steel (NYSE:AKS[4]), -49.7%; Patriot Coal (NYSE:PCX[5]), -41.8%; and Cliffs Natural Resources (NYSE:CLF[6]), -31.0%.

Emerging-market stocks also have disintegrated in the past two weeks, and most have fallen more than their U.S.-based counterparts. No surprise here — underperformance for the emerging markets is par for the course at a time of heightened investor risk aversion. Still, it’s important to keep in mind that this isn’t 1998. Many emerging-market economies feature stronger growth, better fiscal management and substantially lower debt-to-GDP ratios than the United States or the peripheral European countries.

Nevertheless, the iShares MSCI Emerging Markets Index Fund (NYSE:EEM[7]) is off 17.9% in the past 10 sessions, trailing the 16.1% decline in the SPDR S&P 500 ETF Trust (NYSE:SPY[8]). It therefore might pay to investigate emerging-market alternatives to the U.S. stocks that currently are on your buy list.

This summer has been a dark time not just for the financial markets, but for the country as a whole. The good news (for investors) is that trading opportunities should abound in the weeks and months ahead. Succeeding in this environment will be an epic challenge, but the guidelines above should provide a good start toward making the most of this difficult situation.

Source URL: https://investorplace.com/2011/08/volatile-market-investing-strategy/

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