Stock Market Panic

Stock Market Panic: Lessons Learned When the Market Drops & A Fund Buying Opportunity

by Dr. Mark Skousen, Chairman, Investment U
March 5, 2007: Issue #647

“Everyone is a long-term buyer until the market goes down.”
~ Steve Forbes

“Be greedy when others are fearful.”
~ Warren Buffett, 2007 Annual Report to Shareholders “Last week, when world markets tumbled sharply for the first time in four years, I was fortunate to be in London, the world’s most international city. For two decades, I’ve made it a point to come here every year to find out what the world’s gurus are thinking – to get a different perspective from the domestic crowd.

To the two great quotes above, let me add my own: “The best lessons are learned when the market goes down.

This time, I was invited to give a lecture at Cambridge University on Ben Franklin. I also had lunch with several top financial experts at the Adam Smith Institute.

Here is their assessment of last week’s stock market panic…

1. China matters. This is the first time that a sharp selloff in the Shanghai market has rippled its effect throughout the world, reaching Wall Street. China is now a big player, and cannot be ignored in the financial markets. Here at Investment U, the Asian boom is an essential part of our outlook on the global economy and investment recommendations.

2. Good investments fall with the bad during a selloff. Some investors were surprised that gold fell during last week’s crisis. “Isn’t gold a refuge?” they asked. Not really. The problem is that when there’s a big stock market panic, investors often have to raise cash to pay off margin accounts, and that causes them to sell good stocks and commodities, including gold.

3. Watch interest rates to determine the outlook for the stock market. If bonds fall in price along with stocks, watch out below – we’re headed for serious trouble. But if bonds rally and interest rates decline, it usually means that we are only going through a market correction, and smart investors should take this opportunity to buy, not sell.

4. Maintain protective stop orders, just in case you are wrong. Never underestimate the power of the market to go contrary to your own thinking. Always establish stop orders, and trailing stops, to preserve profits. In last week’s selloff, for example, we hit several of our stops, locking in some good profits while building a cash position to buy back in at lower prices.

5. Income investing is still a good place to be in today’s uncertain markets. Recent studies by Jeremy Siegel (Wharton School) and other experts have shown that dividend-paying stocks and high-interest bonds have outperformed the markets with less risk, especially since 2000.

6. It pays to diversify. In my talk at Cambridge University on “Ben Franklin, Father of American Capitalism,” I told the story of the time in 1772 when London suffered a “general wreck of credit” when several banks failed. Investors everywhere lost their shirts in the ensuing market panic, but not Franklin. He noted that he was out of debt and out of danger, and he was well diversified into secured bonds with good companies, bank accounts in three countries, and 6 to 7 rental properties that continued to pay him steady income.

My London experts, including money manager Nicholas Vardy, confirmed my own sense of the world markets: Corporate profit rates are not sustainable at these high double-digit levels. We may well be entering a slowdown, but none of them see an outright recession on the horizon.

The next month will present a good buying opportunity for stocks, both here and abroad, especially with long-term interest rates coming down or holding steady.

My favorite choice is the WisdomTree International 100 Dividend Fund (NYSE: DOO), an exchange-traded fund that invests in the top 100 dividend-paying stocks around the world.

Good investing,

Mark

Today’s Investmentu U Crib Sheet

Excluding dividends, the Wisdom Tree International 100 Dividend Fund had climbed 24% since its launch in June, including last week’s pullback. The S&P 500 is up 11% over the same period. Here’s how to build a complete high-yield portfolio.

A properly diversified portfolio will generate the highest overall returns, no matter what the stock market does in the short run. But what is “proper” diversification, exactly?

Seven years ago, you could have “diversified” into Microsoft, Intel, Yahoo and Amazon.com and gone right off the cliff.

Asset allocation refers to spreading your investments among different asset classes, not just different securities or market sectors. For example

Over the last 7 years, Oxford Club members have invested in high-grade bonds. When the stock market went down, these went up. They’ve also generated positive returns in real estate investment trusts (REITs), inflation-adjusted treasuries and precious metals.

Below is the Oxford Asset Allocation Model, based on the investment formula that won Dr. Harold Markowitz the Nobel Prize in finance in 1990. His paper promising “portfolio optimization through means variance analysis” demonstrates how you can maximize your profits and minimize your risk by properly asset allocating and rebalancing your portfolio.

Learn more about the Club here.

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