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It’s a Set Up!

August 23, 2007 by  


By Bob Wood, Muslim Media News Service (MMNS)

By the time you read this column, the domestic stock market may have taken a rather severe beating. I include the possibility of a full fledged market crash, at worst, but not much of anything for a best-case scenario. But from adversity, we can sometimes find opportunity. And I believe we will find some wonderful opportunities to take for our advantage. Some great investments are now in the making.

Now, before you become too eager, bear in mind that the best bargains may well be unsafe to load up on for several more weeks, if not months! Keep in mind how the bear market cycle of 2000 to 2003 played out. The market broke from its highs in March of 2000, with the eventual bottom not seen until early 2003.

Only at the end of that bear cycle was it safe for investors to wade back into the markets. Along the way, lower prices were available for stocks on buy lists of opportunistic investors, but those prices steadily fell even further as other investors became ever more discouraged and sold to avoid further losses.

I am as positive as I can be that recent market turmoil is just the beginning of the new bear market cycle, or, more likely, the resumption of the secular bear market that began in early 2000. That the S&P 500 sits at a lower level now than its bull market top in early 2000 is a great clue!

You may have noticed that when domestic stock markets fall, the international and emerging markets tend to fall even faster. That fact any investor now loaded up on the long side with those more volatile stocks and funds knows well.

Commonly accepted investing tenets teach that international and emerging markets are considered more volatile investments, based on past performance. And that concept becomes a self-fulfilling prophesy as investors sell first what they have heard are riskier stocks and funds.

What amazes me is that so few investors take time to consider the vastly superior economic fundamentals offered in many foreign markets. Our country’s ultra-loose lending standards for housing and other forms of credit do not exist in most places, excluding Australia, Spain and the U.K., and are not responsible for giving the illusion of their strong economies.

On the other hand, countries like Brazil, Russia, China and Taiwan are doing great business by exporting manufactured goods, energy and other commodities. They are also paying down their external debts, while here, we are taking on so much debt that David Walker, Comptroller General of the United States, compares us to the Roman Empire. He talks about the end of this empire, not the onset of it!

The bursting of the U.S. housing bubble is causing shock waves in the financial markets. And who ever would have thought that money market mutual funds would be blowing up? Many of these occurrences are attributable to the immense amount of fraudulent activity perpetrated by banks and brokers who sold junk bonds to buyers, led to believe they were getting investment-grade debt.

Of course, this debt debacle is just beginning. Huge amounts of mortgage debt soon will be reset to higher interest rates. A large bulge of mortgage debt is scheduled to reset, starting in October of this year and lasting well into next spring. I fully expect more market volatility, at least for that long, as financial markets come to grips with rising defaults.

As domestic markets reel from the realization that this bubble’s bursting will be the most painful one yet, my favorite international and emerging markets shares should see selling that belies their underlying economic fundamentals, as they benefit from leaders who use sane fiscal and economic policies.

Bargains in the international markets are already becoming available. For those not philosophically opposed to owning bonds, some closed-end funds that invest in international government bonds look awfully tempting. In fact, having held them for the past couple years, I am currently enduring an unexpected amount of volatility for bond funds.

Shares of the Alliance Bernstein Global High Income (AWF) fund appear to offer a stellar investing opportunity. With a yield quoted at almost 9%, the fund sells for an almost unbelievable 17% discount to its NAV (as of today, 8-17). Best of all, the fund pays its dividends in foreign currencies, which add a potential hedge against the falling dollar, now enduring a 90-year trend of lost value. Volatility notwithstanding, I added a little of this one to client accounts this past week.

Equally attractive are shares of the Western Asset Emerging Markets Debt Fund (ESD), with a yield close to 8% and a discount to NAV of almost 17%. I’m not as concerned as others with the volatility of these funds. I see a sufficient margin of safety offered by both of these offerings (to do more research, go to www.etfconnect.com ).

For those who prefer investing in equities, other great investments are becoming available. Asian economies are growing stronger by exporting manufactured goods, and some economies are benefiting from the economic progress of China. Interested investors can buy a basket of such stocks managed by one of today’s best emerging markets fund managers, Mark Mobius. The Templeton Dragon Fund (TDF), for example, sells at a discount to its NAV of about 15%. The average P/E for several stock markets in Asia are lower than the P/E of our domestic markets, and the high rates of personal savings in those economies offer an added reason for optimism.

For those wishing to invest in the growing economic picture seen in India, consider two great options — when our markets finally calm down. I believe that turmoil in U.S. markets is just beginning and will last for months to come, affecting these funds that invest half a world away.

As of mid-August, the Morgan Stanley India Investment Fund (IIF) is selling at a discount to NAV of nearly 15%; it invests in the local market, enabling the manager to buy stocks not offered here. A closely related offering, The India Fund (IFN) now sports a discount of about 11%.

Investors like me who see a bright future in the energy sector could consider buying shares in the Petroleum and Resources Fund (PEO), which manages a portfolio of energy related companies. This fund can be bought currently at a discount close to 10% of its underlying value, and many energy stocks sell at P/E multiples lower than the overall market average.

Others exist, of course, but I think we have plenty of time to jump into them. They may be available at even lower prices as our stock market moves lower in the coming weeks, which, I think, is a fair possibility.

In the meantime, while many investors lose money, as so many do in bear markets, you may choose to avoid the stock markets altogether until this turmoil settles out. Or you could take steps to “hedge” your stock market exposure using bear market mutual funds like the Prudent Bear Fund (BEARX), a managed bear-market fund. Shares in the Rydex OTC Inverse Fund (RYAIX) benefit from a falling Nasdaq 100, and shares in ProFunds Ultra Short Emerging markets Inverse Fund (UVPIX) offer protection against losses in that sector. The latter is a leveraged fund, so smaller doses are recommended. I use all three in client accounts to offer protection from losses and also profit potential in a bear market.

Investors do not need only rising markets to profit from their efforts. Bear markets offer different opportunities, but acceptable gains are possible. Bear markets certainly look different than bull markets, but, if the domestic secular bear market that began more than seven years ago is about to endure another leg down, investors need to look for opportunities in different places.

Those opportunities will be there. But it’s up to you to find them and the nerve to invest in them when others are looking for shelter from losses. Bear markets set up opportunities for the sharp-eyed investor. They’re popping up now, and more are coming. Look for them while the crowd heads for cover. But be patient!

Have a great week.
Bob

Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., invest@muslimobserver.com.

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