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Recovery Plan

December 11, 2008 by  


By Bob Wood, MMNS

So here you are, invested in the stock market and nursing big losses, like almost everyone else. Wouldn’t you love to see your investment accounts recover their previous values? With a proper recovery plan in place, there is hope. Without one, you’re flying blind and hoping on a lot of luck.

Where do you begin when formulating a plan to take advantage of a market recovery? Maybe the first question you should ask is, “Who says the stock market must reverse course and head higher?” Investors in Japan, where the home market has remained mired in a slump for nearly two decades, have learned that hard lesson.

Considering America’s current economic fundamentals, with the stock market still selling at a relatively rich level, no law insists that what goes down must, at some point, come back up. Hope for a rebound does exist here, though, even if it would most likely be one of short duration, given the value concerns. Meanwhile, investors are loading up on U.S. Treasury debt, and, as of right now, they’re lending our government, bankrupt in all but official status, money at a yield of just over 3% for 30 years!

Maybe that fact speaks more about how much money is looking for a safe home now, but, at some point, will go searching for a better return. In addition, an estimated $4 trillion is sitting in cash and money market accounts, and that will also eventually go searching for better returns.

So many mutual, hedge and pension fund managers, as well as individual investors, need a rally – desperately! Any sign of an end to all the forced selling from hedge funds will allow investors to return to stocks. History shows that, as a rule, investor sentiment affects the rising or falling of share prices more than the underlying fundamentals.

History also shows that bear market rallies can be wonderful things to experience. Three great examples are the rallies of about 50% to the upside, which were seen in the Japanese market during its 18-year secular bear market.

But lucky investors today need not rely on only one market as they try to catch a meaningful rally. Instead, we can enjoy the options of investing in many markets around the world, as well as in other asset classes — like commodities.

So, what’s the plan? Which markets will you monitor as you seek re-entry into stocks? Or should you be planning to re-allocate your investments with the hope of finding better opportunities for gain?

Before you make that move, creating a written plan can prove invaluable. It will allow you to make rational decisions ahead of time, relieving the pressure of making quick decisions when you are under the duress of possibly being wrong and losing money.

A plan also allows you to set loss limits if you guess wrongly and find yourself losing money again. You can set a limit based on losses of percentage or dollar terms.

The next step would involve selecting your asset allocations and markets or asset classes where you’ll focus your investing. This is where the plan gets complicated. Easier to do is simply building a diversified portfolio using index funds and figuring that, given today’s highly correlated markets, all ships will rise, once a recovery begins.

That method may well prove as useful as any other, since we know that there is much we cannot know in advance! Thinking that we have predictive power to foretell what the markets will do is not a viable option.

With that said, it is up to you to decide on your allocation set, and just as important, the position size for each holding. And here is where you might want to consider doing the unusual thing. And here’s where I insert my usual disclaimer telling you that whichever way you decide to go, you’re on your own!

What follows is a set of suggestions formulated by someone much smarter than I am, John Maynard Keynes, the famed economist of yore. To get a better idea of how his set of rules was devised and how to implement them, I strongly suggest that you read the same book that I read about them. That book, Keynes and the Markets written by Justyn Walsh, is a new release.

About 170 pages long, the book could well have been much shorter, given how it all boils down to Keynes’ method for investing. However, the book includes a nice story about his ups and downs in the markets, leading up to his set of rules, and shows what motivated him to search for a better way to invest.

I wish that someone had given me a condensed version of the book and saved me the time of reading all the preliminary information. So, if you’re like me, you’ll appreciate this condensed version.

In a nutshell, Keynes’ method can be broken down into six basic rules. And, as the noted investor used them, he did well during the 1930s bear market in stocks — during the Depression;

1. Focus on the estimated intrinsic value of a stock, as represented by the projected earnings of the particular security, rather than attempt to divine market trends.

2. Ensure that a sufficiently large margin of safety – the difference between a stock’s assessed intrinsic value and the price – exists in respect of purchased stocks.

3. Apply independent judgment in valuing stocks, which may often imply a contrarian investment policy.

4. Limit transaction costs and ignore distractions of constant price quotation by maintaining a steadfast holding of stocks.

5. Practice a policy of portfolio concentration by committing relatively large sums of capital to stock market ‘’stunners.’’

6. Maintain the appropriate temperament by balancing ‘’equanimity and patience’’ with the ability to act decisively.

So there it is, though, of course, there is much to discover in how each of those rules should be implemented. And an additional burden must be borne by each investor in applying his or her own rigorous estimation of a stock’s worth. This is something that’s hard to do, for most professionals and individual investors alike.

I appreciate the fact that Keynes used this method to invest his own money, with the associated risk of loss. However, he ignored the concept of hedging, which is a valuable consideration in today’s hyperactive markets.

Yes, he left it for us, this one set of instructions for anyone with the confidence to manage his own investments and willing to accept responsibility for his own results. Considering how far world markets have fallen, plenty of great shares are now available to consider for purchase.

But, of course, be careful. The current market environment is one of the most treacherous of all time. And consider waiting until the environment calms down before embarking on such an aggressive strategy.

Have a great week.
Bob

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

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