Dear IDE Reader,

Overseas markets down 10 percent. Dow Futures down more than 500 points. Fed cuts rates by 75 basis points in a surprise move. Market rebounds powerfully off its session lows.

It's been quite a day. But it's probably left you with quite a hangover.

So what should you do now? Buy? Sell? Sit tight?

I've asked our IDE editors to put together some brief thoughts on where we stand and what you should do moving forward. I think you'll find some common themes running through these thoughts that should be very helpful in your investing.

As always, I wish you all the best with your investing.

MaryEllen Tribby
Publisher
Investor’s Daily Edge

Andrew Gordon -

The worst thing you could do is jump off this fast-moving train.  Where are you going to land anyway?  Into Treasuries that are going to have a heck of a time keeping up with the rate of inflation?  You don’t want to do that.

The bad news is the market has a ways to go before hitting bottom.  On the other hand, the market is oversold and will bounce up sooner rather than later.  It’ll be a chance to do some pruning, lock in some gains, and increase your holdings in gold and some anti-recessionary stocks such as consumer staples.  I also like some overseas opportunities that are taking advantage of special growth opportunities (more or less divorced from what is happening here) – tobacco in China and auto in India come to mind.

Chris Johnson –

Hedges on the market (protective puts and inverse ETFs) should serve their purpose this week.  We will likely see some speculative buying on this morning’s large dip and possibly a few signs of a short-term bottom.  If so, these hedges should be liquidated to create additional cash for dollar-cost averaging back into stocks as the market declines.

Similar to the selling after the market opened on September 17, 2001, I expect to see some buying interest, especially after the FOMC dropped a 75 bp cut on us this morning.  This should cause short sellers to step into the market to cover positions.  After that, investors should still line up to sell stocks, as the fear they felt over the weekend is not likely to dissipate with this simple move.  For now, I continue to recommend cash and defensive positions.

Lynn Carpenter -

What’s going on now is not a “correction” to irrational exuberance.  It is a fundamental lack of faith.  That means it could seek extreme lows and keep going until the fear is out of the marketplace.  When is that?  It’s when all the weak investors go home and the knowledgeable, sensible, long-term smart money has the market to itself.  Investors will be fine after the bear is done, whenever that is.

The first thing I would do in this market is take out any money I needed to use in the next five years.  It never belonged in stocks in the first place.  Second, I would review my portfolio to be sure I weeded out poor companies.  Then I would target some of my best choices for additional buying.  Do that before you venture into new investments.  Then, look for other companies you want to own at cheap prices.  Then wait.  You just need good nerves and time.  And keep on buying as the market drops.  Bear markets strongly favor long-term, active investors.

Rick Pendergraft –

The best advice I can give is to remain calm.  Don’t panic and act on emotion.  Those who remain calm when others are panicking will fare much better.  At the same time, you don’t want to dive in headfirst, going long everything in sight.

Stay away from financial stocks, as the credit problems have not totally played out yet.  There are a huge number of earnings reports still due out this week.  And so far, with the exception of Intel, non-financial companies have fared OK this quarter.  IBM beat handily and GE met expectations.  So, look for stocks outside the financial sector that have been performing well over the past few quarters.

Rusty McDougal –

I see all the current financial and economic chaos as friendly to gold and precious metals in the long run.  The emphasis here is on the long run, because most anything can happen short term.

We are in a liquidity crunch, and many positions will be sold off directly in contrast to company fundamentals.  Buying opportunities will present themselves accordingly.  Putting out the current fire with bailouts and money "stimuli" directly impacts the dollar negatively and gold positively.

Charles Delvalle –

The government will try everything to avert this drop.  That means cutting interest rates, making agreements with other banks, and giving tax refunds.  But they won’t be able to solve this problem.  Government intervention never does.

All intervention will do is suppress some of the nastier affects of this slowdown, while at the same time prolonging it.  But the thing is, this recession won’t be stopped by these short-term actions.  The economy needs a good amount of restructuring done in order to wipe out some of the over-investment and re-allocate it into other parts of the economy.

Andy Carpenter –

Huge stocks market drops like the ones we’re experiencing are usually accompanied by small bounces here and there.  The trick for you now is not to obsess.  Don’t get caught up in the media and blogosphere hyperbole … and there will be a ton of it because there are millions of investors who’ve never experienced a bear market.  These neophytes think stocks only go up, and they will be desperate for a bottom that may be months away.  Their fears and tears will fuel media stories that you simply must ignore.

But it’s a great time to ask your inner investor what a bear market means to you.  If the answer is not “opportunity,” then you likely have near-term financial goals that shouldn’t rely on the stock markets.  Opportunity in Asia will mean real buys in infrastructure stocks.  They may get punished, but they won’t get pounded like other sectors will.  These are companies that make construction machinery, build roads, tunnels and hydroelectric plants, as well as trucking companies and railroads.  Finally, the current markets should motivate you to dump some losers you have been too emotional or stubborn to sell.

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Recession, Inflation, Rocks,
Hard Places and Little White Lies

	Lynn Carpenter

A good recession is like a good marriage.  You don’t know the truth of it until you’ve put some time in.  It will be summer before we know whether this winter’s discontent qualifies as the start of a recession.  But odds are this is the real deal because the right catalysts are definitely in place. 

So then what?

If you are worried about losing your job, recession is something to scare you.  But for most of us, it’s just a passing nuisance.  In the United States we’ve had nine of the things since World War II, and only two of them were particularly bad.  The interesting thing about those two recessions is that the Federal Reserve purposely engineered them to put a stop to raging inflation.  The worst of these recessions - from 1973-1975 - knocked 4.9 percent off the GDP.

Or was it the worst?  Unemployment reached nine percent that time.  But in the “milder” 1981-1982 recession, unemployment was worse.  It got to nearly 11 percent.  But fewer industries were hit.

Now we come to rocks and hard places.  It’s why the Fed had to make the situation worse to make it better in the 1970s and 1980s recessions, because inflation is much scarier to government than recession.  Inflation and recession call for opposite strategies.  But if both threaten, the Fed must choose its poison.

If there’s a recession, the Fed can move to head it off by increasing liquidity.  Meaning, among other things, lowering interest rates.

That’s the opposite of the main strategy for halting inflation.  With inflation, the Fed wants to slow down spending, so it raises interest rates to discourage borrowing and spending.

Now we have a problem.  With the current mortgage market crisis, lenders are sitting on their checkbooks.  Liquidity is dry.  Recession seems to be lurking.  The Fed has been tepidly trying to lower interest rates and get borrowers and lenders moving again.  And that would be a simple problem with a simple fix if recession were the only thing the Fed had to worry about.

But now inflation has cast its shadow as well.

And I am here to tell you that this inflation is considerably worse than your local newspaper - or even the mighty Wall Street Journal - is going to tell you.

We are between a rock and hard place, and the Fed is depending on some nice little white lies to keep everyone calm.  What lie?  The consumer price index … it’s wrong, but not in the ways you’ve been told.

Government’s inflation figures are fairy tales.  You know something doesn’t seem right about the numbers.  From 2000 through 2007, annual inflation cost us a cumulative 23.5 percent, according to the government.  Total. 

But if you do the grocery shopping, you know that’s wrong.  The groceries you bought for $100 in 2000 can’t be had for a mere $123 today.  By the government’s own data, oranges are up 70 percent, while eggs are 60 percent higher.  And beyond the grocery cart, gasoline was up 132 percent at the end of 2007, and medical care had risen more than 40 percent.  Health insurance - not on the CPI price list - has gone up even more.

This sounds more like reality.  An average family is not moderately challenged by inflation.  It is severely tested.  So how does the government get such tame results with valid numbers?

The final CPI number is a composite of many costs.  But among them, food, energy and medical costs come to only one-fourth of the CPI’s weight.

Tell that to an average family.  Their food and energy came to a third of their budget.  And that’s before adding medical costs.  That’s before subtracting for childcare.

So every time the CPI supposedly goes up one lousy percent, the real kick is much harder.

“Core” inflation is even more skewed.  It backs out food and energy costs on the ground that they are too volatile, and policy shouldn’t center on them.

We know the truth.  It’s an inflationary world out there. And only two groups of people beat inflation.  The first is active workers who are advancing in careers and getting raises faster than inflation catches up with them.  That doesn’t help for established people or retirees.

The second group is investors. We’ll take S&P data from 1926 to 2006.  In that time, bonds averaged 4.86 percent per year. Inflation averaged 3.04 percent. So bonds beat inflation slightly…before taxes. After taxes? Not by much.

Stocks, however, averaged 10.5 percent, more than twice the inflation rate.

The CPI is a charade. Bonds are boring and barely preserve money rather than grow it. It’s stocks you need for the real world. And though they may lose money some years, the same S&P study found that they never lost in any long-term (20-year) periods.

Long-term investing in stocks is how you win over inflation.

Sincerely,

Lynn Carpenter

P.S.  To let me know what you thought of today's article, send an e-mail to: feedback@investorsdailyedge.com.