Trading In A Volatile Market
The Dynamic Wealth Report
October 1, 2008
Dow Down . . . What To Do Now?
As I write this, Congress is still negotiating. Have you ever heard the
term “Too many cooks in the kitchen spoil the broth?” I don’t think
anything in recent memory better exemplifies that statement than
congress fiddling with the bank rescue package.
Over the weekend I was happy to see a formal bill reach our elected
representatives.
Then Monday morning happiness turned to disappointment as Republicans
and Democrats alike sent the bill down in flames. Of course the markets
reacted appropriately. They posted the largest single day point loss
ever – 777 points. It’s an embarrassment to everyone involved. It’s sad. Our elected representatives are making excuses left and right. I guess
they don’t understand the importance of this legislation.
Why so important?
This bank rescue bill is meant to unfreeze the markets. Most of “Main
Street” misses the point. The problems aren’t in the stock markets,
they’re in the credit markets. Credit markets are giant unregulated
parts of our financial system. Institutions, investors, and large
companies actively trade in these markets, lending and borrowing money.
But the credit markets are getting worse – not better.
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How do I know?
I looked at LIBOR prices. Ok, I know what you’re thinking. “What’s
LIBOR”? LIBOR is also known as the London InterBank Offered Rate. It’s a
fancy way of saying the interest rate banks will lend to each other.
It’s an easy measure of how freely capital flows. The lower the rate,
the easier money flows. When the number’s high it means banks are
hoarding capital. It means banks are fearful overnight loans made to
other banks might not get repaid.
The LIBOR numbers skyrocketed.
A few months ago the LIBOR rate was hovering around the 2% level. This
week it’s spiked to over 6%. Now I know that doesn’t seem like much. Let
me put it in different terms. Banks are now paying 200% more to borrow
money.
It’s like you getting a home mortgage at 6% one week. Then the next week
your interest rate becomes 18%.
Think about that.
Would you rush out and borrow money? No. Of course not. Borrowing costs
are going up. You’ll put the brakes on some of your projects. Banks are
doing the same thing. They’re slowing down lending. Not only to you and
me, but to major corporations as well.
That’s the scary part.
Some Fortune 500 companies use short term borrowing capabilities to meet
payroll. Surprised? I’m not. It’s a well practiced cash management
technique. But guess what. If companies can’t borrow, they might not
make payroll.
Can you imagine a Fortune 500 company missing its payroll?
Now that’s scary.
Personally, I don’t think it will come to that. But you never know. So
in these scary times what should we do? I see two different moves. First, move portions of our portfolio to cash. Second, invest in strong
companies representing great values.
All cash.
Moving your portfolio entirely to cash is something only professional
day traders do in times of uncertainty. I’m not suggesting that you sell
everything in your retirement portfolio. I’m suggesting you
strategically exit the weakest investments, and limit your short-term
trading.
Review your portfolio closely and cut back on riskier investments.
Continue holding and maybe add to your strong, long-term investments.
Don’t be afraid to stop trading. Some of the best traders step back from
the markets occasionally.
Investing for value
Our second move is the take advantage of the down markets. Like Warren
Buffett says: “The time to be greedy is when others are fearful.” Let me
tell you, fear is everywhere in the markets these days.
I know what you’re thinking. “What’s a great value?” Good question. . .
and one that would take lots of space to answer (space that I don’t
have). Let me make a simple observation. Looking at the S&P 500 I
noticed something really interesting. More than 10% of the companies in
the index have dividend yields of over 5%. That might be a good place to
start looking for value.
I’ll let you know what I find over the next few weeks.
• Oil (Below $100 per barrel)
Monday, oil prices fell more than $10. It looks like oil continues to
bounce around the $100 level. I think many investors are waiting for oil
to start trending . . . up or down. The short term direction is
anybody’s guess.
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