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Making Sense of This Crazy Market

October 20, 2008 – by Richard Band

Twenty-one years ago this month, I experienced something I had hoped I would never live to see again. But lately, we have been in what can be described without much exaggeration as a stock market crash.

After the recent lows on October 10, the blue chip Standard & Poor’s 500 index had plummeted more than 30% in two weeks. That’s almost unheard of.

It happened in 1987, when the market dropped 31.5% in two weeks. Other than that incident, though, you have to go back to the 1929 crash to find such a severe decline in such a short period.

A collapse of this magnitude raises serious questions. Have the bailout efforts of the world’s governments failed? Is the global economy headed into a depression a la the 1930s? (See also: "How to Keep Your Money Out of Harm’s Way.")

Perhaps, but we shouldn’t jump to conclusions. Congress passed the biggest financial rescue package in history not too long ago, and the money hasn’t even started to flow yet. When cash replaces the frozen mortgages on lenders’ books, the system should begin to thaw.

What’s more, the Treasury has already guaranteed the vast majority of money market funds, while the FDIC recently boosted the limit on insured bank deposits to $250,000 ($500,000 for joint accounts) through December 31, 2009. So there’s no need for investors to panic about the safety of their cash reserves. (See also: "How the Bailout Affects You & Your Money.")

A Significant Reversal

Recent market action has allowed us all to breathe a little bit easier. For a while last Thursday morning, it looked as if we might have two calamitous days in a row. Industrial production for September, reported before the opening bell, was horrible (biggest monthly decline since 1974).

Then, at 10 a.m. ET, the Philadelphia Fed came along with an equally shocking report on factory activity in the Middle Atlantic states: worst monthly drop ever. So the stage was set for a huge market decline.

But then, almost miraculously, buyers began to appear as the S&P 500 sank within hailing distance of the previous Friday’s low. Slowly, the blue chip indexes regained their composure. By the end of the session, not only had the S&P tacked on a handsome 4.25%, but the small caps and midcaps had posted even bigger gains.

Technically, this was a very significant reversal—even more significant than the previous Friday’s intraday turnaround because this one resulted in a solid finish to the plus side. There will be sharp one-day pullbacks, but I now think the market will trend higher for the next two or three weeks, with volatility gradually subsiding.

How Should You Play It?

If you’re an aggressive trader, you might pick up somnefits from the performance of midcap stocks. Don’t think of this as a long-term holding, though. We’ll probably look to exit in early November once the market’e shares in a mutual fund that bes reflex bounce runs its course.

For the long run, I recommend an especially strong defense company I just added to our Profitable Investing buy list. The stock is selling at a steep discount to its typical valuation of the past give years, and the company carries very little debt. Earnings should hit a new record in 2009, even if the Democrats sweep the upcoming election. (Don’t miss: "Three Tips to Survive a Recession.")

We’ve had several great opportunities to snap up the stock well below our $92 buy limit, which is very important in this market. We don’t want to chase any stocks, even our favorites. Chances are, the major indexes will come back down in the second half of November or early December to test last week’s lows.
If the test looks promising, we’ll buy with both hands. First, however, the market has to prove it can lift out of the current "red zone." I’ll be watching and telling my Profitable Investing readers what to do every step of the way.

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