Trading In A Volatile Market

| October 1, 2008 | 0 Comments

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.

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.

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Category: Stocks

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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