When to buy – and what

When to buy – and what

Gordon Pape
Monday, November 03, 2008


TORONTO (GlobeinvestorGOLD)--This has become a manic-depressive stock market. That's the only description that fits as the mood of investors changes at lightning speed, not just from day to day but hour to hour.

Consider what happened last week. On Monday, Oct. 24, the S&P/TSX composite index experienced the second-worst one-day drop in history, falling 8.1 per cent in what The Globe and Mail described as a "frenzied sell-off of stocks". Then on Tuesday investors reversed course and started buying everything in sight. Over the next three days, they pushed up the composite index by more than 1,300 points, or 15.5 per cent. But by Friday they were back to selling again as the index recorded a modest 93-point decline.

What's going on? A toxic mixture of irrationality and uncertainty with conflicting bouts of fear and greed stirred in. When people wake up in the morning feeling depressed, the urge to save whatever they have left of their savings takes over and the sell orders pour in to brokers. When they wake up thinking that maybe yesterday's sell-off was the culmination and, wow, some of these stocks look like terrific bargains, they turn manic and start buying.

A simplistic explanation? Sure it is. But it also happens to be true. Strip away all the complexities of forced selling and short covering and the bottom line is that investors are trying to pick the bottom of this plunging market and profit from it.

We all know deep down inside that the markets are not going to zero. And most of us believe that the great companies that have been beaten down will rise again and that when they do the profits will flow like swollen creeks after a thunderstorm. What we don't know is where the bottom is or how long it will be before the turnaround starts.

Last week, a worried reader wrote to ask if I thought the S&P/TSX composite would fall to the 6,000 level, as someone she had seen on TV predicted. I replied that I didn't know – any more than anyone else does. No one that I know forecast this big a drop in the TSX. In fact, as recently as mid-summer some highly respected economists were predicting the composite index would be over 16,000 before the end of the year. How ludicrous does that seem now?

We never know where the bottom of a market is except in hindsight. What we do know is that there will be a bottom and that at some point a new bull will emerge.

In a recent research report, RBC Capital Markets technical analysis team, which is considered to be one of the best in the business, reiterated its view that we are in the midst of a prolonged bear market that will not reach its nadir until mid-2010.

"In a 'best case' scenario, this could mean a stabilization near current levels, followed by a broad, highly rotational trading range for the next few quarters," the team wrote in a research report. "A more probable case is that the broad indices will reach or exceed the minus 50-per-cent mark at some point before the start of a new cyclical bull market.

The 'worst case' remains open to the imagination at this point, but historical parallels might be the Nasdaq 2000-2002 (-78 per cent), Nikkei 1990-1992 (-63 per cent), 'Nifty Fifty' 1972-1974 (-67 per cent), and Dow 1929-1932 (-89 per cent)."
In other words, even some of the best technical minds in Canada can't tell us with any degree of certainty how the next couple of years will unfold. The best they can do is to provide some assurance that by mid-2010 – almost two years from now – we'll be back on the right track. Between now and then, who knows? No wonder investors are acting like inmates of an asylum!

This brings me to the core question of this column – when should you buy, and what? The answer depends on your willingness to deal with risk, your time horizon, your bank account, and your nerves.

There is no doubt that there are some wonderful bargains available now. I look at the share prices of companies like Manulife, Brookfield, Suncor, Research In Motion, Royal Bank, H&R REIT, and Teck Cominco, to name just a few, and I shake my head in wonder. Unless the world falls completely apart, every one of these companies is going to be trading at double or triple the current price in less than five years. Yet the market keeps driving them lower.

So when do you start buying some of these bargain-basement stocks? Rule No. 1 is never try to pick an absolute bottom, or an absolute top for that matter. It never works. Experienced investors are content to buy within 20 per cent of the low and sell within 20 per cent of the high.

You can make a lot of money doing that. So the first step is to pick what you believe is the lowest point a quality stock is likely to reach. Be ultra-conservative – a month ago, some of today's prices seemed inconceivable.

For example, if you decide $30 is a rock-bottom price for Royal Bank, start accumulating shares at around $36. If the price drifts lower, gradually add to your holdings. Despite all the troubles in the financial sector, Royal Bank is not going to fail. If it ever came to that, the Canadian government would follow the lead of Europe and the United States and bail it out by buying billions of dollars worth of preferred shares.

Next, focus on strong companies that you are convinced will survive even the worst economic downturn. The big banks fall into that category, for reasons explained above. None of our major oil companies is going down the tubes. The big pipeline operators will still be around. So will the cable companies and the railways.

To sum up, identify sound companies that you want to own and set a low entry point for starting to accumulate shares. Don't rush to buy if the price moves higher, as it did for most stocks last week. My hunch is there will be a lot more buying opportunities before this is all over.
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