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Fear, Baby, Fear: Lessons From a Correction
by Louis Corrigan (TMF Seymor)

"Fear, baby, fear."

Chuck D's words just kept rushing over me as my internal CD stuck on Sonic Youth's "Cool Thing" and Kim Gordon's rock 'n' roll toughness presided over the entertaining spectacle of Wall Street in a panic. Burn, Babylon, burn.

Call me crazy, but with a little cash to invest, I was giddy at the sight of Monday's market meltdown. I was nearly cheering for the circuit breakers to fall. Nothing like watching a little how-low-can-it-go history in the making. Yes, Monday's collapse was a non-event for me and, hopefully, most Foolish investors with a diversified portfolio and an investment horizon measured in decades. But that doesn't mean it wasn't fun. The whole thing gave me a rush. So many paper profits disappearing so quickly. So many stocks that had just delivered gangbuster quarters dropping so hard so fast. Had the pain been even more severe, perhaps that cathartic high would be even greater. Still, what a fun day at the markets.

No doubt my pleasure depended on my confidence that the U.S. markets in general, and my investments in particular, would quickly stage a recovery and that there were real bargains to be had. Of course, I could have been wrong about that. Indeed, I could still be wrong if the recent rebound proves false, but anyone who enjoys investing has to love the pure challenge of it. As a Fool, I think it's right to demystify the act of investing, something easily accomplished with a tour through our Fool's School or an evening spent reading The Motley Fool Investment Guide.

Still, part of the fun of investing involves the repeated challenges, the nearly limitless opportunities for making mistakes. There's always a new lesson worth learning. So in the spirit of education, I wanted to share my top ten loosely defined lessons from this week's correction, in no particular order.

1. Learn to Love a Short-Seller. Yourself.

When I checked my portfolio after Monday's close, I found a bunch of 5% to 15% losers. Then I saw my shorts down, or rather up, 15% to 20%. What a lovely hedge. Selling borrowed shares in order to buy them back later at a lower price is a bit riskier than just buying stocks. In general, you need to do more homework, but if you can discern attractively valued stocks, you should be able to spot those that are overvalued. Not all of these will make good shorts, but a community of intelligent short-sellers in Fooldom can help you learn how to pick the ones that might. Every investor could probably use a couple of shorts in a diversified portfolio. They come in handy when 19 out of every 20 stocks on the NYSE fall.

2. Individual Investors Still Remember the Lesson of 1987.

Will the little guy panic? Or will the millions of new individual investors who've become owners of corporate America over the last decade still be willing to buy when Wall Street holds an apparent sale? Stepping into the breach is a strategy that has worked well since the crash of 1987. Judging by my own glee, the relative lack of redemptions seen by mutual fund companies, the nearly universal comments from individuals quoted in the media, and Tuesday's recovery, the answer is, "Yes, we still remember." Will we wish we hadn't? Who knows, but with the U.S. economy still strong, I doubt it.

3. Wall Street's Wise Should Take a Fool to Lunch. Somewhere Nice.

Many of Wall Street's money managers close up their fiscal year at the end of October. That's when their performance bonuses get tallied. With these pros looking to protect their nifty twelve-month gains, both fear and greed instructed them to sell in the face of the Hong Kong flu. So Monday it appeared that the so-called pros were selling. After individual investors appeared to step up to the plate Tuesday morning, the pros got back in and seem to have padded those bonus checks as a result. Now, we can't take all the credit for that, but with a very Foolish appreciation of long-term investing becoming more widespread by the day, the short-term professional focus becomes more and more a tool in the individual investors arsenal, not something to loathe.

4. Soros Knows About Global Markets.

"Financial markets are inherently unstable and liable to break down unless stability is introduced as an explicit objective of government policy." So has said boom/bust philosopher and billionaire speculator George Soros, the insecurities analyst with a keen sense of our global interconnectedness. "When speculators profit, the authorities have failed in some way or another," he said in 1995. "But they don't like to admit failure; they would rather call for speculators to be hung from lampposts than to engage in a little bit of soul-searching to see what they did wrong." In his view, currency speculation is a symptom of a financial, economic, or political problem rather than its direct cause. Speculation is the smoke behind which one might surmise a fire that can spread sometimes uncontrollably through world markets. With much of Southeast Asia literally covered in smoke, we should have listened to George.

5. Barton Biggs Is Sometimes Right

Biggs is chief analyst for Morgan Stanley Dean Witter Discover (what a mouthful!). Bearish for months, he succeeded last March in calling a cyclical peak in "technology" issues after most of the computer networking companies were already down more than 30% and ready to head higher. Monday morning he told his firm's clients by conference call that the market "could go down 30% to 40%" from its peak and that a bear market "is likely... is overdue... has finally happened." Later in the day, as the market was tanking, he told CNBC that by Tuesday afternoon the market could be in the midst of a vicious rally, though that would be mere prelude to an ensuing fall.

Biggs may turn out to be right about the bear market. Eventually. So too might Michael Metz and the other oft-quoted bearish authorities. But in the meantime, if we're going to have a bullish gooroo presiding over this market, it's nice to have Abby Joseph Cohen, chief strategist for Goldman Sachs. She's an unassuming, no-nonsense muse who has persistently and correctly reiterated her bullish outlook because she understands what the inflation hawks have missed: in a low-inflation economy, earnings deserve higher multiples because they are literally worth more.

6. The Disinflation Genie Is Out of the Bag.

Economist Roger Bootle has argued in The Death of Inflation that the West's real problem may be creeping deflation, or the threat of falling prices. Mocked as a "new era" fantasy, serious disinflation bordering on outright deflation actually represents a return to the norm of the pre-World World II era, Bootle has said. While some emerging markets may at times overheat and then falter, their emergence creates an expanding supply of goods and labor that adds to an already existing glut. Those forces are and will remain disinflationary for the foreseeable future. A small but growing minority of economists is beginning to entertain this possibility. Bootle has conceptualized it, but probably no one has described the actual process at work as well as liberal journalist William Greider, whose One World, Ready Or Not: The Manic Logic of Global Capitalism might keep you awake at night.

What's ironic is that the Asian tigers' troubles may produce some of the same effects as their recent economic success has. Weakened Asian currencies will no doubt cut into U.S. exports and thus corporate profits, but that also ensures that Asian goods sold in the U.S. will cost less in U.S. dollars, dampening overall inflation here. Also, multinationals engaged in intra-company exporting from their factories overseas may benefit nearly as much as U.S. consumers will. Plus, the financial flight to quality drives the U.S. bond market higher, lowering interest rates so that it becomes cheaper for American companies to make productivity-enhancing capital improvements. With real interest rates (the nominal rate minus negligible inflation) still very high, there's plenty of room for them to fall. The lower cost of capital and the increased productivity may offer U.S. companies ways to make back in reduced expenses whatever gets lost abroad in sales. Even somewhat weaker corporate profits should look great in an increasingly deflationary economy. Or so it would seem.

7. Terry Keenan and Ron Insana Can Manage the Graveyard Shift Without Turning Into Vampires.

After a full day under the lights at CNBC, Ron and Terry managed an intelligent telephone interview with the Templeton Fund's globe-trotting Mark Mobius even though Cinderella had already raced home. And they actually looked good. CNBC's producers, though, seemed a little tired. At one point, they cut to an hysterical shot of some reporter, his finger probing around his cheeks as if he'd just taken a piano out of his mouth and wanted to get things back in place. I think he was preparing to file a report. Luckily, he was spared further embarrassment.

8. Online Brokers and Telebrokers Can't Have Too Much Capacity.

The Fool loves discount and online brokers. They empower individuals and highlight the farce that is traditional Wall Street. They also help pay our bills. And their TV ads are getting better all the time. But guys, you flubbed your first big test. If the busy signals, disconnections, and cyberfreeze I experienced were a common problem (and I think they were), then we all got another lesson in the limits of technology. If you can't get quotes and place orders when you really want to, then it doesn't matter how reasonable the fees are.

9. Embrace Patience and She Will Embrace You.

If you're an investor who can't find any values, look harder. Or wait. Opportunities that swim away from you often swim back. Even if they don't, you exude extraordinary charisma and personal charm. (Check your horoscope.) A lovely and intelligent investment will eventually chase you down if you keep your eyes open. Sometimes it will look like the whole market has fallen for you. Play hard to get, but make sure you allow yourself to be seduced.

10. Never Catch a Falling Knife, at Least Not With Your Teeth.

Traders say never try to guess the bottom. Traders say that a falling stock is like a falling knife, try and catch it and you can get hurt. Recognize that you're not a trader. Ignore the insanity. Don't worry about whether a stock might go lower. It might. Instead, value a company's business and be happy if you can buy into it at a fair price. If you somehow missed your chance (see #8), then consult #9 and #5.

What Lessons Did You Learn?

There's always a lesson that doesn't make the Top Ten but should. It's the one you're going to wish you had learned the next time the market collapses. If you know it, let's hear it. Visit the Lessons Learned message board and share your lessons learned with the rest of Fooldom. A random group of Fools (that would be whomever I can drag into a conference room) will choose the 10 best posts. Each of our ten lucky winners will receive a pair of Fool boxer shorts, a t-shirt, and a Fool Quiz.

 

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