A Smoldering Opportunity

Ugly day, isn't it?

Even with Federal Reserve Chairman Ben Bernanke trying to save the day with an emergency rate cut of 75 basis points -- a move that lowered the federal funds rate to a mere 3.5% -- the markets are still under fire.

The Nasdaq Composite opened 5% lower this morning. It made back about half of those losses an hour into the volatile trading day, but who knows where the market will be by the time you read this? The ticker tape is moving awfully quickly -- enough, in fact, to have wiped out the market's gains for all of 2007 in a matter of weeks.

Most of us are poorer on paper than we were several weeks ago. I can certainly attest to that. However, I would be lying if I told you the sky is falling. I would also be cheating you if I followed up that observation with a pat on the back and some hollow words of optimism.

What should you do, then? Party like it's 2006? Make the most of the blazing fire by popping some marshmallows on your skewers? Well, there are two good, solid reasons to remain upbeat despite the crumbling markets around you. I'll spell them out for you.

1. Fed Flintstone
This morning's cut was special. When is the last time you saw the Fed slash rates by more than a token 25 or 50 basis points? Exactly. The Associated Press went all the way to 1990 to arrive at the conclusion that a cut of this magnitude is unprecedented.

The Fed can't keep doing this forever, of course. It's now brought the federal funds rate to just 350 basis points from zero. However, when you couple this cut with other recent rate reductions, the end result of lower interest rates will help fix many of the problems that got us into this mess in the first place.

Now that the ugly practices of subprime lenders have been exposed, financial-services companies are more careful in their lending habits. Lower rates will also help to keep foreclosures in check down the road, since adjustable rates will no longer shoot through the stratosphere.

Attractive financing rates will naturally help depressed sectors such as homebuilders and automakers. The new rates won't be enough to send home prices back to the zany levels they reached in many inflated markets, but buyers will get more bang for their mortgaged buck. It's not a shock to see that some of the first stocks to turn higher this morning after depressed openings were developers such as Toll Brothers (NYSE: TOL  ) , Centex (NYSE: CTX  ) , and Lennar (NYSE: LEN  ) .

2. Pump up the value
Banking opportunist Baron Rothschild is famous for arguing that the best time to buy stocks is when there's "blood in the streets," but I always add one question: What blood type? Lower prices translate into lucrative entry points, yes, but only if the fundamentals of a stock remain intact. The distinction is important.

For example, it didn't make sense to buy banks such as Citigroup (NYSE: C  ) or developers such as Toll Brothers during last year's bloodbath, because you knew that their very livelihoods hung in the balance. Estimates were being slashed.

So where are the opportunities? You'll find them in companies where prospects are holding up even as share prices crumble. If you want to be truly rewarded, seek out companies for which profit projections are actually climbing as their shares go the other way.

Sun Microsystems (Nasdaq: JAVA  ) is a good example. Even during last week's uninspired trading sessions, analysts raised their profit targets on the company. Likewise, Internet bellwethers such as Google (Nasdaq: GOOG  ) and Rule Breakers recommendation Baidu.com (Nasdaq: BIDU  ) have seen their shares getting slammed in recent weeks, yet analysts have jacked up their earnings estimates on both companies over the past month.

In other words, don't just approach falling prices as a storewide sale. Take the time to pick out the stuff that's truly worth buying.

Volatility is your friend
In a whipsawed trading day, wild swings will leave losses transformed into gains and vice versa. The best investors aren't the ones who guess which direction the next tick will go. No, the best investors are the ones who know where those cumulative ticks will go over longer stretches of time.

Whether you're long or short the market, there will always be opportunities. They just happen to protrude in a more obvious manner on wild days like these.

Pretty day, isn't it?

Get more from The Fool about the market's recent volatility:


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