If you could predict the future movements of the stock markets, could you make money with that knowledge?
To quote a certain political figure, "You betcha!"
Most of the time, trying to divine future market movements with any accuracy is a fool's (not Fool's) game. But I have a feeling that these are not those times. The bulls we saw yesterday were a mirage.
I'm not being a pessimist; I'm just learning from history. Another of the biggest one-day gains in the history of the U.S. stock market came the day after the Crash of 1929 -- which only marked the start of years of market pain. Call yesterday a dead-cat bounce or a relief rally or whatever you like, but with a tough recession looming and more credit leverage yet to be unwound, my sense is that Tuesday's move was not the opening phase of a new long-term bull market.
In fact, at some point soon, I expect the markets to head right back down to the neighborhood of the recent lows, or maybe even lower. To be clear, I don't know exactly when -- could be tomorrow, could be sometime after the election, could be next spring -- but I think it's likely.
And if history is any guide, the up-and-down cycle will repeat itself (though hopefully with less drama) until lots of people give up on stocks altogether and put their remaining money in Treasuries or CDs instead.
That's called capitulation, and it's historically the last phase of a bear market. To make a long story short, I'm inclined to think that recent events weren't the capitulation we'd been hoping for.
Of course, I could be completely wrong. So what do we do right now?
Do this right now
The first thing we should do is decide not to worry about near-term market antics. Don't panic when the market's down 5%. That, too, shall pass. Don't panic because you had some cash that wasn't invested when Alcoa (NYSE: AA ) went up almost 20% yesterday, or because you didn't buy Apple (Nasdaq: AAPL ) well under $100. You didn't miss the boat. There will be more gains (and more losses) in the future.
Just don't panic, period. Panic leads to bad decisions, the kind that can wreck a portfolio. We're all wired, deep in our prehistoric animal brains, to follow the herd (by buying when prices are up) and to flee danger (by selling when the numbers get big, red, and scary).
That is not the road to sustained investment success.
Follow this road instead
How do we find success in the markets? These principles work better than any others I know:
- Buy good businesses at a discount. Stick with the basics. A good business has solid, steady management. Its business is sustainable -- it's not a fad. It's in excellent financial shape. And it's selling at a discount, by which I mean one of two things: It's selling for less than its intrinsic value right now, and its price should rise once the market recognizes it -- or it's poised for significant growth, after which it'll be worth a lot more than the price it's selling for today.
- Construct your overall portfolio deliberately. Asset allocation works. And it doesn't mean you have to be only one-third invested in stocks and miss the fun while the bulls are running. (Although that doesn't sound too bad right now, does it?) An all-stock portfolio that is allocated to different corners of the market using a good plan, and rebalanced from time to time, will outperform a more focused portfolio over the long run more often than not. But remember that your "portfolio" includes all of your investment accounts -- and might take things like real estate holdings and your job into account, too.
- Remember your thesis, and stay informed. If you bought Marvel Entertainment (NYSE: MVL ) at $35 because you thought it was in the early stages of a great long-term growth phase, is that thesis less valid now because Marvel is down around $30? If you thought Pfizer (NYSE: PFE ) was a rock-solid dividend machine at $21, is it less solid at $17.50? Is Koninklijke Philips (NYSE: PHG ) less of a value at $17 than it was at $21? Sometimes, an investment thesis can change -- hello, Bank of America (NYSE: BAC ) -- in which case selling could be the right course. Sometimes it's less clear, and dependent on things that are tricky to predict -- will oil prices recover enough to make Contango Oil & Gas (NYSE: MCF ) worth holding on to, or even a buy at these levels?
It's a lot to think about. If you'd like some expert help, along with some great stock ideas for today, consider a free trial of the Fool's flagship Stock Advisor newsletter service. Every month brings all-new recommendations for new money now, and updates are issued whenever market conditions warrant. It's a great way to learn the art of stock analysis while profiting from experts' picks. You can see all of their current recommendations right now -- for free -- with a 30-day trial.