The Most Dangerous Way to Invest Today

This market panic has taught or reminded investors of many important lessons, including the importance of diversification, investing only in companies whose business you can understand, and that "cash ain't trash" after all.

Another lesson that must be heeded is that "bottom up" research is a downright dangerous way to invest. To review, "bottom up" research looks at businesses first and de-emphasizes macroeconomic factors. If this market has taught us anything, however, it's that ignoring the economy can have dire consequences.

No Fa-Fa-Fa-Foolin
Picking a stock without considering the economic environment is like picking out your clothes in the morning without considering the weather that day. Sure, that Def Leppard 1987 Hysteria Tour T-shirt may be comfortable and give you tons of street cred, but it's just not practical in a foot of snow.

All joking aside, no matter what sector you're looking at, there are macroeconomic factors that will make a big difference to your investing thesis -- durable-goods orders if you're looking at manufacturers, housing starts for homebuilders.

Right now, for example, companies dependent on consumer spending are facing some serious headwinds:

  • The American labor force is weakening. In the last three months, the economy has shed 1.25 million jobs. Unemployment currently sits at 6.7%. Add that figure to the 12.5% underemployment rate (part-time workers who want to work full-time), and you have nearly 20% of the American workforce not contributing its full potential to the economy. These figures could get higher, since they haven't even taken into account the massive layoffs recently announced by Bank of America (NYSE: BAC  ) , 3M (NYSE: MMM  ) , and Dow Chemical (NYSE: DOW  ) .
  • Consumer credit is drying up. To compound the problem of unemployment, credit card companies like American Express (NYSE: AXP  ) and Capital One Financial (NYSE: COF  ) have become much more conservative with their lending standards, raising rates, reducing credit limits, or denying credit altogether. With 60-plus-day delinquencies up some 24% since August, it's hard to blame them for these moves. But the combination of less available credit and less income from employment will inevitably lead to less spending.
  • Baby boomers are being walloped by this economy. This economy couldn't have come at a worse time for the 78 million or so baby boomers approaching or already in retirement. According to Fidelity, at the end of 2007, its 401(k) participants aged 60 to 64 held a median 66% of their portfolios in equities. Given that the S&P 500 is down 38% year-to-date, it's reasonable to assume that the median boomer 401(k) lost about 25%-30% of its value this year. Besides the stock market losses, an estimated $4.5 trillion of wealth has been wiped out as a result of the real estate market crash of the past two years.

This new reality is significant on many levels, but the biggest consequence of a poorer boomer generation may be found in the retail sector. The boomer demographic accounts for about 40% of total consumer spending (about $3.8 trillion annually). Since consumer spending makes up 70% of our GDP, you can see how much a suddenly stingy boomer generation can hurt our economy.

If boomers cut just 10% of their $3.8 trillion in annual spending this year, it could set GDP back some 3%. Less boomer spending would negatively affect retailers across the board, from women's clothiers like Ann Taylor (NYSE: ANN  ) to casual-dining restaurants like Darden Restaurants' Red Lobster and Olive Garden.

Where we're left
Despite these mounting economic woes, there are still stocks worth buying in this market. But the research process must begin with a macroeconomic analysis, followed by a thorough vetting of businesses.

Since we launched our Motley Fool Pro service in October, we've taken the plight of the U.S. consumer very seriously, focusing our research on companies that produce goods and services that people need, versus what they want. For example, we'd be much more inclined to research a stock like Johnson & Johnson (NYSE: JNJ  ) versus a beaten-down retailer like Abercrombie & Fitch. Consumers can do without $100 blue jeans, but they are much less likely to do without things like Band-Aids, Sudafed, and Tylenol.  

Even though Abercrombie may look like a value at the moment from a bottom-up approach, it could be an even better value six months or a year from now. After all, even value is vulnerable without a catalyst to unlock it, and there appears to be no economic catalyst in sight for consumer-goods companies like Abercrombie. Ignoring that fact could cost you money and sleep while you wait -- potentially for years -- for retail to rebound.

At Pro, we're only interested in buying undervalued stocks with both strong fundamentals and positive economic support. Our top priority is accuracy, and we have a goal of generating positive returns with at least 75% of our investments. This means we must not only be selective with the investments we make, but also fully consider the economic environments in which they operate.

If you'd like to learn more about our Pro strategy, please enter your email address below.

Pro analyst Todd Wenning pours some sugar in his afternoon coffee, in the name of love. He does not own shares of any company mentioned. Johnson & Johnson, Dow Chemical, and Bank of America are Motley Fool Income Investor recommendations. 3M and American Express are Motley Fool Inside Value picks. The Fool owns shares of American Express. The Fool is investors writing for investors.


Read/Post Comments (21) | Recommend This Article (103)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 19, 2008, at 4:48 PM, ssmitty wrote:

    Whoa! Massive layoffs at 3M???

    1800 ? This is small potatoes!

  • Report this Comment On December 19, 2008, at 7:32 PM, ds10 wrote:

    " reminded investors of....the importance of diversification"

    Afraid not: diversification has been of little help in the Panic of 2008: all sectors of the economy are down.

  • Report this Comment On December 19, 2008, at 7:39 PM, NoMoeMoney wrote:

    They forgot to mention that Abercrombie & Fitch was selling those $100 jeans with holes in the knees, yes, that was the 'fad' so they sold them with already made rips at the knees. I almost fell over when I saw them! You know, you can get jeans with holes in them at the Salvation army for less. I guess thats why Abercrombie & Fitch will NEVER be a buy in my book!

  • Report this Comment On December 19, 2008, at 7:46 PM, Mojo218 wrote:

    Fully agree with your take on reduced consumer spending. Given that, why should a Fool be interested in any kind of Buffalo Wings or Mexican or Steak & Shake, all of which are pure discretionery? I don't see a moat here.

  • Report this Comment On December 19, 2008, at 8:26 PM, joeblixkavic wrote:

    does anybody know what these laid off people are going to do? they are, as we speak, setting up their own whoevertrade account. as we all know, the stock markets are ponzi schemes, but they're legal!!!! work the market with that thought in mind and you'll do just fine.joeblixkavic

  • Report this Comment On December 19, 2008, at 10:00 PM, simonkathrein wrote:

    I just watched 2 clips yesterday on this very subject. I'm only interested in trading short term... both sides of the market, and holding the balance in cash.

    click the link, scroll down to the bottom and watch Harry Dent's 2 youtube videos. Then read the article.

    http://stockcapitalist.com/?p=1026

  • Report this Comment On December 20, 2008, at 12:24 AM, YEN4PESOS wrote:

    Nice article, No foolin'. Thats the reality that is out there today. Many Boomers are looking at that reality that, "Oh NoOOO, I can't retire at 62.!" And the whole world is looking different than it did through those rose colored glasses of the last 30 years. Boomers have one asset that will help them keep their heads ,... Their parents came out of a depression era and we've heard the stories... over and over again, I might add. But, some of the things that were learned from "Dad and Grampa" are: Don't live and buy above your means.... There is still value in even the hardest times.... And, Don't buy on margin or get in debt. Suck it up and keep movin, forward...... As a matter of fact... be foolish at times.

  • Report this Comment On December 20, 2008, at 4:44 AM, toraab wrote:

    Or you can just go to histocky.com and Learn all you need to know on the past price movements of the stock you trade and then and only then get into the game ...don't lose your money...

  • Report this Comment On December 20, 2008, at 9:54 AM, JudgeHuey wrote:

    The most dangerous way to invest today is to pay any heed at all to the financial media, there are far too many sources out there promoting ideas that are very simply passé and irrelevant to the current environment.

    Motley Fool has been an occasional read for me for some years and I'm still waiting for them to come with something that isn't am easy teenage cliché arriving a dollar short and a day late.

  • Report this Comment On December 20, 2008, at 7:39 PM, Shonny594 wrote:

    This seems to be counter to the fools advice of investing in good companies and not trying to time the market. Oh and by the way you can pay for another membership.

  • Report this Comment On December 21, 2008, at 10:08 AM, 181736065 wrote:

    "This seems to be counter to the fools advice of investing in good companies and not trying to time the market."

    Exactly. They "backtracked" on their basic philosophy (which I always believed was flawed, and has demonstrated to be thus so over the last decade as stocks have not gained at all according to the S&P averages).

    I think they should offer their subscribers who stuck with them for years a discount, or some incentive, as this is a breach of philosophy.

  • Report this Comment On December 22, 2008, at 10:59 AM, jcarter2 wrote:

    I agree that the underlying premise of this article, that one should take "the economy" into account when investing is not what the Fool has advocated through the years. the Fool has advocated buying good companies at good prices. What constitutes good companies may depend on factors like your age, your personal risk tolerance, and other things often discussed, but the basic message has been that there are always good companies that, at any given time, are good investments, often because they are undervalued for whatever reason. With this economy and the 'panic' there probably are a lot of these.

    Personally, i agree that J&J will always be higher on my list that a fad marketer that sells preworn jeans. More to the point, I also agree many who have written that too many Fool articles are written as come-ons for one of the fool services. I subscribe to one of the services, believe it is valuable and also enjoyable. I think reading many of the non-subscription articles is still worthwhile, but it is not the original Motley Fool. It may be the best financial web site available, but the Fool did lose something when it became primarily a subscription web site with something to sell.

  • Report this Comment On December 22, 2008, at 3:30 PM, rfaramir wrote:

    If you want to avoid being irritated by a newsletter sales pitch, try looking at the top of article. Above the title and below the search field is the category path ("Home > Investing" in this case), possibly followed by "Sponsored by" and a newsletter name ("Motley Fool Stock Advisor" in this case). Use this info to pre-judge the article. Almost all of these sponsored articles will have a pitch. If that offends you and will negate the value of the content (for you), skip it entirely. Don't let the pitch at the end ruin your day, causing you to post critical comment (often unrelated to the actual content) to blow off steam, causing me to share your irritation.

    Or if you can't stand NOT reading the article once you've arrived there, use the sponsorship info to give you a heads up on their angle. Each different sponsor will have a different point of view. The Motley Fool is not a monolithic, one-size-fits-all organization. Play a game with yourself of guessing what they will write about based on the title plus the sponsorship (and maybe take into consideration the particular author once you get to know them a little), and see if you're right.

    Another game might be to find the sponsored articles that DON'T have a pitch at the end. There are a few.

    A better occupation, if you own a subscription, would be to spend most of your time on the boards. The info there is high quality, relevant to the stocks and point-of-view of the newsletter, and low on noise. The Motley Fool employees/associates have no reason to be selling to you there (you have already paid), and everyone else is there for sharing relevant info. It's a nice environment. There's good comraderie (we're all in this together, in good times and bad), a little fun, a lot of honest opinions and experience (i.e., mistakes that others can learn from), and always a few info-nerds that really dig up and summarize the nitty-gritty of financials, which we then discuss and put into perspective.

    Fool on, peacably.

  • Report this Comment On December 26, 2008, at 1:17 PM, charlie30078 wrote:

    yes all those investment letters are a fake. Altho I have only bought one stock they have recommended I have lost 90% of my investment. I have also been keeping track of the suggestions they give and within the last year 15 out of the 17 stocks have gone down from 60% to 99%. Two stocks are still up, one by just over 400% and the other 200% Not a very good record as far as I am concered.

  • Report this Comment On December 26, 2008, at 1:32 PM, wuff3t wrote:

    rfaramir,

    Wonderful riposte. I wish I could recommend your comment! People do seem to post comments without either reading enough of TMF's articles to really understand what TMF stands for - or worse still not even reading the article in question properly.

  • Report this Comment On December 26, 2008, at 2:19 PM, snakeflake wrote:

    Motley fool should take the word motley out of its moniker. If you did not lose 60% of your portfolios value, then you should be buying value stocks on sale right now. I did not lose any money in stocks because I had no money in stocks. I have lost a little bit of my 401k, but I moved my 401k money in the money market acct. a few months before the downturn. I dunno I just had a hunch. Anyway, now I am on a spending spree. When everyone was buying guns, I bought SWFC and soubled my money. I have also had good luck with a few other spec stocks, but most of my money is in value for the long run.

  • Report this Comment On December 26, 2008, at 8:04 PM, JimNKate wrote:

    THose who repeatedly point out that socks haven't gained in the last decade are technically right, but only on the technicality that we have lost a mass of value recently. The reasons for that are evident to most of us: the failure to live by the lessons of the past. As Yn4pesos puts it, "some of the things that were learned from "Dad and Grampa" are: Don't live and buy above your means.... There is still value in even the hardest times.... And, Don't buy on margin or get in debt." instead, people were trying to buy everything in sight at bubble prices, on margin (or didn't you know what a mortgage was?). That's the basis of a lot of the runup since the Clinton years, and the air has come out of it.

    Now our home prices are heading back to a sustainable level (i.e, average house can be bought for average income), stocks are closer to sustainable p/e ratios, etc. None of this is new; it goes back as long as there have been free markets where people lose their sense of perspective and begin to think they can be rewarded for not working and not taking risks.

    There's no such thing as a free lunch or easy money, at least not for long. Read up on the Dutch Tulip Bubble and the South Seas Bubble. Now substitute condos in Miami and CDOs, and you see where we are. People always get hurt in these environments, and those with the biggest exposure and the least liquidity get hurt worst. The only people I really feel badly for are those at the bottom of the economy who got clobbered for no choice of their own. The rest of us got a haircut. Move on. If you have money, invest it while the prices are good, but hold on for the long haul. If you don't have money to risk, don't risk it. Learn from the past.

  • Report this Comment On December 26, 2008, at 10:11 PM, whatalotacrap wrote:

    i have been recieving the fool newsletters (junk mail)for years and most of the time I del them without reading them unless a headline happens to catch my interest. The letters talk to me as though I am a fool and that tells me spending money for their service would be foolish. really guys if you are going to pay for a service spend your money on a company that sends out free daily market commentary which is sensible and not foolish reading. a company that will talk about short optons as well as medium or long holds. Then if you like their way of investing pay for their full service. take a look at wstreet.com (wall street stratagies) i have been taking their daily news letters for years and read every one of them, they write inteligently for adults with minds. anyone who would pay for fools services after reading one of their letters doesn't have a mind they are a sucker being suckered. and no i don't subscibe to wstreet services as i live half a world away, but i probably would if i were in your time zone.

  • Report this Comment On December 26, 2008, at 11:18 PM, jlclayton wrote:

    I do have an issue with those who say that this article is counter to what they have been preaching about strategy all these years.

    Most investors do not have an infinite amount of money to invest and can only choose 1 or 2 stocks at a time to start building a position in. This article doesn't say to time the market, but to look at the big picture for a company's sector in the current economic environment. There may be 10 companies that I determine are valued at a great price and would be good buys at this level. But looking at the economic challenges and advantages of each one and the outlook over a short and long term time frame based on the overall economy is a smart way to help me decide which 1 or 2 stocks are a better investment for my money.

    I have read the fool newsletters for a long time now and do agree that many are a lead in for whatever subscription they would like to promote. But for those of us who are just trying to get some good common sense guidelines to build decent 401ks, the articles are interesting and informative.

  • Report this Comment On December 27, 2008, at 4:23 PM, jimnall2003 wrote:

    net net... i've read, CAPs'd, and sometimes invested in various Fool recommendations (Global TTM comes to mind) and my 'test' portfolio is down about 40%.

    Time for a sea change....either gold or 'have to have' commodities seems right.

  • Report this Comment On January 02, 2009, at 1:09 AM, fffoolin82 wrote:

    Sorry Todd, you lost all credibility with me when you mentioned the Hysteria tour t-shirt. "Foolin" was from Pyromania, not Hysteria. Nice try, though.

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