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5 Rules and 5 Stocks for a Panicked Market

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On a recent radio show, I heard firsthand how fearful individual investors are these days. Remember: Scary markets are there to provide you opportunities. A little planning ahead can help you take advantage of the current, manic environment.

The guy next door nearly always gets his investing decisions wrong. No offense intended.

I say that because, unless you live next to a certain well-known geezer in Omaha, the odds are that your neighbors are, as you read this, falling victim to market-lagging, returns-killing mass psychology.

Worse yet, the odds are that you do, too.

Everybody does it ... wrong
As Peter Lynch explained (and much research confirms), most mom-and-pop investors buy in when markets are high, and get out when markets are low and falling. By buying when everyone else is, and selling when they're scared, they even manage to underperform their mutual funds' performance. The psychology is easy enough to understand. Take, for example, SodaStream International (Nasdaq: SODA  ) , which seems an unlikely market beater, as it sells an answer for a problem most people don't have: "How can I take up valuable counter space to make my own expensive soda at home?"

 Earlier this year, this hot stock advanced on continual growth, and those who sat out the early gains thinking, "It can't last," eventually succumbed to the pain of watching "everyone else get rich." Next, they compounded the error with bad sell decisions (as the SodaStream chart also shows).

Highfliers aren't the only stocks that fall victim to panic. When a boring Ford (NYSE: F  ) falls, whether for company-specific reasons or as part of a panicked market downturn, the fears kick in. "Better to get out now than to wait until it's all gone!" Bang, your neighbors are selling at low prices, heedless of the relative value of the company, in order to "preserve" their capital. What they preserve are losses, along with the painful memory of lost capital. (I know this one firsthand, as I was one of those panic sellers of Ford back in 2008, when I sold the automaker despite its position as the best of a bad bunch.)

Deja vu, again
I got several earfuls of neighborly fear when I recently did a call-in segment on Minnesota Public Radio's Midmorning. With the pain of the 2008 market collapse still fresh, and the recent roller-coaster ride stirring fears, many callers picked up the phone to let me know that they would never be back in the stock market.

Another, whose job loss and near foreclosure wiped out her retirement savings, swore she wouldn't buy stocks, but would invest instead in small, local businesses (which are riskier, less transparent in their financial reporting, and much, much less liquid).

Unfortunately for Mom and Pop, this fear and loathing of stocks isn't an isolated anecdote masquerading as a trend. According to a recent Morningstar article, the rush out of the market continues. Mutual fund outflows in July were nearly as bad as during the peak of the financial crisis in October 2008. I believe (as does Morningstar) that August's market fits will make things worse.

In other words, your neighbors are looking at the volatile markets and taking action. As usual, they're doing exactly the wrong thing and getting out of stocks at exactly the wrong time. In the years since the financial crisis, corporations have strengthened their balance sheets; they've cut back on expenses and right-sized their inventory. Hundreds of public companies are more efficient, more financially powerful, than ever before, and thanks to recent market panic, they look cheap by any standard.

How can you avoid your neighbors' mistakes and improve your returns?

One way is to do nothing. If you remove much of the decision-making from your investing, you remove most of your opportunity to make mistakes. That's why I (and The Motley Fool) have always advocated regular, automatic investing (into index funds, ETFs, mutual funds, or individual stocks) as a perfectly reasonable way to grow wealth for the long term. But I think you can do better than that.

Take the Dangerfield approach
Here's a simple lesson from Caddyshack. Rodney Dangerfield's Al Czervik answers his mobile phone, and finds his broker on the other end. "Buy! Buy! Buy!" he says. "What? They're all buying? Then Sell! Sell! Sell!"

The line is good for a laugh precisely because it sounds crazy. Deep down, everyone knows how difficult it is to do the opposite of what the crowd is doing, especially during manias and panics. But that's precisely what you must do if you want your best shot at beating your neighbors, and beating the market.

Five simple rules
Simple isn't the same as easy, so I follow a few rules to help make market panics work for me -- and to help make my process nimbler in these days of quick market reversals.

  1. Plan Foolishly. Your portfolio should reflect your individual financial realities. Are you living off your investments? Then you may not want to be in stocks at all. Got 30 years until retirement? Bonds are probably a bad bet.
  2. Reassess your risk tolerance. If you can't sleep at night following 10%, 20%, or even 40% downswings in individual stocks, then you shouldn't be buying them at all.
  3. Plan ahead. The middle of a market panic is no time to change your asset allocations. Taking a big bath on stocks in order to move the funds into "safer" assets locks in losses.
  4. Keep a cash cushion. I've long advised people to keep at least six months' worth of living expenses in cash in case the worst happens. In addition, stock investors should keep enough investing cash on hand to buy three or four positions so that they're ready to take advantage of market sell-offs.
  5. Keep a shopping list. Know what stocks you'd like to own and the prices you'd like to pay. Computer-driven drops can reverse in minutes. Your shopping list helps you move quickly enough to take advantage of the market's irrational fits.

Shopping list ideas
Need to seed your own shopping list? Here are a few stocks at the top of mine.

Air Products and Chemicals (NYSE: APD  ) sells medical gasses, as well as those necessary to the production of just about everything we use or consume, from refining fuels to making gadgets. Since the financial panic of 2008, it has done a great job of expanding margins and growing the top line. It's cyclical, and selling at the low end of its usual P/E range, presumably due to fears of an oncoming recession. I think it's worth a buy here, as well as a wait for better potential prices, especially in a panic.

Corning (NYSE: GLW  ) capitalizes on the trend of feeding our heads: Its display technologies business is growing by leaps and bounds as demand increases for LCD screen glass, and at the same time, the data flowing to those computers, phones, and tablets flows through Corning's fiber optics products. Throw in a fast-growing environmental division plus a cash-rich balance sheet, and the current price looks like a bargain.

Apple (Nasdaq: AAPL  ) might seem too obvious, but maybe for that very reason, it's worth another look. How often do you pay only 15 times earnings for a company with expanding market share in existing and new product categories, expanding margins, and 30% top-line growth?

PotashCorp (NYSE: POT  ) looks poised to continue profiting from growing worldwide demand for fertilizers. Recent, bad harvests in many areas of the world have kept certain crop prices high, and though that may moderate, the need to feed the world and feed our industries agricultural stocks suggests to me the long-term trend here is up.

Waste Management (NYSE: WM  ) rarely goes on sale, but at current prices, it's about as cheap as it gets. You won't see a quick five-bagger here, but the garbage business is remarkably steady, and scale matters. That's why a behemoth, like this one, deserves a spot in any portfolio.

For five more ideas, check out the free report "5 Stocks The Motley Fool Owns -- And You Should Too."

Seth Jayson had no position in any company mentioned here at the time of publication. You can view his stock holdings. He is the co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. The Motley Fool owns shares of Apple, Waste Management, and Ford Motor. Motley Fool newsletter services have recommended buying shares of Waste Management, SodaStream International, Corning, Ford Motor, and Apple. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Motley Fool newsletter services have recommended creating a write covered strangle position in Waste Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (13) | Recommend This Article (83)

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 September 06, 2011, at 7:08 PM, ehuerta93 wrote:

    WM for the win :). Time to add to my position.

  • Report this Comment On September 06, 2011, at 7:50 PM, TruffelPig wrote:

    Agree with you. Shopping list for bad days:

    Instead of POT I prefer CF - has a lower PEG and excellent momentum right now. Same argument as you.

    Oil service industry got spanked - HAL would be established, RES a small jewel I think. Oil service will be increasing with increasing demand. Maybe a driller like SDRL or ATW. I prefer SDRL cause of the dividend (10% yield).

    Some tech stocks are cheap right now - e.g., TTMI

    Utilities! Overlooked and super-strong: BIP - I made money with it since July! It doesn't go down. Super earnings recently.

    Wow, I could go on. I must be an eternal bull.......

  • Report this Comment On September 06, 2011, at 8:28 PM, sails2 wrote:

    I like this kind of thinking. A couple of years ago (2008) I was driving to the dump (we live in the boonies) and heard on NPR that, at the then current rate of new car sales, the US auto fleet would have to last 23 years to sustain itself. When I got home I bought a couple hundred shares of Ford at about $2.25. Wish I had bought more. It was, in some sense, a gamble. But so far we won on that one. I am still underwater on the Ford I bought over 10 years ago. But the new batch..... got it on sale.

  • Report this Comment On September 06, 2011, at 8:57 PM, hbofbyu wrote:

    Hmmm. Don't be fooled into thinking that being a contrarian is always a safe play. What about "Don't try to catch a falling knife" or "Even a dead cat bounces".

    At footbal games when everyone stands up, I sit down. When there's a fire, I run into the building while everyone else is running out. It hasn't seemed to work for me so far.

    The only way to win at the stock market (and be able to claim legitimate responsibility for it) is to:

    1. Know some information that the big players, market manipulators and insiders don't (very tough to do and is usually illegal on some level).

    2. Get lucky.

    3. See into the future

    4. Be able to invest in time frames of 10 years or more (this is not foolproof being that the averages self select and the losers are not counted after they die).

    Other than that, it's a hunch that too many take credit for when, by design, every trade has a winner and a loser. The truely smart people are the ones who collect commissions or get you to buy a subscription to their newsletters.

  • Report this Comment On September 06, 2011, at 9:53 PM, JungleGent wrote:

    Excellent article, Seth. I totally enjoyed reading it. My most favorite sentence is "If you remove much of the decision-making from your investing, you remove most of your opportunity to make mistakes."

    Indeed, your imple rules aren't easy to follow. But if you can follow them, you'll make money. It took me 15 years and so much money lost to learn that "simple" lesson. I now buy when my "neighbors" panick and sell :-)

  • Report this Comment On September 07, 2011, at 12:51 AM, TempoAllegro wrote:

    Excellent article! There is much truth and good advice in it. However, some of those simple ideas are SO hard to follow that I would say they are nearly impossible for most people. How many of us can say we have six months of emergency cash plus enough money to open 3 to 4 positions when the prices drop for stocks on our watch list? Considering most people do not even start investing until their early 40's, I'd say that's not a lot. The author is describing an ideal situation...for me, I keep putting money into my brokerage, keep learning, and only once have I taken money out of it. I hope I can avoid that until retirement, which I assume will be 20+ years off.

    TruffelPig's comments are great! I agree with the picks there as well. I have SDRL and am considering BIP. As to which fertilizer company, while CF is good, I like MOS in the USA and SQM abroad because in addition to potash, it has natural iodine and lithium deposits. I want to wait for SQM to come down again to buy. My main question is on the oil majors - say, XOM, CVX, PBR, TOT, or others...I feel one or two should be in a portfolio, but cannot decide which. Also, it would seem now would be the wrong time to have them with the world economy slowing and oil prices plunging (same for companies such as BHP, RIO, or VALE). Suggestions, anyone?

    Any other suggestions on industries, like consumer staples, medical devices, or pharma? How important is the size of a company when pulling the trigger in this environment? My instinct is to go with bigger companies because I figure they will be more likely to survive any market turbulence.

    Finally, what are people’s thoughts about being on margin now? If you have a stable job and can comfortably remove your margin loan in 3 to 4 months, would you risk it assuming that the amount borrowed never exceeds about one-third of the total value of your portfolio (or what percentage do you suggest)?

  • Report this Comment On September 07, 2011, at 2:21 AM, daveandrae wrote:


    This will tell you everything you need to know about buying on margin.

  • Report this Comment On September 07, 2011, at 2:36 AM, Franky102 wrote:

    Apple is the best pick of the bunch. I totally agree that now is the perfect time to buy stocks. The "mom and pop investors" are scared of doomsday and stocks are cheap right now. Jobs in the US will remain weak but multinationals will keep posting massive profits in China and international markets. This article below really says it all with Apple:

  • Report this Comment On September 07, 2011, at 7:50 AM, SAMSCREEK wrote:


    in the energy sector, you might consider PNY

    and WEC. PNY has had a sell rating for awhile

    and it has done nothing but make money for me

    and has a nice dividend which they increase each year. Same with WEC. Any down turn I use to pick up more shares.

    You might want to look at Mainstreet Capital as a

    cash generator. It has raised it's divident twice in

    the last 12 months. It operates as a BDC company.

    Also, CBOE, MKC, HRL & CBL make up the rest of the stocks I have in my grandkids account.

    I use the dividends these stocks generate to purchase more shares in these companies, especially on big down turns, with the intent that

    i'm not selling for the next 20 years. So I like big

    market drops, because I know these are good companies and will rebound with a market upturn.

    Hope this may be of help to you, but do your own research.


  • Report this Comment On September 07, 2011, at 8:53 AM, RedandBlack wrote:

    I know Seth didn't write this because he hates Apple or maybe he just hates Apple products. Great article though.

  • Report this Comment On September 07, 2011, at 9:46 AM, TempoAllegro wrote:

    daveandrae - wow, great video on margin (basically). Buffett is an amazing speaker there, comparing going on margin to Russian roulette ("not a lot of upside for me and a very clear downside") - and on enjoying life. Don't risk what you can't afford to lose for what you don't really need.

    Samscreek - thank you very much for your suggestions. I see you have a good strategy, and discipline to buy on dips using dividend proceeds. I would like to reinvest dividends for some time first, but when I get closer to retirement I think your ideas are great (it must be good to be your grandkid, too!). My "main" problem with Main Street Capital is there is no way I can understand what they do. Yes, their dividend looks juicy and some other numbers look good. I noticed your pics are high on enterprise value relative to market cap (basically a good buy) but they all seem to have significant debt, which worries me. I still appreciate your giving me some stocks to research and applaud the reminder to do my own research.

    I am happy right now to take Seth's advice and DO NOTHING (except keep saving).

  • Report this Comment On September 07, 2011, at 9:53 AM, TMFBent wrote:

    @ RedandBlack

    You're right, I do hate Apple, Steve Jobs, and Apple products, but if everyone else in the world is happy with being enslaved by the iZombiepocolypse, then even a hater can like the potential profits.

    Everyone else, thanks for the comments. I've entered the stocks from the shopping list above into CAPS, as well as some of those you've mentioned. After some time, we can return to them to see how they fared.

  • Report this Comment On June 24, 2015, at 3:13 PM, dswallen wrote:

    Two out of five. Not great considering how incredible the market has been since this was written.

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