Stock market - is it time to buy again?

Are stocks on sale? Or is there more pain ahead?

First of all, there's no doubt that stocks are "on sale." Assuming that means that they've dropped significantly from their highs over the past few years. Many top blue chip companies have fetched prices not seen for nearly a decade in the past few weeks and months. The question is - is the bleeding over? Is now a good time to buy? The answer to this question is manifold.

A good company is a good company in its own right

The reason disciplined investors can profit greatly during economic down-times is precisely because just about all stocks suffer during a recession/ depression, even the good ones. There's companies out there with rock solid fundamentals - high earnings, low debt, and high cash flow. While they may not sustain these numbers as readily during economic lulls, the ratio of their fundamentals to their share price often gets better. That is, the company gets to be even cheaper relative to earnings and other metrics.

Use a balanced investing approach

One reason we here at Informed Investments advocate a balanced investing approach - that is, shorting stocks at the same time as going long on securities - is precisely for times such as these. Sure we're confident the stock market will gain in the long run, as it has for the last century, providing investors with an average return that out-does just about any other investment vehicle. But the key is to do your research, and diversify, for there will always be companies that decrease in value or go bust. By investing in the market in both directions we feel you can maximize your opportunities for higher returns. Your short investments will hedge your losses, not only during recessionary periods, but in general.

Consumer spending on credit artificially inflated market performance

Given the current economic climate, we feel we may only be at the beginning of a deeper recession. Particularly when we consider the fact that the last ten years of economic growth are hinged primarily on consumer spending. Once you take consumer spending out of the equation, the economy has not done so well - in fact, its growth rate has shrunk over the past decade. That means stock prices have been pumped up by consumer spending habits - habits that turned out to be based in credit that is now growing into piles and piles of debt, a lot of which will never be repaid. That's a lot of lost money for companies and Wall Street in general, as this year has already shown.

Commercial real estate and option-ARM mortgages are next

The credit crunch for consumers looks to just be beginning, which means an even greater decline in spending in the coming years. Industries that appear to be next in line to suffer include credit cards, commercial real estate (which until now has not suffered nearly as much as residential real estate), and banks that have option-ARM loans on their books. There's an estimated $500 billion worth of option-ARM loans set to expire between 2009 and 2012.

What is an option-ARM loan?

An option-ARM loan allows borrowers to pay a minimum payment on their monthly mortgage payment, the difference of which is added on to their mortgage balance. The concept, and anticipated fallout, is similar to minimum payments on credit cards, and ever increasing lines of credit. More on option-ARM mortgages in an upcoming article.

Dollar-cost average your way back into the market

At this time we feel the best approach is to dollar-cost average your way back into the market. There's many large, solid companies, with minimal exposure to the sub-prime mess, that are feeling the pain of investor panic and therefore trading at significant discounts to their fundamental valuation. But since we're uncertain the bleeding is over, our approach is to buy a little, and if the market drops, buy some more. This way, we can dollar-cost average our way into a lower price that, once the markets recover, should garner significant returns. This is especially intriguing considering that the prices of many Fortune 500 companies are at five-year lows, and in some cases, ten-years and more.

An example of dollar-cost averaging : Coca-Cola (KO)

Coca-Cola's (KO) stock price has hovered in the $40 to $80 per share range in the last ten years, and, at the time of this writing is towards the bottom end of that range, in the mid $40's. So an example of dollar-cost averaging your way back into Coca-Cola stock over the next few years (not being sure as to whether or not the stock has hit a bottom), would be to purchase some now, at say $45. Then, set buy orders at $35 and $25, which will trigger in the event that the stock drops even lower. If one or both of those orders kick in, you will have lowered your cost basis (average cost) for the stock, to $40 or $35 (assuming you purchased equal portions each time), respectively. You can also opt to buy a greater amount of stock at lower prices, which will lower your cost basis even further. Then, when the economy recovers and Coca-Cola stock climbs back up, you will be in place to reap the profits.