What to buy after the next crash

This week, Mr Market is subjecting us to a chilling reminder of what lurks beneath

The balance sheets for what remains of the UK banking system remain in tatters. Hence the re-emergence of the taxpayer-backed Asset Protection Scheme, which has thrown another £25bn at RBS.

We're also still in recession. The Office of National Statistics surprised us all by revealing that the UK contracted by 0.4% in the third quarter. That's six quarters of 'negative growth' on the trot.

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Maybe that's why stocks have had such a trying week. The FTSE 100 index of leading shares is down 3.03% in the past five days.

However, despite many claims to the contrary, this is no reason to panic. We've been through this routine more than a few times before and know that after a correction in stock prices, markets tend to resume normal service once again.

If you, too, believe that there is potential, after some pain, for more stock gains then I've got something that may interest you. I've been conducting a little bit of market research. I've called every accountant, analyst and investment adviser in my rolodex. I've canvassed my colleagues at Fleet Street Publications and quizzed the team at MoneyWeek. To each, I asked the same question:

"What is the first stock you will buy if the markets correct?"

It's a simple question that has elicited some brilliant responses. So which stock topped the list?

Randgold Resources (LSE: RRS) This blue-chip gold miner has risen 54% in 2009, and it's still rising. I've made the case for gold on more than one occasion and I must pay Randgold it's dues. It's correlation with the price of gold is beneficial but this stock is also highly volatile.

The rest of the results are also worth considering:

BHP Billiton (LSE: BLT) Infamous mining group has outperformed peers.

Standard Chartered (LSE: STAN) One of the only banks not to require direct government assistance.

Apple (Nasdaq: AAPL) Sales have beaten analysts forecasts every quarter this year, by a country mile.

ICAP (LSE: IAP) Tory Treasurer Michael Spencer's broking empire made a fortune on the way down and the way back up again.

Burberry (LSE: BRBY) International sales helped push Burberry into the FTSE 100.

Tullow Oil (LSE: TLW) Fortunes are made and lost trading this 'high beta' stock. In 2009, the bulls profited as the shares rose 90%.

Goldman Sachs (NYSE: GS) The first investment bank to pay back its TARP money has a knack for getting the big calls right.

The JP Morgan Emerging Markets fund (LSE: JMG) Emerging markets are still the dominant trend among economists and stock pickers alike.

The list served up no big surprises.

I had an inkling that Randgold, BHP and Stanchart would be near the top of the poll.

After all, BHP is a play on basic base metal buying in China. Randgold Resources is a play on precious metal buying in China. And, Standard Chartered is a play on wholesale banking in China.

The economic growth displayed by the Asian giant is the envy of the rest of the world. China has resumed its pre-credit crunch crown as the theme that every investor wants a piece of.

However, what this list tells me, as a value investor, is that these are exactly the type of stocks you should be avoiding right now.

Too much, too soon

Out of curiosity, I did a value check on the stock wish list above. Here are my findings:

The average price to earnings ratio is 45.5

The average price to book ratio is 4.4

The average dividend yield is 1.5

That is too high, too high and too low (respectively) for a UK value investor.

I concede that the figures were skewed higher by the outrageously expensive Tullow Oil. Nonetheless, the message is clear. The problem with entering the stock market at this late stage in the day is value.

There is a dearth of cheap value plays, and not just in our racy shortlist.

Across the market, stocks have been bid up far too far. Popular strategist Andrew Smithers said last week that the S&P 500 is overvalued by 40%. Closer to home, my colleague Paul Hill of Precision Guided Investments thinks the FTSE could fall 20% in the coming months.

I'm not going to put a number on it, but I too can see signs of exhaustion in the rally.

What to buy in the meantime

That's why I have been taking profits on several trades recently. In many respects, a correction is desirable. It would present a great opportunity for investors to buy into some of the stocks I've listed above that are too pricey at present.

In the meantime, I'm sticking with gold, corporate bonds and call options. I don't yet see much value in my shortlist of high flying stocks.

This article was written by Theo Casey, investment director of the Fleet Street Letter , and was first published in the free daily investment email The Right Side on 4 November 2009.