How to ride out the market turmoil

The markets have been in turmoil for a year now – and things still look bleak. The key for investors is to be patient and concentrate on investing rather than speculating. Do some work, take your time making your decisions and don't panic. Meanwhile, here are four US stocks that may be close to a bottom.

By MoneyWeek

published 27 August 2008

in Features

One year and counting

That's about how long the financial markets have been in turmoil.

And when the stock market finally recorded a 20% decline from its October highs (the technical definition of a bear market), it provided plenty of fodder for the "experts" to shout about.

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It seems the so-called astute investment community adopted the traits often found in government or public officials: The usual inability to identify problems until well after they've occurred, banishing the chance to be proactive in dealing with them.

In truth, the dramatic decline in the US financial and housing markets was quite evident in early 2007, yet the Federal Reserve, Treasury Department, and investment bankers alike were all lulled into dangerous states of inactivity. Combined with the extraordinary rise in energy costs and commodity prices, these factors have taken a heavy negative impression toll on the economy.

Here's what you need to know - and which companies could combat the current situation best from here

The market's 2008 burden

Although the US dollar has climbed against other major foreign currencies like the euro, pound and yen over the past 10 days, its overall devaluation hurts Americans travelling abroad, but helps US exporters and foreigners travelling here to pick up bargains.

Still, the picture remains bleak, as we've witnessed the demise of Bear Stearns, billions of dollars in bank write-offs, the implosion of Fannie Mae and Freddie Mac, the continuation of the sub-prime mortgage debacle and resulting foreclosures as real estate prices sink.

At the same time, Americans' spending power is rapidly eroding, as inflation continues to rise. So what can we do now to prepare for the future?

Invest more speculate less

Although the next 6-12 months seems bleak (if you listen to a lot of the mainstream press anyway), I believe it will create significant investment opportunities for patient investors, who rely on facts, rather than following the panicking herd out the door.

Yes, while factors both here and abroad warrant caution (examples include the resurgence of Russia as an aggressive nation, a changing of the guard in Pakistan, nuclear tensions in Iran, an economic slowdown in Europe, and the US presidential election), they certainly don't signify financial ruin.

The difference between investors and speculators is knowledge. Yes, every investment is somewhat speculative, no matter how safe you think the asset may be. But a good analyst relies on a wide array of data in selecting a pick in order to give the best possible chance for success.

Those tools include monitoring industry trends, and thoroughly analysing balance sheets, income statements, cash flow analysis and the history of that entity under various scenarios. Many go even further by interviewing management, competitors and customers.

You can then make a better judgment about when the asset should be bought or sold, plus the probability of success. It takes time - but it's time well spent.

Don't bet on the Fed this time

Don't pin your hopes on the Federal Reserve. The bankers are virtually out of options that can save the system, short of bailing out every struggling financial institution or creating rampant inflation.

The fact is, the "good old days" are gone... the financial sector shakeout probably has further to go... and the value of underlying assets and the ability of the various institutions to raise capital is still uncertain.

In the absence of much leadership, I continue to remain sceptical about a sustained rally or the beginning of a new bull market. But there is hope.

Signs of a market bottom (which will be the first indication of full recovery) might include market capitulation, a shakeout of money managers - including hedge funds - and even greater negative sentiment.

Longer-term positives would include oil prices dropping closer to about $70 a barrel, a rally in the US dollar to about $1.10-1.25 versus the euro, and a basing in the housing market, with stable housing starts and fewer foreclosures.

In the present, though, US corporate balance sheets are quite strong, and stable share prices can create a major stimulus to cash flow and corporate profits.

Two more stocks for your watchlist

In my last column, I mentioned two companies that might be within striking distance of a bottom - Walgreen Co. (NYSE:WAG)and Verizon Communications Inc. (NYSE:VZ). Since that time, Walgreen is up slightly and Verizon is down a bit. But both are still worth considering on pullbacks.

Today, you could take a look at Nokia Corp (NYSE:NOK)- the world's largest cell phone manufacturer. It's another large-cap company that provides a relative degree of safety and is dominant in its respective markets. Two of the most dominant include China and India, where the firm is still expanding.

Selling at less than 10 times next year's earnings, the stock yields about 3.3% and has a strong balance sheet. Even if it approaches its 52-week high of $42.22, it would appreciate by nearly 70% excluding dividends. And that gives long-term investors a potential return of 30% per annum over a 24-month time horizon.

If you can take on more risk, check out Enzo Biochem (NYSE:ENZ)- a small biotechnology company that has made several acquisitions over the past year. Those purchases should enhance revenue growth and give the firm a strategic presence in its markets, while simultaneously giving it the ability to pursue its vast intellectual property

All told, Enzo Biochem has significant long-term opportunities and I'm confident that it will enhance its future prospects - especially with $75 million in cash and new management.

This article was written by Aaron Lehmann for the Smart Profits Report