Rational Blog

A Rational Blog for Irrational times

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So what will you do during a nuclear apocalypse? During the Cold War, I'd imagine myself sitting on my lawn chair, donning some shades, and watching the mushroom cloud from my front lawn.

Such a scenario is not a funny matter, but what the heck else are you going to do. I figured if I was going down, I'd go down cool.

Well fortunately we don't really need to worry about nuclear Armageddon today, but what about financial Armageddon?

What started out as a contained correction could turn out to be something much worse. Led by sub-prime fissure material, we are now truly facing what could be a global financial meltdown of epic proportions.

What is a Rational Investor to do?

For me, I'll take the same laissez faire approach mentioned above. No sense getting emotional over something that has been fairly easy to predict. In fact, I think I want to pop open a bottle of champagne.

The bargains that are being created in the wake of across the board selling are too good to be true. So many good companies are being sold in reaction to what is becoming mostly emotional selling.

Some of the most reviled sectors of today can be expected to be the biggest winners in a portfolio going forward. That means dabbling in the homebuilding, banking, mortgage insurance, and consumer retail industries.

My game plan will be quite simple. I want to own value and I want to sell excess.

I will scour the carnage and begin building a portfolio of undervalued companies that will survive and thrive no matter what happens to the economy in the short-term.

I'm very interested in the homebuilding sector where many companies now trade for very large discounts to book value.

Yes, I am well aware that book value is likely to be reduced as land values decline, but some of these companies are trading for 10% of book value. Even a 50% whack to book still makes these stocks historically cheap.

Following that line of thinking leads me to, you guessed it, financials. Banks are cheap no matter how poor the lending. In my opinion, much of the damage has already been priced into these stocks. The big money center banks in particular should be able to ride out this storm.

One of the most beaten down assets of late is the greenback. Frankly, I just don't get the selling in the dollar. Well, actually I do, but the logic of where we are trading today makes little sense. I want to own the dollar aggressively in any portfolio here.

That also means I want to be selling gold. The fear mongers shilling for gold will be reminded shortly when the rest of the world clamors to own dollars. A slumping world economy will be the trigger for this action.

On the short side of the market I want sell the excess of foreign stock gains. If the United States sneezes the rest of the world will indeed catch a cold. The concept of decoupling is far from reality.

The United States is the engine that turns the world economy. We have struggled of late and much of those struggles are priced into the market. My thesis going forward is that we are at or near a bottom with an upswing all but certain.

It is an excellent time to be buying all things American. The rest of the world has not yet corrected like we have. Put simply, I want to build my portfolio accordingly.

Timing is not important. Whether we go all in today or build our portfolio over time matters little. What is important is finding a bargain, making a commitment and sticking to it.

Keep cool. It may get a bit dicey as that mushroom cloud appears in the financial markets, but just remember there is little action today that can prevent the inevitable.

Wear those shades, pop open some champagne and get ready to buy some fabulously cheap stocks.

I'll have more specifics in my next entry.

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Wag the Dog

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Does the dog wag the tail or does the tail wag the dog?

I'm not so sure anymore.

The emergency action of the Federal Reserve is welcome relief from the carnage of a collapsing economy, but its timing shakes my confidence in this venerable institution.

I've been a Federal Reserve fan for a long time. Despite what you may hear from other pundits criticizing its actions, I feel quite strongly that the central bank has done a fabulous job of stewardship over the last 30 years or more.

Those blaming Greenspan for the housing bubble and ATM aspects of easy credit fail to properly assign blame to Wall Street, banks and borrowers. In addition, lower rates in the early part of the millennium staved off a deflation that would have lasted for many years.

We will never be able to prove such a belief because doing so would require us to change history, but I am quite certain bold action then prevented something far more scurrilous than a wee bit of inflation.

Flash forward to today and the new leadership of the central bank has me worried. Chairman Bernanke and his wish for transparency and consensus may be the wrong mix for the current situation we find ourselves in.

The recent cut in rates may have been the right move, but one has to wonder how they missed the boat in December when its actions were more timid and its statement continued to show much worry over inflation.

It is all a bit too wishy-washy for me at a time when bold leadership was needed to guide us through this morass. Did the Federal Reserve simply act to appease Wall Street preventing a correction that may indeed be quite necessary?

I think so and as a result the central bank thus loses one of its key tools, confidence, in its mission to achieve stable prices. So far the results have been favorable, but I do think caution should be used in our approach to the market.

No matter what the Federal Reserve does or does not do, I am a believer in the U.S. economy. That includes a strong belief in the value of the U.S. dollar and a suspicion over the supposed booming world economy.

To me the world is still heavily tied and levered to the U.S. If you figure the world is about six months behind the U.S. then world markets should lag the U.S.

In my Marketocracy portfolio I will act accordingly. That means building primarily long positions in domestic equities, done slowly over time, and selling global markets.

I'll start with a purchase of the ProShares Ultrashort China (FXP), Ultrashort Emerging Markets (EEV) and Short EAFE (EFZ) funds. I want to sell basic materials with a purchase of Ultrashort Basic Materials (SMN). I'll take $25,000 positions in each.

I also want to be long the dollar here and I will do so with the Rydex Strengthening Dollar x2 (RYSBX). I'll take a $100,000 position.

As for stocks I will start with a purchase of I-Shares Russell 2000 ETF (IWM). I'll take a $100,000 position here. Small cap stocks have been pummeled of late and to the extent the U.S. rallies, small caps should outperform.

Next week I'll start using the rest of my cash to take positions in long stories that I believe are undervalued. I'll be dollar cost averaging with monthly purchases over the next 6 months.

Jamie Dlugosch
The Rational Investor

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