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Investing Ideas How to Protect Yourself from a Dangerous Rally
Investing Ideas How to Protect Yourself from a Dangerous Rally 
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| How to Protect Yourself from a Dangerous Rally |
| Friday, 19 October 2007 | ||||||||
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Dear Reader, I recently wrote an article for our INCOME subscribers detailing a very important hint to picking winning investments when the markets are acting crazy. This article comes from the Macro Minute section, in which I give a big-picture overview of what’s going on in the market. I hope you enjoy … Judging by the recent highs the market has been hitting, you’d think everything in the economic world was hunky dory. But that’s far from the truth. The truth is that the market is rallying in the face of slower domestic growth, a slowdown in manufacturing, weaker corporate earnings, and a slowing employment picture. In other words, there really isn’t a good reason for it. That’s not to say there’s not a reason for this rally, even if it is a bad one. It’s simply this: Wall Street expects the Fed to continue to lower interest rates.Never mind the fact that the Fed would continue to lower interest rates only to battle worsening economic growth. (That would be far too rational for Wall Street to comprehend.) But lower interest rates usually divert money from short-term bonds and into the market, because short-term bonds pay out less interest. That’s why lower interest rates are expected to juice the market.The question for us is this: What happens to the market after it gets its short-term boost? Well, what happened to Barry Bonds when he went off steroids? This rally could be short-lived. It’s certainly no time to jump into it with both eyes closed. Rather, it’s a time for caution. You need to pay close attention to the companies you invest in. Take Google (GOOG), for example. Sure, Google is the number-one search engine in the world. But would you pay 50 times earnings to have a piece of it? Let me put this into perspective. Paying 50 times earnings for a company is like paying $5 million for a company that makes $100,000 a year. At that price, it would take 50 years for your investment to finally break even!
Are you willing to wait 50 years to hit breakeven? And Google isn’t unique. There are companies all over the market that are now going for ridiculous premium to their true value. Why would anyone pay a premium for a company when the economy is starting to slow down?No logical person would. And when the market starts heading south again, overpriced companies like Google will be the first ones to drop. So how do you protect your portfolio during an economic slowdown? By buying into cheap companies that pay a steady dividend. You see, the beauty of a cheap company is that it usually doesn’t get much cheaper. So while the Googles of the market are losing 25 percent during a slowdown, the cheap companies barely lose any value at all. In fact, most could gain. And the reason is very simple. Let me explain … When consumers hear the word “cheap,” they think “poor quality.” But the cheap companies I’m talking about are exactly the opposite. These cheap companies have very strong balance sheets, make steady dividend payments, and have global exposure that helps shelter them from any blip in the U.S. economy. And the best part is that a lot of these cheap companies have been growing for 20-30 years. In other words, they’ve been through all types of market crashes and crazy economic scenarios – and it’s only made them stronger. Let’s not forget the dividend payment you’ll receive a few times a year, no matter if the market is flying high or crashing. And your portfolio will reflect that growth with outsized returns. Good trading, Charles Source : Investor's Daily Edge
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