As Of: October 10, 2001

UNCERTAINTY

A Time Of Opportunity And Danger

    The stock market has two immediate problems: 1) Profits have been declining as the economy has slowed down dramatically. How and when profits will turn around in the future is uncertain. 2) America is at war against an unseen adversary in unknown locations. The size of this conflict, the duration, the cost, and the final result is uncertain.

    Lack of forward visibility in the stock market results in uncertain decisions, lack of confidence, and volatility. Investment success in this kind of an environment requires avoiding the confusion, potential panic, and chaos of the crowd. It is important to chart a clear course and stick with it.

    In order to develop an investment plan, focus on the known facts and the probabilities:

1) We are in a declining economy. (I call it a recession, but the label isn't important.) The events of 9/11 aren't in the official numbers yet. The full effect of the terrorist attacks will not be known for a long time, but the immediate effect is to drive us into further decline.

2) From its low on 9/21, the stock market has bounced up. It would be historically very unusual for the market to keep going up without at least testing the previous lows.

3) There is no clear end to the war on terrorism. There is little reason to believe that the markets will realize a surge of optimism due to some kind of a definable victory. It is probably more likely that once the novelty wears off, we will become war weary.

4) Volatility is the hallmark of uncertainty. No matter which direction the market ultimately takes, the trend will be masked by a lot of volatility.

5) Time is as important as direction and degree. The worst case may not be that the market goes a whole lot lower. The worst case may be that the market simply does not go up. In this case, some dividends and interest will be more important than growth.

6) The government is engaging in a large amount of monetary and fiscal stimulus. This may do nothing in the short run and help in the long run. It may help in the short run and hurt in the long run. Or it may simply be ill advised and only prolong an inevitable economic cycle.

7) The basic structure of the global economy has not radically changed. No matter how bad things get in the short run, there is reason to believe that the economy can eventually return to a healthy, balanced state of growth.

    How does one make sense of all this? I perceive three themes:

1) Invest defensively and emphasize income from dividends and interest.

2) Invest for the long run by selecting companies that represent good value and have the economic strength to weather this downturn, regardless how long it lasts.

3) Use volatility to advantage. Buy the dips and sell the rallies. Be nimble. Be disciplined. And do not assume that we will see any clear trend for a while.

See the special report titled: The Mortgage Time Bomb -- An additional economic consideration.