On Thursday, Aug. 15, the stock market was shaken by news that the
scandal surrounding Salomon Bros., a leading investment bank charged
with rigging Treasury securities auctions, was far more serious than
it had first appeared. The next day, the Dow industrials fell 30
The following Monday came the shocker that Soviet President
Gorbachev had been ousted by hard-drinking hard-liners. The Dow
plunged another 100 points in the first hour of trading.
Yet before Labor Day rolled around, the Dow hit an all-time high
of 3055. If you had sold because of the coup, which quickly
collapsed, you would have passed up average gains of 6% in less than
Wall Street pros get a kick out of saying that small investors
always panic and sell on bad news. By promoting that cliche, these
self-serving experts are sending a simple message: they're smart,
you're dumb; so you need their advice. And unfortunately, much of the
financial media parrot that idea.
The facts, however, show the experts are wrong. The pros are the
ones who dump stocks in a sweat; the little guys are the ones who
On the morning of the Soviet coup, for instance, a poll of 221
stock investors taken by Fidelity Investments found that 66%
considered the upheaval to be an opportunity to buy, while only 9%
thought it was time to sell.
Buying on bad news is often a smart strategy -- but not always. In
the week after Iraq invaded Kuwait in August 1990, the Dow dropped
148 points. Instead of rebounding, though, the Dow sank another 352
points over the next two months.
So when a headline makes the market plunge, you must first figure
out whether a quick recovery is likely. If it is, you can then
confidently buy stocks that have been knocked down. Here's a
step-by-step guide to savvy bargain hunting:
Keep a cash reserve. Even if you keep your money in stocks, you
should always have at least 10% in short-term investments such as
money funds so that you have cash to invest.
Maintain a ''buy'' list. Rather than trying to spot bargains in
the middle of a crisis, prepare ahead of time by putting together a
list of financially strong blue chips you would like to own.
Set target prices. The stocks on that list should be reasonably
priced to begin with. Then write down the target prices that would
make them a steal.
When a crisis begins, assess the economic backdrop. ''Stocks
didn't bounce back after the invasion of Kuwait because the economy
was already slipping into a recession,'' explains David Bostian,
chief economist at Josephthal & Co. ''But in the case of the Soviet
coup, the economy was starting a recovery.'' Bet on a rally only if
the backdrop is favorable.
Be sure the crisis doesn't have major financial effects. ''As a
general rule, news events have only temporary consequences for stock
prices,'' says Eric Miller, chief investment officer at Donaldson
Lufkin & Jenrette. ''The exception is something like the Arab oil
embargo in the fall of 1973, which altered the economic
fundamentals.'' By pushing oil prices from $10 a barrel to $19, the
embargo rocked the gas-guzzling U.S. economy and triggered the 17-
month recession of 1973-75.
If you decide today's crisis will be tomorrow's dim memory, buy
any stocks on your list that have dropped below your target prices.
Also, resist any new spur-of-the-moment strategies inspired by the
latest headlines. ''Whatever your impulse tells you to do, don't do
it,'' says Michael Metz, chief investment strategist at Oppenheimer.
''Just act as if there were no crisis at all.''
In short, let the others panic, while you profit.
The Federal Reserve will push down interest rates, if necessary,
to sustain the recovery and keep the economy growing at a 2% to 3%
rate over the next 12 months.
With the outlook for corporate profits mediocre at best, stocks
appear overpriced by 15% to 20%. The safest buys are blue chips with
yields of 4% or more.
If inflation stays down and the Fed lowers interest rates, bonds
could give you capital gains of 5% to 10% in addition to their yields
of 8% or so. But big profits on long-term issues are unlikely.