To Everything There Is a Season

02/27/2008 12:00 am EST

Focus: MARKETS

Kelley Wright

Managing Editor, Investment Quality Trends

Kelley Wright, managing editor of Investment Quality Trends, reflects on the current market turmoil and urges investors to remember some fundamental truths.

That the word recession strikes such fear in the minds of investors is due in large part to the financial media. A recession in simple terms is two consecutive quarters (six months) of negative growth in GDP (gross domestic product). Stated more simply, a recession is a period of economic contraction.

The simple fact is that economies expand and contract; one begets the other. The same principle can be seen in the seasons: growth emerges in the spring, accelerates in the summer, is realized (harvested) in the fall, and goes to rest in the winter. This natural order also applies to markets on a macro level and to stocks on a micro level.

The seeds for every bear market are sown in the preceding bull market as the seeds of every stock decline are sown in the preceding advance. Excesses, whether to the upside or the downside, are unnatural [and] unsustainable and therefore must be eliminated.

Preoccupation with stocks and/or sectors that were the previous leaders is, unfortunately, a tendency most investors pursue. On some level, perhaps, it seems logical that what once traded at X price must certainly return. Generally though, new leadership emerges at the onset of every new bull phase.

Equally unfortunate is that when the majority of investors finally accept the change in leadership, these securities typically no longer offer good value. Bad habits being difficult to break, however, the persistency of chasing performance after the fact inevitably leads to negative returns, frustration and often, resignation.

The remedy for these situations, in our experience, is easily attainable. Rather than fixating on events out of our control, attempting investment methodologies that are outside of our skill set, or being preoccupied with previous leaders, we suggest that investors focus on what has proven to work over the long-term: quality and value.

High-quality stocks with proven track records of increasing dividends offer the greatest potential for capital appreciation, income from dividends, and a growing income stream from increasing dividends. Purchased at historically repetitive areas of undervalue, these stocks will be the new leaders when the next bull phase gets underway.

Can these stocks be buffeted by the winds of sentiment that accompany a recession or a bull market? Of course; even high-quality stocks are not impervious to the short-term gyrations of Mr. Market. Generally though, these stocks will stay within a 10% range of their undervaluation areas with the dividends providing a floor of safety. With diversification as an ally, a portfolio of select blue chips will withstand most periods of high volatility and will reward the patient, enlightened investor, for years to come.

Subscribe to Investment Quality Trends here…

Related Articles on MARKETS