In the Middle of the Storm, a Compass Can Be Your Best Friend

Everyone from high-test hedge fund managers to retirees is telling me that he or she is looking for a money-making strategy for difficult times. That's precisely the right thing to do in punky stock markets that have soured on speculation.

Today is not a time to make wild bets. Instead, it's time to stay calm, cool and collected and to apply cold reason to a cruel market. It's time to embrace sound stock investment strategies designed, first and foremost, to protect your assets, and secondly, to earn you a decent return. (By decent, I mean 15% a year.)

There is no one strategy, obviously.

For the professional, George Soros-style macro player, a long/short strategy that allows you to use your informational edge and minimize market risk might be just the ticket. For instance, if you think the property and casualty insurance companies and the reinsurance companies are in sound shape, you might go long those not overly expensive stocks. Then, if you expect more credit quality problems at commercial banks, simultaneously going short the banks wouldn't be a bad idea.

This strategy has a powerful logic. The property and casualty insurers and the reinsurers are, for the first time in years, raising prices. And the up-cycle could last longer than usual because we have yet to see massive inflows of new capital come in and brainlessly compete for the business without regard to underwriting margins.

Meanwhile, the commercial banks may well suffer more unexpected loan loss reserves before too long. (A few months ago, do you recall a lot of people expecting Wachovia(WB - Cramer's Take - Stockpickr) and SunTrust(STI - Cramer's Take - Stockpickr) to announce credit problems? I don't.)

For the less aggressive, you might simply want to go long some of the insurance stocks. (This Soros-style trade could, however, be dangerous to your financial health if you're not lightning quick to unwind it if you see it going awry.) I'm no insurance guru, but many of these companies are projected by Wall Street analysts to show 10% to 15% earnings growth next year. And the 12-month forward P/E ratio for many of them remains in the 13-15 range, which is not overly pricey given the estimated earnings growth rate. The stocks also have some nice price momentum going for them, always a good sign in a weak market. And the Fed has yet to begin lowering interest rates, which typically helps the financials. While I'm not holding my breath waiting for the Fed to make a move, insurers should get a second wind when it does.

If you doubt the wisdom of buying something as stodgy as insurance companies, perhaps you might be impressed by the fact that no less an investor than Warren Buffett has been upping his insurance exposure in recent years in his holding company, Berkshire Hathaway. After slumping in the first third of the year, Berkshire shares have rallied strongly, and show no sign of folding. When speculation gets a bad name, the flight to quality almost always leads to Buffett's door.

Finding Your Compass

Speaking of Buffett, I can't help but think of the investing book he has plugged as "by far the best book on investing ever written," The Intelligent Investor by Benjamin Graham. It's the bible of value investing. And value investing is not a bad way to go today.

In chaotic times, you need a compass, a discipline and the value approach gives that. I urge you to read this book, especially chapter 8, "The Investor and Market Fluctuations" and chapter 20, "'Margin of Safety' as the Central Concept of Investment."

Value investing is, of course, by no means the only valid strategy. But it seems just right at the moment. It tends to lead you to steady earners, defensible valuations and to stocks with a nice wind at their backs. This comes as more and more of those who mistakenly speculated on stocks that are not coming back anytime soon look for shelter from the storm.

Don't kid yourself. There is a storm raging outside. No one knows how serious the economic slowdown will be. No one can call a bottom. But one thing I am confident of is that there is more capitulation to come in many high P/E stocks. Tech stocks have gone down, yes, but generally not on massive volume. (A source who recently attended Morgan Stanley Dean Witter's annual big money conference in Lyford Cay, Bahamas, reports that the meeting was filled with "fully invested bears.") The Nasdaq Composite is off about 35% in the year to date. We haven't seen three consecutive up days on the Comp since August. Yet, we are not seeing record volumes.

I think we will before this is over.

You need an investment strategy to survive whatever comes. I plan to write more about this in the days ahead.