OK, you just discovered the stock market in the last year or two. You have been buying stocks, trying to take control of your finances, trying to make some money in a market that has been on fire. You have beaten your mutual fund or your broker. You are thrilled with it all. You love the excitement.
And then you run into Tuesday's buzzsaw, and all of a sudden, you are thinking, "What the heck? Hey, am I over my head here? Should I buy more? I mean, I have my 401(k) contribution to make. I have some cash on the sidelines. Do I raise more cash, as I am still up big from last year? Is this selloff the beginning or the end? Is it an opportunity? Or is it the big comeuppance that I always hear those old guys talk about on TV?"
You've come to the right place. This article's for you. I don't have any merchandise to sell you. I don't want your commissions. I just want to help level the playing field, and after a day like yesterday, the playing field feels awfully lumpy and unfair.
First, forget about whatever you have heard on TV or read in the papers. When we have these selloffs, nobody really knows when they are going to end. What the heck, as my wife said to me midday, "Didja really expect that after a plus-85% year on the
that it would just keep going up?"
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We were due for a correction. What does due mean? It means the same as when
went 0-for-whatever after 56 straight games. Didn't make DiMaggio a bum. But it was sure a letdown. Did the Yankee Clipper then hit in another 56 straight games? Nope. Still didn't make him a bum.
I pick sports because, unlike most of the talking heads I have huddled with over the years, it correctly infects your thinking with elements of chance. It correctly sets the odds. In other words, if I were saying right now, "Buy because it is done going down," and it stopped, and I claimed that there was a skill behind that call, I would be bluffing. I would have gotten lucky.
So, if we don't know when it is going to stop going down -- if ever -- why buy anything? Why not sell? A perfectly good question. For these moments, I always fall back on the tenet that has served me well in my stock-picking career: There are bulls, there are bears, and there are pigs -- and only pigs get slaughtered. Simple homily, not as precise as "I always sell based on MPEG," or "I take it off the table when the P/E equals 3 times the growth rate minus the book value squared by the return on equity." But it is commonsensical. And it always applies.
Then, you might say, why not panic and get rid of everything? You've made more money than you could have ever believed. Can't it all be taken away?
To which I am asking you to rely on my laboratory. I have traded with all my heart and with all the dough I had since 1979, and I have never ever seen panic pay off. In fact, the great moments to invest during the '80s and '90s were not the "dips" per se, but the ones that felt like routs or panics because somebody, some guru screamed, "Get out now." Even if you can't take the volatility -- and, believe me, there is no crime to that; I know many professionals who vomited yesterday -- I would go for a staged reduction. In other words, don't order the helicopters to the Saigon embassy; there is a better way out of Vietnam.
What does my experience with turbulent markets tell me? First, I like to dig deeply into the reasons why we are having a selloff, even as I know we were due. I want to know if anything has
. Is there something in the firmament that is so different that this time it would be stupid, heretical or anti-common sense to put some money to work?
Interest rates sure have taken a big jump here. They are getting more competitive as an alternative, but I don't think they are there yet. I know that if I were to make a 401(k) contribution today to bonds, it would not be to make a big profit; it would be because it was somehow "safer" than stocks. Sure, if rates went up to 7%, they would be more attractive, and at 8% it might be sayonara market for now, because you just can't beat 8% compounding after you have just socked in some big gains in risky stocks.
Oh yeah, by the way, you may have discovered Tuesday that they are risky. One of the more embarrassing moments yesterday was watching "great first day pop"
get halted and
on the very same day that one of the least risky strategies for making money in this bull market was playing out: initiation day. Yep, 30 days out of the IPO chute, the bankers get to start promoting, but this glitch -- did it or didn't it lose GM and did we really discover it from some radio interview last month but just learn about it today? -- sure did kibosh the strong buys of the world. That FreeMarkets trading was amateur hour for everybody involved.
How about that for something that has changed? The risk/reward. Does it make sense that stocks that have gone up hundreds and hundreds of percentage points have more risk in them than stocks that have done nothing?
Believe it or not, this one is a bit of stumper. The carnage in this selloff has extended to areas that looked like they were pretty immune from further selling. The real drubbings here have been in the drugs and the bank stocks. The only "can you believe where that stock has gone to?" conversations I had with
around the office yesterday revolved around
No, the only thing I saw that was truly different yesterday was that stocks that hitherto had not traded as a commodity, notably the
, did so yesterday.
At the risk of forcing you to scroll down some more, let's go into the velocity of this selloff so we can understand why something may be a little more dangerous than I thought, but not so dangerous as to make it unpalatable to you at home.
Ever since the advent of stock index futures, stocks have been lockstep linked with bonds. When bond futures sold off in Chicago, stock futures then sold off, which led to the selling of the underlying stocks. We don't have time to go into how that works in this piece, but you should check my archives, I have gone there many times. (Again, why I love the Net. You can just click on
Best of Cramer, and I have some stuff in there about this.) For the purposes of this piece, let's accept that interlocking nature of the markets. When rates go up, it has been historically difficult to make money in stocks. When rates go down, it has historically been good for stocks. Bonds are like the backdrop. A rate rise is like rain; it just isn't that much fun playing in stocks in the rain, especially a vicious rain like we had in bonds last year.
However, most of the stocks individuals buy themselves are over-the-counter tech stocks, many of which are too new or too "unseasoned" to trade in sync with bonds. First, many are not part of any index. Don't forget
just got added. That meant these stocks don't trade with the same established patterns that older stocks groove to. (Yahoo! was whipsawed huge by an
sell program in the last half-hour yesterday, by the way.)
When bonds go down (rates go up) they haven't impacted these newer stocks the way the older stocks get impacted. (It is precisely
of this linkage that the S&P 500 vastly underperformed the unhinged NDX last year.) Instead, what has controlled these stocks' movements is a rare combination of individual enthusiasm, some mutual fund embracing and some excellent fundamentals.
Yesterday, however, wasn't like that. Institutions were selling index futures for all sorts of different indices, and they knocked down both old and new stocks. They had not been able to do that before. The individuals could not stem the decline with their purchases. In fact, individuals who were on margin contributed to the selling to beat the margin calls that will occur if the stock market keeps going down.
You could read that as meaning "the party is over" because once these stocks are connected to other assets, they will lose their magic quality.
Part of me says that is true, and that it would be a better idea going forward to lessen exposure to the so-called
Red Hot stocks. In fact, there is an excellent article in today's
about how managers are fed up with the high prices of some tech and are looking elsewhere for exposure. I know I want to look for bargains among the drug and bank rubble, but I still am more drawn to the tech stocks that have gotten clobbered. That's where I am most confident of the fundamentals even as the valuations have been stretched severely.
Which gets us back to the basic question: What do you do if you have money on the sidelines or you are already in somewhat and scared?
If I had taken nothing off the table at all and am running around fully margined, I would take advantage of any lull and trim back.
You can't afford to be margined up here. You could lose it all. Sorry, but I am calling that strategy by the name that comes to mind: "stupid." If I had something in and have cash, I would now add to some of the stocks that have gone down the sharpest, even though they were up huge last year. Indeed, that was my game plan yesterday and will again be today because I do have cash coming in and cash on the sidelines and I had been hoping for a pullback to put money to work. Now that it is happening, I can't shun it in fear. It never feels good to buy during the best times to buy.
And if I were making a contribution to my 401(k), I would take advantage of the decline and put the money to work. To sum up, we amateurs and professionals don't know when the selling is going to stop. But equities remain the preferred competitive investment to bonds, stocks, gold, cash or real estate here. That hasn't changed.
Could I be wrong? Sure, happens all of the time. Have the methodology and thought processes outlined here worked for me for the past 20 years?
James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund was long Yahoo! and Ariba. Cramer's fund also may be long or short certain stocks in his B2B rotisserie league or Red Hot index. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column at