Stock markets are up 50 percent from the March lows and you need to prepare for a correction. Whether you believe that a 10 percent pullback is reasonable or that something greater is coming, it makes sense to invest with the perspective that a retracement is coming and still be positioned for more market movement forward.
There's a way to play a market downturn and still not be caught in the trap of guessing when the market will rise or fall.
Yes, the ideal strategy is to simply be out of equities when the market drops. But as this recent rally has shown, that's easier said than done. Many brilliant investors who were right about the downturn in the equity markets were wrong about the upswing and are suffering the consequences now.
So, if you follow the timing path, do so with a healthy dose of recognition that it is a tough road to be sure. Remember, everyone knows yesterday’s lottery numbers; few can guess the numbers a month from now.
There are several keys to long equity investing when the future direction of the market is uncertain (and when is it not uncertain?):
Own Companies in Tailwind Industries
These are sectors where the general outlook will help companies perform. These sectors include energy, infrastructure rebuilding, wireless, and healthcare. These areas will likely grow in importance in the next five years and give added boost to potential investment returns. Companies to investigate include Exxon , Caterpillar , Vodafone , and Baxter .
Buy Companies with Great Cash Flow
Free cash flow, a favorite investment theme of Warren Buffett, is a good measure of company financial strength. Despite reports about problems in their financial division, GE has a great stable of businesses and continues to raise their capital levels (as evidenced by recent reports of the sale of their security business). Don't count out GE. Warren Buffet hasn't; he put $3 billion into General Electric . He loves cash flow companies; you should too. (GE is the parent company of CNBC.)
Invest in Companies with Solid Management
Navigating today's environment is not easy and requires pro-activity and vision. Jamie Dimon at JP Morgan has done well; he is a good example of a thoughtful, opportunistic leader. You need someone running a company with these traits in a volatile environment.
Companies with diversified cash flow on a global basis will help when specific economies struggle. True, the concept of decoupling is pretty much in shambles right now but there is some truth that international diversification can reduce fluctuation risk and increase potential returns. McDonald's , with an aggressive expansion plan for China, is a diversified global company with revenue from around the globe.
By holding the right type of equity assets, you can weather a downturn and still be positioned if the pullback is less than you expect. It's a probability game and positioning your portfolio for both scenarios is the key to long-term success.
There is a great scene in “Indiana Jones and the Last Crusade” when Harrison Ford must choose among a number of goblets (dozens of choices) in a dark cave and must be right in his choice. The right choice brings great rewards; the wrong choice only disaster. As he ponders his decision, the guard in the cave calmly says to him "choose wisely." The same can be said for investing in today's environment; choose wisely. Do not choose based on emotion, whether it be anxiety or euphoria. Choose wisely and you'll reap the fruits for years to come.
Michael A. Yoshikami, Ph.D., CFP®, is Founder, President, and Chief Investment Strategist of YCMNET Advisors, Inc., a registered investment advisory firm (www.ycmnet.com). He oversees all investment and research activities of YCMNET. He is a respected lecturer speaking frequently on market issues, tactical asset allocation, and investment strategy. Michael and YCMNET were ranked as one of the top investment 100 advisors in the United States for 2009 by Barrons. He appears regularly on CNBC and CNBC Asia and can be reached directly at email@example.com.