Author: A.T.

There is a small but real chance our lives will be considerably disrupted January 1, 2000.

The purpose of this comment is not to alarm you or to join the ranks of perennial gloom-sayers. It was great sport making fun of them in the late 1970’s and early 1980’s. These were the folks who insisted inflation could not be reined back in without a total collapse of the economy, that a well diversified investment strategy consisted of a home in the woods with a gun, some gold coins, and a year’s supply of trail mix. Not to say things couldn’t have spiraled out of control back then … just that these folks seemed so sure that the “morons” in responsible positions did not grasp the problem and would almost surely not do sensible things to solve it. That’s where my naïve optimism paid off: I didn’t think the Volckers of the world (Paul Volcker: then head of the Federal Reserve) were remotely morons. I thought that when push came to shove, they would shove back as needed. It is this same naïve optimism that leads me to hope that Japanese leaders will act in the nick of time (they need, for starters, to cut way back on their tax rates, nationalize some of their banks, and “open the books” to more transparent accounting), thus to avert an even much worse Asian crisis that could easily become a world crisis.

One cannot be sure of such things, which is why one hedges one’s bets. (Note that Warren Buffett, no market timer, has nonetheless bought billions of dollars in zero-coupon, long-term U.S. Treasury bonds and millions of ounces of silver. I am not recommending either of those for mere mortals like us — for one thing, the price of those zeroes has gone way up since he bought them. But I do know that money you might need in the next five years belongs in the bank, not the stock market.)

But the Year 2000 problem is different. The Y2K problem can’t be solved by getting the powers-that-be to adopt sensible policies. Yes, part of the problem could be one of leadership and psychology — if people panic, panic alone will cause a financial calamity that could otherwise be avoided. So we need to count on our leaders to avert that — and I think they will. But part of the problem is simple nuts and bolts. For one thing, January 1, 2000 arrives in 501 days and cannot be put off. Can you think of another such crisis? Not counting the precise arrival time of an incoming comet? Any Y2K problems prior to that date will be primarily psychological in nature (The comet is coming! The comet is coming!), and thus avoidable. But any problems from that date on — well, they would be real.

Which is why companies and governments are spending billions and billions and billions of dollars to fix the problem … which is why, in turn, most of us assume it will be a minor annoyance at most … which is why we could be caught unprepared … which is why I’m writing this column now rather than, say, next summer.

The Y2K problem will probably be a minor annoyance to most of us, but it could quite possibly be a huge mess.

The biggest worry is what we’d do if the power went out. Which means, I think, that gasoline would soon go out, too, since gas stations run on electric power. No light, no heat, no refrigerator, no elevator, no computer … if it lasted just a few hours, as after a bad storm, it would be no big deal. But longer?

Probably this won’t happen, but it’s pretty hard to be absolutely certain. A friend of mine who I can say without a trace of modesty is much smarter than I am, long ago founded an institute to consider such nuts-and-bolts planetary problems. He is concerned about embedded processors. These little items are buried in things like the railway system. They took the place of the guy who would go out and manually switch tracks at the appropriate time, so trains careening through a junction headed in the right direction. So what if 2% or 5% of these embedded processors have a Year 2000 problem and, because they think it’s 1900, fail to switch properly? How long would it take to locate them all (they’re embedded! buried!) and replace the ones that need fixing? And in the meantime, he asks, how would things like food replenish your supermarket shelves?

Somewhere else I read about the problem — I hope it’s a myth — of an ancient piece of software that tells old computer fans when to go on and off. It naturally wouldn’t affect your Compaq. But what of some of the old mainframes? Everything else is working perfectly, according to this disaster tale, except this virtually prehistoric little bit of code controlling the fan. The fan does not go on (the code thinks it should wait 100 years before 20 minutes will have passed since the last time it went on), the computer overheats and goes down, and whatever it is controlling — the air traffic control system, your Social Security check — goes down with it.

I do not remotely have the competence to assess the reality of these kinds of threats. I know they’re real, or companies wouldn’t be spending hundreds of billions of dollars to try to deal with them. I know they’re real, also, because people like my friend the institute-founder do have the competence to assess these things and do not believe 100% of the Y2K problems around the world can be solved by midnight on December 31, 1999. And I know they’re real because the world is sufficiently interconnected that a problem in Japan or Italy can easily cause a problem in your home town. A score of 95% is an A in high school but would leave 5% of the Y2K software glitches undetected. Depending on what they were, these glitches could cause tremendous problems.

So the comet is coming, and now, when nobody’s panicking, is the time to do our emergency-preparedness stuff. Because the paradox is that if we do all prepare for food shortages and panic-in-the-streets, there won’t be food shortages or panic in the streets. But if we don’t, there just might.

Tomorrow: A Shopping List

But first a joke. (Surely it’s high time for another joke.) This one came a long while back from Dr. Steven Rubin, so inspired was he by the Jewish parrot joke. But I didn’t want to push my luck, so I’ve been holding onto it for a while.

An elderly priest invited a young rabbi over for dinner. During the meal, the young rabbi couldn’t help noticing how attractive and shapely the housekeeper was. Over the course of the evening, he began to wonder if there might be more between the elderly priest and the housekeeper than met the eye. Reading the young rabbi’s thoughts, the elderly priest volunteered, “I know what you must be thinking, but I assure you my relationship with my housekeeper is purely professional.”

About a week later the housekeeper came to the elderly priest and said, “Father, ever since your young rabbi friend came to dinner, I’ve been unable to find the beautiful sterling silver gravy ladle. You don’t suppose he took it, do you?” The priest said, “Well, I doubt it, but I’ll write him a letter just to be sure.” So he sat down and wrote:

“Dear Rabbi: I’m not saying that you DID take a sterling silver gravy ladle from my house, and I’m not saying you DIDN’T take it. But the fact remains that one has been missing ever since you were here.”

Several days later, a letter came from the rabbi. It read: “Dear Father: I’m not saying that you DO sleep with your housekeeper, and I’m not saying that you DON’T sleep with your housekeeper. But the fact remains that if you were sleeping in your own bed, you would have found the gravy ladle by now.”

Tomorrow: Getting Ready for 2000

 

From Billy Cravens: “I would like to get started in buying small stocks and I know very little and would like to make enough small gains on my investments and I would like your advice. The amount I was intending to start out with was around $500 to $1500 and I really need some help. P.S. I also have a 401k account and I realize the importance of long term investments so any help is appreciated.”

Good for you for wanting to start. I don’t want to discourage that. And the time to lose a portion of your money through inexperience is when you don’t have much – so that’s good, too.

Still, you’re about to sit down at a table with some very smart, very aggressive players. And it turns out even they have an all but impossible time racking up 20% a year after tax, on average (most will average more like 6% to 12% over long periods of time).

So we’re talking about growing your $500 to $600 – maybe – a year or two from now.

What’s my point? Two points:

1. It’s far more important that you simply get into the habit of saving/investing money periodically from now on … that WILL make you rich, or at least comfortable … than that you try to find a way to make a lot of small (taxable) gains by playing the market against the pros with your $500. Find a stock you really believe in and hold it for the long term. And keep putting aside whatever you can each month or quarter or year to add to your investment portfolio. You’re already doing that with your 401(k), which is great.

2. If you can find the time, and if I may be so presumptuous, go to the library or bookstore and read The Only Investment Guide You’ll Ever Need. It was written for you.

 

From Jin Hee Park: “I am interested in opening an IRA for my parents. After reading your article, I have learned that the Roth IRA is probably not a good one for my parents, especially my father. He is 58 and has no savings or retirement plan. I think he may retire in about 10 years. He doesn’t make much money, but needs a plan that will produce growth in a pretty conservative manner in the 10 year period. What type do you suggest? Please write me soon. I would like to start his plan as soon as possible.”

I may be missing something, but it sounds to me as if a Roth IRA would be fine for your father. You say his income is modest, so he loses little by not getting the tax deduction of a regular IRA – yet he will never have to pay tax on the withdrawals. So as between a regular and a Roth IRA, the Roth would seem to me to make more sense.

The next question is how to get “conservative growth.”

Big question. It depends on how conservative you feel you need to be. Bear in mind that though he may retire in 10 years, we hope your dad will live for 40 years – or certainly 20 or 25 years if he’s in normal health. So in that sense, you have more than a 10-year time horizon. If you bought stocks or mutual funds that were depressed 10 years from now, nothing would force you to sell them all the day he retired.

There are a million possibilities. Here’s just one: Open a Roth IRA for each of your parents at a deep discount broker. Put the full $2,000 a year into each one each year, if possible $4,000 a year. Put $1,000 of it each year in SPY – “spiders,” as they are commonly known, which will more or less mimic the performance of the Standard & Poor’s 500 … $1,000 a year in MDY, which is the same thing, only for the S&P MidCap 400 … and split the remaining $2,000 a year among three or four WEBS – these are like index funds for various countries. My hope/guess is that some of these countries will still be here 10 and 20 years from now, despite their current problems, and we may actually look back and think their stock markets were unreasonably depressed in 1998. (If they crater further, as they well may, you’d just buy more in 1999. One day, I think, they’ll turn back up. But you never know.)

Or just put it all in Intel and hope for the best.

A really conservative and not entirely idiotic strategy, though, is to start your fund someplace really safe and convenient, like the local bank, and just let it grow there, at least at first. Your parents probably won’t have as much money over the long run, but they will have the security of knowing where it is and that it will not go down in value.

As I say, though, there are a million possibilities and no single “right one.” Good luck.

 

Yesterday and the day before I wrote about DEP, a company that had gone into bankruptcy but emerged – to no fanfare – and managed to make some lucky, patient holders like me a heartening return. It’s not an investing style that’s for everyone, by any means, nor is it a style that always works. Not remotely.

Anyway, I know what you were thinking yesterday and the day before. You were thinking: “Why didn’t you tell us about DEP before it tripled?” And the answer is twofold. First, I’m reluctant to tout stocks I have any meaningful share in – especially little thinly traded stocks like DEP, where what I write could move the price. Second, this stuff is really risky, and I don’t want you to make an investment that turns out to be a clunker.

That said, I do have a stock you might want to look into – Calton Homes (American Stock Exchange symbol CN), understanding that I own a lot of it, purchased years ago, and that it really could fall five-eighths of a point. That doesn’t sound like much of a drop, especially for a American Stock Exchange-traded stock, but in this case, at least as of my writing, it would bring the price to zero. Zero, I need hardly mention, is a price at which it is hard to feel flush no matter how many shares you own and a decline from which, no matter how adroit the court-appointed receiver, it is hard to recover. Zero is not good.

So here’s the deal.

A smart guy with a very expensive faxed newsletter for exclusive clients (and me, as a favor) identified this homebuilder at around $5 a share when, by his calculations, just the undeveloped land it owned was probably worth that much. So you paid a fair price for the land and got the business for free. My kind of stock, but I didn’t buy. For one thing, home building is cyclical (unlike hair gook – no matter how bad times get, people are going to want to run bright blue or red gook through their hair) and I claim no ability for predicting the cycles. For another, you can’t buy every tempting idea that comes along.

But I did follow CN in his newsletter with each subsequent fax … and when I noticed it down at 2½, I couldn’t resist. The land at half price, if his calculations were right; the business for free. In I jumped for 2,000 shares. I bought more at 2 and then at 1¾. Where I really bought boatloads of it, near the end of 1995, was at three-eighths of a dollar. (Then, waiting 31 days, I sold the original shares for a tax loss. You have to wait or the IRS considers it a “wash sale.”) And then again, near the end of 1996, at 25 cents a share. (With a truly hopeless stock everyone is totally disgusted with, as Calton was, November and December can be a good time to buy, as last-minute tax-planners finally just kick it out to get the tax loss.)

Part of this was out of pure stubbornness or self-flagellation or that thing we do (well, I do) when you’re playing Hearts and you know, rationally, you cannot successfully shoot the moon but, well, you just can’t resist trying anyway and … well, what I’m saying is that part of it may have more to do with dreaming-of-the-big-score than doing any sensible thinking. Let alone actual research. (I have never, for example, seen a home built by Calton or visited any of the putatively valuable land.)

But part of it was that the fellow who had founded and built the company from 1981 to 1993 had by now stepped back in from retirement to try to rescue his investment. Owning 11 million or so of the 28 million shares outstanding, he has a strong incentive to try to restore the health of the company.

Will he succeed? Maybe not. Will he be hit by a backhoe on some job site and have his life — and my dreams — dashed? Maybe. (Sure the backhoes beep when they’re backing up, but maybe his hearing isn’t what it used to be.)

But this is the bet. The stock last week was trading between 56 cents and 62 cents, and I really, really, really mean it when I say it’s risky and you could well lose every penny making this bet.

Yesterday, I told you a little about a company called DEP. Today I want to show you, through excerpts, how a 120-message thread evolved from mid-January, when the stock was around 1¼, up until last month’s takeover announcement at 5¼.

I tell you up front that what struck me about this thread, when I happened on it recently, was the level of … well, let’s just say there are more than a few players in the game today who lack a great deal of experience (one worries for them), not to mention a handful who are incredibly rude.

The thread appears on the Yahoo! Message Board. It’s a place to trade thoughts about any stock.

Near the beginning of the DEP thread was this sensible January 19 posting, from Bill, 47, from Florida:

“I am playing this company as a turn around play. They once made about a buck a share, and they probably will do so sometime in the future. When they do, this stock will be worth about $15. Which gives us a reward/risk ratio of about 10 to 1. Odds I like and will play all day. In the meantime, we’ll just have to wait for it to be discovered as earnings continue rising.”

These were my thoughts exactly. Bill, who seems to be “my kind of investor,” only better at it than me, went on to say:

“I bought Chrysler in their bankruptcy phase too, actually the preferred stock for $4 which had $15 in interest arrears. And Ford in ’83 when Templeton indicated on Wall Street Week that they could make $20 a share in a good year. The stock was selling for $20. I put everything in. Three months later it was selling for $15 so I mortgaged the house. Sold at $80 in a few years. I do not mean to imply that DEPCC is as solid as Ford was, but when you play these stocks, patience is a mandatory requirement as is the ability to lose your money. Remember, it is a gamble with the odds highly in your favor.”

Mortgaging the house — even for Ford — is a little scary, but you can see there are profits to be made from Bill’s style of investing.

Around the same time, Tom asked:

“Anyone know why the volume is so low? I realize this stock is coming out of bankruptcy and not well known, but the other day the volume was 0. Is there any other reason for this?”

To which Oldflyboy replied:

“It would seem reasonable people have no interest in this company and that those who do have shares are desperately hoping the price will go up so they can sell. In reality, though, the price goes down. Does anyone really think this company has a future?”

OK. This is what makes horse races. Here is a man who probably uses no bright blue gook in his hair. But his comment is perfectly civil — and he could have been right, although if he’s basing his opinion on any research or financial analysis, he doesn’t tip his hand.

RedCrownYankee chimed in:

“There are four of us following this stock and that is the problem. Time and positive earnings reports will turn this stock around. Until then, BE PATIENT!!!”

Orion:

“There are more of us following DEPC [DEPCC] than you may think. I know of at least two others. I’ve been following this stock since September and have bought and sold it once since then. I am waiting to see if it dips below 1½ before buying again.”

Even a stock with only 7 million shares outstanding needs more than six guys on Yahoo betting on it to make it go up. And judging from his message, Orion seemed really to be betting, not investing. Trading in and out means fun! But it also means commissions (albeit very small ones), spreads (between the bid and the asked, which with DEPCC amounted to at least 3% coming and going), and taxes (in case you had a gain). Better with stocks like DEPCC and most others to buy and hold (and hope and pray).

Fast forward to late March. LT_Georgia has chimed in:

“Does anyone know when the next earnings come out? My research showed that 17% of their sales come from Wal-Mart. Wal-Mart earnings are up, so I am expecting the same for DEP. Hope I am correct.”

I’m not sure there’d be too close a link between Wal-Mart success and the success of any particular one of its few thousand smallest suppliers, but I admire LT_Georgia for doing a little research and trying to find a straw in the wind.

Now it’s June, DEPCC is up in the low two’s, the company has reported earnings of a few cents a share, and someone named MARKET_2000 is providing a somewhat broader overview:

“Dep should finish the year with $11.5 million in EBITDA. If you put a 10 multiple on this you get a $115 million enterprise value. The company currently has about $48 million in debt. Thus, the implied equity value is $67 million.

“The company has 7 million shares outstanding. Thus, the implied equity value per share is at least $9 a share. Any way you cut it, Dep Corporation is extremely inexpensive.

“Does anybody care?”

EBITDA (rhymes with KEY-bit-dah) is earnings before interest, taxes, depreciation, and amortization. I’ve always been a little puzzled by it, because interest is something you really do have to pay (taxes often you do not, and depreciation and amortization are accounting charges that can be ignored with greater or lesser peril depending on the nature of the business). Still, and especially with hindsight, his analysis seemed plausible.

Another way of looking at something like this is as a multiple of sales, if you think a reasonable profit margin can one day be earned on sales. It varies greatly from industry to industry (because industries have different average profit margins and growth prospects), but a company valued at “one times sales” is not ordinarily a company grossly overvalued unless it’s headed for the dumpster. DEP had sales of about $120 million — not at all far from the $115 million valuation MARKET_2000 had come up with. (Is he “MARKET_2000” because he has his eye on the year 2000, I wonder, or is he an incredible bear?)

It is now July 4 and, while there have been some thoughtful messages with additional information about the company’s turnaround, skeptics are surfacing. NAFART writes in response to one of the bulls on the stock:

“Guys like you talk it up and are selling out as guys like us that you sucker in buy. This will be a penny stock in the next year.”

Someone called Dreckola (42/M/Biloxi,MS) agrees with NAFART:

“I agree. Start shorting this bowser. One way to go: S O U T H.”

Needless to say, July 4th would have been a bad time to start shorting this stock, still in the high two’s. The next day, someone named vontzen (32/M/Wicjhita) provides this message:

“This stock has peaked unless big shareholders keep promoting new people to buy in, which is making shareholders who bought in at a 1½ a lot of money. Eventually there won’t be new money and it will be back to a buck and a half. There ought to be a law against investors buying at the lows and hyping it on every message board they can find. This puppy is going south.”

Presumably vontzen was basing this opinion on something. My guess is: bitter experience. But it was about to get more bitter if he shorted DEP, because just a few days later the takeover at 5¼ would be announced.

And I suppose this was when it began to get … ugly, because someone calling himself TommyLeeJo replied to vontzen:

“Now we know where the kids from special ed are hanging out!!! The market is obviously too complex/simple minded for you morons!!!”

Much gentler was MARKET_2000, replying to NAFART:

“This company is turning around and if you are short, you are going to get smashed. Be careful.”

On July 6, Bill — with whose message I began this sampling — was obviously in a breezy mood when he responded:

“I don’t think there was any hype on this board. As a long whose average cost is less than a buck, I am only accumulating. Nice day today, up 3/8 on heavy volume. Somebody is buying a lot. Regards.”

Throughout history, there have been longs and shorts, bulls and bears, winners and losers. This day, Bill was long, and winning.

“To All Bears On DEPCC” read the heading of a message July 7 from “Bluepointer” –
“What fundamentals will cause this stock to go down? Last year the company earned 32 cents in the fourth quarter. What makes you think that this year will be any different? If you are going to sell this stock you should do it after October when the big numbers have already moved the price. If you want to lose money, go ahead and do it now. My prediction is that you’ll get squeezed good and hard.”

Vontzen, the 32-year-old from “Wicjhita,” did not take all this lying down:

“This special ed kid has more money in his pocket than you have if you list all of your belongings and your mamas. See ya, TommyLeJoMamaLOOOOSER”

It is my experience that when people begin bringing “your mama” into a discussion, the civil underpinnings of that discussion begin to totter.

TommyLeeJo — in a message he headlined “Greaseball” July 8 — fired back:

“Then why are you hangin’ on a two dollar stock bulletin board??? Did you sell all of your shares of Microsoft and have nothing else to do??? GET A LIFE!!!”

NAFART fired back:

“TommyLeeJoMamaLoser — These boards aren’t bad until pompous asses like you treat them like your personal chat rooms with stupid inflammatory posts.”

“Put your money where your mouth is and short the stock!!! Loooooooser!!!!” suggested TommyLeeJo later that day in a riposte he titled “Greaseball II.”

“The only money you act with is the two nickels you have,” NAFART offered TommyLeeJoMamaLoser the following day, July 9. “Your big time investing is with Monopoly Money. Grease up your hair with Dep, looooooooser!”

It was about this time I began to think that talk of a speculative bubble, with too many unsophisticated “investors” in the market for the first time, might have some validity to it.

“So, [expletive deleted]-for-brains,” shot back TommyLeeJo the same day, “short the stock and let everybody get on with their life ….”

A new voice chimes in July 11. HSCORE writes:

“You are all losers and liars!!! If you are long, good luck, this company is going nowhere fast!! If you say you are short, yah right!!! At the end of June, total short interest in the stock was a whopping 386 shares!!!! Looks like we have a bunch of liars here ….”

July 12: TommyLeeJo addresses “NAFART, HSCORE, etc.” —

“Do you ever get the feeling that the bus stopped in front of the loony bin just as there was a group escape? Why don’t all of you idiots go back to the institution and let the rest of us move on with our lives!!!”

Next day, Dreckola from Biloxi chimes back in, addressed to “TommyLeeJoMamaLoser-NeedstoGetaLifeBesidesThisBoard” —

“Sell this [expletive deleted] short, especially if it hits 3. Couldn’t be an easier way to make money. To [sic] bad you [expletive phrase deleted].”

You can just see this sort of dialog going back and forth between analysts with opposing views at Smith Barney and Merrill Lynch, say, only neither one, to my knowledge, had an analyst covering DEP.

TommyLeeJo, July 13, 9:41AM EDT, to Dreckola:

“Sell the stock short and you will get squeezed!!!! Or maybe you don’t understand that move, MORON!!!!”

Later that day, DEP hit 3.

July 13, 1:31PM EDT NAFART addresses TommyLeeJoMamaLoserKnowsAllAbout-SqueezesFromMaMa:

“Watch and learn TommyBoy”

Minutes later, Dreckola piled on with something truly unprintable.

The next day, the stock doubled as a takeover was announced at 5¼ a share.

My ship had come in, as had Bill’s and TommyLeeJo’s and Bluepoint’s, whoever they are.

If Wall Street was once the exclusive province of the straight-laced, white shoe, well-heeled (or any other footwear superlatives), I think the Internet has pretty well ended that era.

With all my moaning over Amazon.com (I shorted it), more than a few of you have become concerned for my solvency. Actually, I place such relatively small bets that no one of them, however ill-conceived, is likely to sink me. (Conversely, no one of them will make me rich, either.)

Still, I was not having a lot of fun watching my shorts climb to the sky. And just when things seemed bleakest, with Amazon at $145 a share, my ship — a ship nearly four years out to sea — finally came in.

The company is called DEP (symbol: DEPCC), and it makes brightly colored hair gook. When first I heard of it, DEP had fallen from $15 a share to $6, the result of a disastrous acquisition it had been too eager to make. (With eagerness comes sloppiness — they had not scrutinized it adequately.) But management had been at this game for decades, had most of its own family fortune tied up in the stock, and with time, I figured, might work their way back out of the mess. (They might also collect $40 million from a lawsuit they had filed against the seller of the disastrous acquisition — but as it turned out, they did not.)

So I bought 500 shares at $5¼.

And then a bit more at $4½ and a good chunk at $3 — well, for one thing, the company was about to file for bankruptcy protection, which tends to depress a stock — and a lot more at 2-and-change and a boatload last year at 1-3/8. (By then, it had emerged from bankruptcy.) And still people bought brightly-colored hair gook.

At 1-3/8, the entire company, divided into about 7 million shares, was being valued at barely $10 million, yet it had sales of around $120 million. Imagine if it could one day struggle back to the $1-a-share in earnings it had had before that disastrous acquisition! It would take a while, because it had $50 million or so in debt, much of it taken on to make the acquisition. But I was in no rush.

A few weeks ago, it was announced DEP would be bought by a large German company at $5.25 a share. The stock now trades at just a few pennies under $5.25; the German company hopes to have it all wrapped up in a few weeks.

I raise all this partly to brag, gloat, and just generally dance a jig on the dining room table — finally! But also to suggest that there remains a place for the boring school of backwoods stock picking. I recognize that hair gook pales in significance beside high-tech innovation. The rapidly evolving future of the human species will have little to do with hair care products. But high-tech stocks hardly lack for enthusiasm; relatively few languish unconsidered or on the bargain block. When was the last time you read a research report on a boring $100 million hair gook company?

I raise all this also because I was fascinated to read, in the last few months, some of the small-investor dialog concerning DEP on Yahoo. Tomorrow I will offer you a sample of those messages and show you what I mean. Thursday I will suggest another totally obscure, ridiculous (and highly speculative) stock that could conceivably follow the same script as DEP (but that, given my luck, doubtless will not).

[The following question and answer were written shortly before the recent market drop.]

“I know they don’t ring a bell when the market hits the top, but a fish company doubling because they whisper the word ‘internet’ does reverberate somewhat. How would you suggest an ordinary investor protect against a big market collapse? I would like to hedge against a drop without risking all or most of any potential continuing rise (in case there are more ‘greater fools’ out there.) I’m sure there were similar signs as the market struggled to break through the then unheard of DOW 3000 level, and obviously selling would have been a disaster. I have a mix of tax-sheltered and after-tax investments. What I am looking for is a way to turn some of the potential paper losses into real gains in the event of a big drop, yet at a small enough cost such that if it doesn’t happen, I will feel the price was worth the peace of mind. I know this is a tall order, but if anyone has a practical answer, you’re the man.” – Paul Berkowitz

Thanks, Paul. You are looking for the thing EVERYONE wants, and it comes under the category of a free lunch.

You can certainly buy puts or short some stocks or find a hedge fund you think will short stocks better than you could … but the simplest solution is often best. In your case, it would be to take some profits in your tax-deferred account.

If the market just keeps going up, you’ll be pleased – and may not hate me for getting just 5% or 6% on half the money in your tax-free account (in shortish-term bonds and sensibly-chosen REITs, say). After all, you’ll be getting rich in your taxable account and part of your deferred account.

If the market plunges, you’ll be glad you took some profits.

In assessing the mix between stocks and cash (or other pretty safe stuff), each person needs to find his own sleeping point. That is not the point, I should note, at which people blissfully ignorant of the risks sleep well but rather the point at which you, who do understand them, sleep well.

To buy enough puts to accomplish the same sweet sleep is very expensive (and shorts are no way, really, to get any sleep at all, witness my piranha-infested swim down the Amazon.com). What’s more, any gains, by and large, will be fully taxable.

 

“I have about $10k that I can invest for one month only. I was considering buying Home Depot stock, but I have never bought stock before and do not know if buying stock for only one month is worth the transaction fees. Can you tell me what you think of HD stock and if you think it’s worth investing for one month?” – Joy

Buying stock for one month is: CRAZY. Unless you totally don’t care if you lose a chunk of it and just feel like flipping a coin. In any given month, any stock could easily drop, climb or stay even. And since you have use of it for only one month, I assume you DO need this money.

The place for this money is, basically, a bank (or any other completely safe place).

And don’t feel bad: good for you for having it in the first place!

 

“Interesting suggestion on Japanese stocks. You recently mentioned a Korean fund that was not trading at a large premium. Is there such a Japanese fund? Can you buy the Nikkei like you can buy “spyders” here? Also, Japanese P-E ratios were sky high in the past, as you pointed out before the dive. Are they reasonable now by US standards?” – Dan Stone

I’m not sure Japanese stocks have much e these days to divide the p by.

EWJ is the symbol of the Japan WEBS (single-country index funds), but they trade with no discount.

Some believe that active management is worth paying for in Japan because a good manager will shun the stocks that are artificially propped up by face-saving old-boy-network cartel arrangements.

TKIOY is the symbol for a Japanese insurance company with a portfolio of stocks that are, theoretically, worth more in the market than TKIOY is. I haven’t researched it well enough to know whether much of that portfolio is the propped-up kind.

I don’t think it would be unwise to make a small long-term bet on Japan (and Korea and Thailand and maybe Malaysia and Russia and, well, lots of other places as well). And maybe average down a year or two from now in case things in Japan get decidedly worse. (One good sign: If you make bets like these, most people will say you’re nuts.)