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Crafting an Investment Plan for a Downturn

Central bankers managed to keep the financial world from falling off the cliff over the past few weeks. Between China's rate cut, Federal Reserve chairman Ben Bernanke's comments that the Fed is ready to act, and news that Spain was poised to ask for a bank bailout all managed to soothe some investor worries.

Jeremy Glaser 25.06.2012


Central bankers managed to keep the financial world from falling off the cliff over the past few weeks. Between China's rate cut, Federal Reserve chairman Ben Bernanke's comments that the Fed is ready to act, and news that Spain was poised to ask for a bank bailout all managed to soothe some investor worries.
But at best, these moves have just bought a small amount of extra time. The Greek elections still loom large on the horizon, and some extra cash for Spain's banks is not going to suddenly revive the European economy.

There is still an unusually large amount of uncertainty in the global economy, and the choppiness of the stock market in recent weeks is a reflection of that. Unless Europe pulls a rabbit out of its hat, it seems unlikely that the choppiness is going away anytime soon. So far, the concerns over the health of the global economy has sent stocks from being almost fully valued in March to looking 13% undervalued today according to our staff of equity analysts. But even that 13% discount is a far cry from the 23% discount we saw in October of last year or the 45% discount at the peak of the financial crisis. It is very possible that some of the worst-case outcomes from the ongoing saga in Europe are priced into stocks. Markets could easily fall from here if the situation continues to deteriorate.

For value investors, a big sell-off can present a great opportunity. You can pick up stocks at a huge discount to their intrinsic value and then reap the gains as the price moves back to the fair value over time. But there is also a huge amount of risk. There is no guarantee that the market won't keep falling or that the market will eventually agree with your assessment of the intrinsic worth of a stock. The risk doesn't mean you shouldn't put money to work when stocks fall, but it does underscore the need to have a solid plan for investing in a downturn and to stick to it.

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About Author

Jeremy Glaser  Jeremy Glaser is the Markets Editor for Morningstar.com.

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