Buy on bad news

Kate Warne, PhD, CFA, Market Strategist, Edward Jones, comments: Economic news appears to be getting more negative with many reports of recession. Banks have reduced credit, and residential property prices are declining. Despite signs of economic weakness, inflation remains high.

With the preponderance of negative news, what strategies should long-term investors take? In the past, such news generally has indicated a good time to buy quality shares, either individually or in mutual funds (unit trusts).

STOCK MARKET LOOKS FORWARD

As the stock market looks forward, it moves before the economy. The market already has declined more than 20% since its high in June 2007. Therefore, much of the bad news already has been reflected. The 20% decline defines a ‘bear market' for shares. Based on the 11 bear markets since 1948, the average decline is 32%. By the time you know it's a bear market, most of the decline has occurred.

If you're feeling nervous, now may be a good opportunity for you to consider buying equities. This is what it feels like to ‘buy low'. Historically, when the stock market begins to rise again, adding lower-cost shares has helped boost returns. We believe it's a mistake to try to wait for shares to reach bottom, as no one can predict specifically when they will begin to rebound.

You also may want to consider pound cost averaging. By investing a fixed amount on a regular schedule, you purchase more shares when prices are low and fewer if prices rise. Pound cost averaging doesn't prevent a loss, but it can be a successful strategy during volatile markets.

FEARS OF RECESSION

Understandably you may be worried by all the talk about recession. No one yet knows whether a recession is imminent, but some history may help calm your fears.

Recessions tend to be short and much of the pain for investors happens in advance. The UK economy has suffered only three recessions since 1945. They've been relatively short, lasting an average of 14 months. You may think shares decline during a recession, but historically the stock market started to decline an average of 12 months before a recession began. In the past, the stock market had already declined an average of 20% by the time the economy moved into recession.

More importantly, the FTSE All-Share Index rose on average during past recessions, as it started to rebound an average of five months before the economy. As a result, when the economy is struggling, we believe you should consider adding equities as it's one of the best times to buy shares at lower prices. Speak with your Edward Jones financial adviser to learn which investments might be appropriate.

INFLATION WORRIES

One of the most difficult challenges for investors is to construct a portfolio that is appropriate for both higher inflation and slowing economic growth. To help solve this issue, we recommend owning shares of companies that have historically increased their dividends and are expected to continue doing so. They can provide rising income that can help with rising prices. In many cases, companies with a variety of business units also have tended to decline less during market downturns.

DECLINING PROPERTY PRICES

After several years of large price increases, property prices have started declining rapidly, and many expect them to fall further. As this very cyclical market has just started to decline, we continue to caution investors to limit residential property investments. Some investors believed property provided a ‘less risky' alternative to shares, but unfortunately that seems unlikely. We believe a prudent strategy is to evaluate your ability to weather a continued downturn in property prices. Once you've done this, you can decide if a change is needed, rather than hoping property prices fall less than forecasted.

NOW FOR THE GOOD NEWS

If you focus on your long-term goals and own a diversified portfolio of quality investments, you should be well positioned for this downturn. In the past, those who stayed invested through times of falling share prices and slow economic growth were rewarded for their long-term approach when times improved. Again, consider adding equity investments into your portfolio in this environment.

We believe you should be prepared for many possibilities, rather than trying to take advantage of specific predictions. This may be the best way to reduce risk in your portfolio. Historically, when we've faced uncertainty, this approach has benefited investors, and we think it's particularly important today.

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