Turn short-term fear into long-term profit

By Jim Jubak

Volatility is way up. Your stomach, tied in knots by the drop in global equities and commodity prices, tells you that. Fear is back.

But, like everything else in the financial markets, fear moves in cycles, which makes this a good time to remind yourself that fear is a short-term phenomenon. It has very little, if anything, to do with the long-term value of a stock or other investment. Fear doesn't change fundamentals, even if it can powerfully shift how much we're willing to pay for those fundamentals. It is so dangerous to investors because it can make them forget long-term economic and market trends and abandon long-term winners at temporary bottoms.

The best antidote for short-term fear is to run down your list of those long-term trends that you believe will turn some stocks into winners. And then to use the short-term market overreaction to fear as an opportunity for building positions that will profit from those long-term trends.

In this column, first, I'm going to run down five long-term trends that I want to own in my portfolio. And, second, I'm going to give you a tip or three on how to buy into these trends with the most safety while the stock market is still in the grip of fear.

The odds are, I think, that we've put an end to a period of extraordinarily low stock market volatility that stretches back to 2003. The VIX ($VIX.X), the Chicago Board Options Exchange index that tracks the volatility of the Standard & Poor's 500 ($INX, news, msgs) stock index options, shows a low reading when investor fear of volatility is low. So, in the complacency that preceded the bursting of the technology bubble in March 2000, the VIX had dropped to an average of just 22.7 for that month. The VIX numbers climbed after that in reaction to the market's bust, seeming recovery -- and bust again. By March 2003, the VIX stood at 30.6.

That turned out to be the high point for this cycle. In March 2004, the VIX averaged a reading of 17.7. By March 2005, the average was just 13.1.

The first four months of 2006 saw VIX readings as low as 10.74. For the year through May 10, the beginning of the current sell-off, the VIX averaged just 12. Investors had become accustomed to low volatility, and fear had dropped to levels even lower than in the run-up to the 2000 bubble.

I don't think we're headed to anything like a replay of the bust of 2000. Stock market valuations aren't nearly as stretched, future economic growth looks far better and market liquidity is relatively supportive.

Instead, we're headed back to normal times when stock markets and stock prices fluctuate with something like their average volatility. Given the recent abnormally low level of volatility, a return to normal is going to hit some investors hard. Abnormally low levels of volatility have led some professional investors to load up on debt in order to pursue risky investments.

But as I look through my list of the five trends that form the backbone of my long-term investing strategy, I'll be darned if I can find a single instance where the return of stock market volatility to normal levels changes anything. I still want to own stocks that give me a piece of these trends over the next five years. (Why only five years? Seems short for long-term investing, doesn't it? A column currently in the works will explain why long term is a lot more short term these days. Look for it.)

What are these five trends?

The developing world is growing richer

Oh, not all of it. But countries such as China, India and Vietnam -- more than 2 billion people just in those three, and many more in other developing nations -- are growing their economies at rates double or triple the 3% growth rate for the developed world projected by the Organisation for Economic Co-operation and Development. That will add hundreds of millions of consumers to the global middle class who will demand middle-class products and services such as life insurance, home mortgages, hotel rooms and cars.

In a February 2005 column, I picked 12 global winners flying below the radar screen. Nothing has changed my mind about the fundamental trends driving stocks such as insurance giant American International Group (AIG, news, msgs), South Korean banking company Kookmin Bank (KB, news, msgs), hotelier Accor Asia Pacific (ACRFF, news, msgs) and the Philippine beverage producer San Miguel (SMGBY, news, msgs).

Demand for commodities will continue to exceed supply

A fast-growing developing world has created demand for commodities that global commodity producers in industries from oil to copper to coal to iron (and don't forget water) are having a tough time meeting. That has produced what some Wall Street investment houses are calling a "supercycle" boom in commodities prices.

I gave a talk on the commodities boom -- and why it will last longer than the usual commodities boom -- at the Las Vegas Money Show in mid-May. You can find a link to the PowerPoint version of that talk here. That presentation and recent columns on this topic -- "3 stocks for the commodities rebound" (May 19) and "Don't write off emerging markets yet" (May 24) -- recommend stocks such as BHP Billiton (BHP, news, msgs), Phelps Dodge (PD, news, msgs), Newmont Mining (NEM, news, msgs) and Companhia Vale Do Rio Doce (RIO, news, msgs).

We've seen the low in the inflation cycle

Although it will be a very odd kind of inflation, higher energy and commodity prices will bleed through into the core inflation rate. "Loose money" policies in China and the United States and the need to recycle petrodollars will keep the globe awash in cash, although not as much as at the peak in 2005-2006. However, thanks to the surplus production capacity added to the global economy from China, India, et. al., the prices of manufactured goods aren't likely to climb very fast.

Official government measures of inflation are likely to lag subjective impressions of inflation and the measurable inflation in specific economic sectors that have scant competition from developing economies, such as education and health care. This kind of stealth inflation will keep the fire burning under trends such as outsourcing, especially of service-sector jobs, downsizing and contracting out to contain costs.

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