What to do When the Market Plunges

Last Wednesday (August 11^th), I was taking a day off with my family and while we were having fun in the sun, the market took another hit on Fed’s concern over the American economy. The US indices dropped by 2-3% while the Bloomberg app on my BlackBerry was beet red on the international markets too. We are in the midst of very “interesting” times for investors.

After the huge crash in 2008 followed by an important surge in 2009, we are now dancing on a thin wire between 2 buildings. Government debts are at their highest in history, the unemployment rate is becoming the curse of the decade and investors’ worries are heightened.

So what do you do when the market is off?

I see 2 possibilities; one for the long term and determined investors and another for the soft hearted. Mind you, there is nothing wrong being soft hearted; actually, the best investing strategy is the one that lets you sleep at night ;-).

#1 Search for growth dividend stocks

As the stock market goes down, it creates several opportunities. The best of both worlds is certainly picking undervalued stocks that pay high dividends. The most interesting example I saw back in December 2008 were Canadian banks that lost more than 50% of their stock value and were offering double digit dividends. Only 6 months after their lowest level in years, they went almost back to pre-crisis levels.

This means that you could have bought a stock paying a 10% dividend yield and also be sitting on a potential capital gain of 100%. Not bad for taking the risk, huh? I really wish I had more nerve back then to buy those stocks!

If you are using this strategy, you must be willing to take the ride and see your portfolio move up and down. Stocks that are losing value don’t necessarily stop going down the day you buy them. In the meantime, you can always appreciate a good dividend yield and wait until it is fit to sell the stock.

As for an idea for a stock pick, I like Microsoft (MSFT, 2.14%) which lost about 20% of its value in the last 6 months but is still expected to raise its dividend in the upcoming quarters:

Investing in undervalued stocks is always appealing but you have to remain careful with your stock picks. One thing is for sure, I would stay away from the oil companies for now. With the recent spill disaster, chances are that the cost to follow stricter regulations will definitely affect current and future oil production. It may also stall the exploration of new sites.

#2 Look at the consumer, non-cyclical sector

Why consider the non-cyclical consumer sector? Regardless if the economy goes boom or bust, people have to buy goods. These companies are generally well diversified (in term of products and geography as well), have a steady income flow and several of them pay a good dividend.

The fact that they are well diversified and that they are less likely to lose their customers during a recession makes their stock more stable. You can look at the following charts that show JNJ compared to the Dow Jones and S&P 500 from beginning of 2007 to August 2010:

More importantly, the consumer, non-cyclical sector raised their dividends by a higher amount than normal. JNJ for example raised their dividend by $0.05 (largest increase in over 12 years). Among the other big dividend increases we found:

Dr. Pepper Snapple Group     $0.15 (67%)

Mckesson Corp                    $0.18 (50%)

In this sector, I must admit that I really like JNJ with a dividend yield of 3.57%. And if you don’t mind vice stocks, Lorillard (LO, 5.34%) and Philip Morris International (PM, 4.76%) should increase their dividend yields in the next quarters.

So what do you do when the markets tumble?

Are you going to search for undervalued stocks and take the dividends while you wait for the appreciation or are you going to stick with “sure values”?

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