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Harry Newton's In Search of The Perfect Investment Newton's In Search Of The Perfect Investment. Technology Investor.

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8:30 AM Thursday, October 13, 2005:
There are two schools of thought. There are ALWAYS two schools of thought. One says all sorts of nasty things are brewing and there'll be more declines. The other says the bottom is about to be reached and happy days will soon reappear. And there's a third school: Sell on Rosh Hashanah, buy on Yom Kippur. Today is Yom Kippur.

Your guess is as good as mine, though mine tends to be negative. My main concern: energy costs this winter will eat consumers alive.

The ONLY thing we know is that in trying times like these you can't sit there and do nothing. What can you do?

* Sell all your stocks that are down 15% or more. No exceptions.
* Fire managers or mutual funds that are down 10%. No exceptions.
* Pick some highflyers and cockroach stocks to short. But don't be too greedy. When you've made some profits, take them. Areas I like for shorting include technology, housing, automobile, transportation and some high-flying energy stocks.

* Don't be too tempted. My son believes Refco's troubles are due to one man. He's gone. Therefore the stock will recover strongly. His father thinks Refco smells like a classic Cockroach stock. Further, his father doesn't like catching falling knives, viz.

* Stay away from the stockmarket. Look for investments elsewhere. Soon there'll be decent distress buys in real estate.
* Stay in cash. The name of this game is not protecting yourself against inflation. (There's actually very little.) The name of this game is capital preservation.

Shorts which Fred Hickey has: His October newsletter shows he is short (or has puts on) Intel, Best Buy, CDW, IBM, Google, KLA-Tencor, Netlogic Microsystems (NETL), Dell, Amazon, Apple, Texas Instruments, Business Objects (BOBJ), Hyperion Solutions (HYSL), Toll Brothers (TOL), Goldman Sachs, Lehman Brothers (LEH), Capital One Financial (COF) and Countrywide Financial (CFC). His largest put option is Research in Motion (RIMM), whose management has recently become desperate -- and announced a big share buyback. I say "desperate" because it means the poor management doesn't have the imagination to think of ways to improve their product. I wish they'd ask their customers (like me). I'd give them 734.

The Wall Street Journal muses: How to Prepare Your Portfolio to Handle Three Potential Investment Nightmares.

Bold conviction, meet event risk.

Oil above $60 a barrel, the specter of economic weakness and fears of inflation have combined to spook investors. Indeed, thanks to the recent stockmarket slump, both the Dow Jones Industrial Average and the Standard & Poor's 500-stock index are underwater for the year. Yet such turmoil is par for the course. I got my first job in financial journalism 20 years ago, and I am still waiting for things to calm down. Consider what's happened:

• The Dow industrials plunged 22.6% on a single day in October 1987.
• Japanese stocks peaked in 1989 -- and today are 65% lower.
• Twice in a dozen years, stock investors were rattled when the U.S. went to war with Saddam Hussein.
• The largest one-day point drop ever in the Dow industrials occurred when the market reopened after the September 11 terrorist attacks.
• The S&P 500 posted 20%-plus gains in five consecutive calendar years in the late 1990s -- and then immediately got whacked with three consecutive losing years.

Yet, despite all this turmoil, many folks continue to insist that 10% is the typical annual return for stocks. Sure enough, the S&P 500 did indeed clock 10.9% in 2004. But a "normal" year like 2004 is, in truth, far from normal. Over the past 20 calendar years, there have been just three years when the S&P 500's annual return was above 6% but below 16%, according to Chicago's Ibbotson Associates.

What about the other 17 years? Among them were nine years when the S&P 500 soared 20% or more and four years when it lost money.

Thanks to this year's lackluster market, stock valuations don't look so terrible. The S&P 500 is at less than 19 times trailing 12-month reported earnings and the dividend yield now hovers around 2%. While that may be rich by historical standards, stocks look reasonable compared with 10-year Treasury notes, which yield less than two percentage points above the likely inflation rate.

That said, if we get a single scary headline, stocks could easily tumble 20% or more. Experts in behavioral finance have found that investors tend to be far too confident.

Real-estate investment trusts? Gold shares? Florida condos? Energy stocks? Overconfident speculators are convinced these highflying investments are a one-way ticket to wealth.

But a few years from now, we could be lamenting these investments the same way we now lament tech stocks bought in the 1990s. My advice: Never forget what happened to dot-com investors -- and build your portfolio with well-informed trepidation.

To that end, consider three key investment pitfalls: resurgent inflation, recession and sudden crises that shake investor confidence. In that last category, include the fallout from events like currency devaluations, political turmoil and terrorist attacks.

How would your investments perform in each scenario? In all three situations, money-market funds, Treasury bills and other "cash investments" would be the model of stability. But loading up on cash investments is no solution, because you won't make money over the long run, once you figure in inflation and taxes.

Take bonds. You might spread your holdings across a mix of high-quality corporate and government bonds, inflation-indexed Treasuries, high-yield "junk" bonds and foreign bonds, knowing that only some of these sectors will do well at any one time. For instance, if recession hits, junk bonds will get crushed as investors fear defaults. But your high-quality bonds should post gains, thanks to the likely fall in interest rates. Investors will also tend to flock to high-quality bonds, especially Treasuries, during crises of confidence.

On the other hand, conventional Treasuries would get pummeled by resurgent inflation. But in that environment, your inflation-indexed Treasuries should hold their own. And if the renewed inflation is sparked by an overheated economy, your junk bonds could notch impressive gains.

Foreign bonds, for their part, are a wild card, because currency moves are impossible to predict. That, however, is part of their allure.

When everything else fails, your foreign bonds may ride to the rescue, helping to prop up your portfolio's performance. That will be especially true if the next crisis is triggered by worries over U.S. debt levels.

You can apply the same analysis to various classes of stocks, except the potential gains and losses are far larger. While an inflationary spike might dent stocks initially, shares should fare well longer term, as corporate earnings climb with inflation.

Recession would also cause short-term trouble for stocks. Meanwhile, it's hard to know how shares will react to the next crisis. Given all that, you should spread your bets widely, always owning at least some bonds and allocating maybe 25% of your stock portfolio to foreign shares, 5% to real-estate investment trusts and 5% to gold stocks, commodities and other natural-resource plays.

REITs and natural resources should perform well if inflation picks up, and foreign stocks could save your portfolio if the dollar nose-dives. But who really knows? Investing is racked with uncertainty -- and broad diversification is your best defense.

The Wall Street Journal's TRIPLE THREAT

Here are three possible pitfalls facing investors -- and the investments that are likely to flourish in each scenario.
Recessions: Bonds -- especially long-term government, municipal and high-quality corporate bonds.
Inflation: Gold stocks, commodities, real estate, inflation-indexed bonds.
Crises of confidence: Treasury bonds, gold stocks.
Instead, to score decent gains, you've got to take more risk, and that means tapping into the stock and bond markets. But keep your overconfidence -- and your portfolio's risk level -- in check.

Postal Service's tracking system sucks: Contrary to what I wrote, the Post Office does have a tracking system. But it's useless. It only tells you when your package was delivered. You can't find out where it is or when it will be delivered. In other words, you can't trace it.

Today is Yom Kippur:
A priest and a rabbi are discussing the pros and cons of their various religions, and inevitably the discussion turns to repentance. The rabbi explains Yom Kippur, the solemn Day of Atonement, a day of fasting and penitence, while the priest tells him all about Lent, and its 40 days of self-denial and absolution from sins.

After the discussion ends, the rabbi goes home to tell his wife about the conversation, and they discuss the merits of Lent versus Yom Kippur.

She turns her head and laughs.

The rabbi says, "What's so funny, dear?"

She replies: "40 days of Lent - one day of Yom Kippur . . .so, even when it comes to sin, the goyim pay retail!"

Recent column highlights:
+ How my private equity fund is doing. Click here.
+ Blackstone private equity funds. Click here.
+ Manhattan Pharmaceuticals: Click here.
+ NovaDel Biosciences appeals. Click here.
+ Hana Biosciences appeals. Click here.
+ All turned on by biotech. Click here.
+ Steve Jobs Commencement Address. The text is available: Click here. The full audio is available. Click here.
+ The March of the Penguins, an exquisite movie. Click here.
+ When to sell stocks. Click here.

Harry Newton

This column is about my personal search for the perfect investment. I don't give investment advice. For that you have to be registered with regulatory authorities, which I am not. I am a reporter and an investor. I make my daily column -- Monday through Friday -- freely available for three reasons: Writing is good for sorting things out in my brain. Second, the column is research for a book I'm writing called "In Search of the Perfect Investment." Third, I encourage my readers to send me their ideas, concerns and experiences. That way we can all learn together. My email address is . You can't click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads. Thus I cannot endorse any, though some look mighty interesting. If you click on a link, Google may send me money. That money will help pay Claire's law school tuition. Read more about Google AdSense, click here and here.
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