No two financial crises are exactly the same. There are times to be an observer, watching from the sidelines. And there are times to act.

A week ago Monday, when the Dow Jones Industrial Average plunged 777 points after the House rejected the proposed $700 billion rescue legislation, the Nasdaq Composite dropped through my latest buying target, which was 2025. As I reported last week, I stepped in with a list of banking stocks and did some buying. The next day the market rallied, quickly rising above the 2025 threshold. I was pleased by gains in my recent purchases, but hardly euphoric. In my experience, buying opportunities rarely last only a matter of hours. And by Thursday the Nasdaq was again below the threshold. My gains were wiped out. On Monday it dropped so much that it was time to begin thinking of the next buying threshold, which is 1750.

I’m repeatedly asked: Why am I buying when the market is plunging? When we’re in the midst of the worst financial crisis of my lifetime? When the bad news seems like it will never end? When so many people are panicking?

The answer is simple: That’s when stocks are cheap.

Regular readers of this column know that I follow a disciplined system of buying on 10% declines in the Nasdaq, and selling at intervals of 25% gains. These are based on historical averages for corrections (an average 20% decline) and bull markets (an average 50% gain.) The goal is simple: Buy lower and sell higher.

I never try to predict where the market is headed next. This is obviously a long-term approach intended for patient investors like myself. It’s very important to distinguish this way of thinking from that of a trader, for whom a day is long term, and months an eternity. Much as I respect my good friend Jim Cramer of “Mad Money” and enjoy his show on CNBC, we are fundamentally different in this regard. Cramer recently said that money you need in the next five years should be pulled out of the stock market. In contrast, I’d say that money with a five-year horizon or less never should have been in the stock market to begin with.

And let me remind readers that the time to sell isn’t now, with the Dow hitting five-year lows. It was last year, with the Dow hitting records. As I said on April 24, 2007, with the Nasdaq above 2515 (my then selling target), “They don’t happen all that often, and selling thresholds are especially satisfying.” As I reported then, I sold Goldman Sachs (GS: 115.00*, -10.49, -8.35%) at what now seems an almost unthinkable price of $250 a share (though I also continue to own some). I cashed out of energy and commodities in May (see column of May 13.) This is why I have the liquidity to buy now.

That was then. There’s no point in bemoaning any failure to act when times were good. The important thing is to take advantage of opportunities now. The last two buying opportunities came quite close together last January, when the market first entered bear territory. This past week marks the third 10% decline without an intervening 25% rally, the first time that has happened since the bear market that began in 2000. With benefit of hindsight, I would have waited to buy, but no one has the benefit of hindsight. No one has perfect timing. Back in the bleak years of 2000-02, when the Nasdaq dropped more than 80%, affording eight consecutive buying opportunities, I followed this system. The purchases made when things looked their worst ended up being the most profitable.

I’m hardly alone in this approach. Surely you’ve noticed that someone else has been on the prowl for bargains this past week: Warren Buffett. True, Buffett is getting high-yielding preferred stock and warrants on terms that I can only dream of. But after years of lamenting that assets were too expensive, Buffett has opened his purse strings. As a stabilizing force he’s being compared to legendary financier J.P. Morgan.

I like what one commentator called this: “patriotic profitability.” I do take personal satisfaction from buying in times of crisis. In my own extremely modest way, I’m supplying liquidity for people who want to cash out. When some people I know are literally pulling cash from their bank accounts and putting it somewhere they consider “safe,” like a cookie jar, I’m saying I still believe in the system. I credit my late father for this approach, who grew up in the Depression and never lost faith in the U.S. economy or stock market. To the readers who inevitably accuse me of soft-hearted idealism, I can only say that it has paid off over two generations.

by James B. Stewart
8th October 2008

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