Making Money Amid the Chaos: Investing Tips for a Turbulent Market

NYSE ARCHIPELAGO HISTORY (** FILE **Traders on the floor of the New York Stock Exchange work frantically as panic selling swept
AP file, Peter Morgan

While there is always some degree of turmoil ongoing in the markets, the last several months have been unusually disorderly.

Investors are caught in the middle of a seemingly contradictory situation -- economic tepidity and geopolitical anxieties mixed with a confusingly optimistic and upward-trending stock market.

At the same time as pundits are decrying the government shutdown as a market-saboteur, a sandwich shop experiences a one-day gain of 120 percent in its initial public offering. In many ways, the macro-environment appears to be in shambles while plenty of investors and traders are earning strong returns.

What's an investor to do in this noisy, irrational period of economic mania? Do you take the blue pill and ride with the madness, or is it more important than ever to stick to fundamentals? Or is it, perhaps, time to pull out your money and head for the sidelines?

Here are some ways to stay afloat when the market is moving too fast.

Put Your Blinders On

A horse in the wild is a preyed-upon animal -- that's why its eyes are placed on the side of its head. With its excellent peripheral vision, the horse takes in a wide range of sights that can cause it to move erratically.

%VIRTUAL-article-sponsoredlinks%Thanks to the 24-hour news cycle and the seemingly endless stream of data pouring out of research firms, governments, and the media, investors are subject to a similar information overflow, which can lead to the same sort of erratic behavior. The jobs report may come in 6,000 less (or more) than predicted, and the consumer spending report the next day says that middle America isn't going to the mall as much as they should to prop up our still shaky economy. The market at large reacts to this data, sending portfolio holdings skittering off, and tempting the investor to take action.

That's why, in times like these, when things seem to be moving up and down at the same time, it's important to put on those blinders.

It's not to say that macro events are irrelevant or unimportant to investors -- they can create many opportunities or material disadvantages. But there will always be companies that are making things work despite headwinds, and that will keep doing so regardless of tailwinds. They make take some more hunting to find, but rest assured, they are there.

Take your focus off the headlines and search for good companies in isolation. It's a much less stressful and potentially more profitable way to navigate these choppy waters.

Take Your Money Elsewhere

In case you missed it, the United States is going through a bit of a rough patch. During the summer, the threat of the Fed taper sent the market into tizzy, as investors panicked that the cheap liquidity that had propped up the economy in the depths of the Great Recession would soon come to an end.

Since then, Fed Chairman Ben Bernanke has stepped back from tapering -- essentially leaving investors in the dark as to when the shoe will drop. Then came the manufactured twin crises of government shutdown and the debt ceiling: Retailers, analysts, pundits, defense contractors, and many others have expressed the rational concern that the loss of all those paychecks, along with the chance of default (whether the Senate's 11th-hour deal succeeds or not) will drive consumers into hibernation, dragging down an already tepid recovery. Factor in the relatively high valuation of U.S. stock markets, and there isn't much to shield us against an economic torpedo.

Meanwhile, emerging markets are showing some of the most enticing valuations, and their economic uncertainties -- though still present -- may be subsiding.

After the roaring success of emerging markets through 2010, investors have backed far away from them. So far in 2013, the iShares MSCI Emerging Market ETF (an effective barometer) has slipped more than 8.5 percent. The S&P 500 is up 20 percent. China's economy has been slowing, India has battled inflation issues, and various countries in Latin America have experienced both problems.

But the difference between the domestic market and the emerging markets is that stock prices overseas actually reflect the real uncertainty present. Other than the dips it has suffered as we approach the debt limit deadline, investors in the rallying U.S. market are acting like they're ignorant of reality. But, despite the problems in various emerging markets, the long-term growth prospects for in those regions still vastly exceed the outlook for U.S. GDP growth.

China's economy is showing some weakness, and its GDP is still growing at 7.5 percent. U.S. GDP is growing less than 2 percent. Brazil, Argentina, Russia, India -- they're all pegged to grow much faster than the United States. Those nation's stocks have the headroom to produce higher prices and higher valuations. The S&P 500 has far less.

So for healthy profits, consider looking abroad.

Take a Breather from Stocks

There's nothing wrong with this option, even if it may mean missing out on short-term gains or that high-flying IPO your neighbor scored on.

Moving into a substantial cash position is an effective hedge against an uncertain economy and high market valuations.

The usual arguments against this are that cash earns a zero return -- actually, it's a money loser as soon as you factor in inflation. But, as evidenced by the tactics of some of the world's greatest investors, such as Seth Klarman or Prem Watsa, holding a large cash position is a difficult and mature strategy. It may require tremendous patience and that gut-wrenching feeling when the markets continue to fly high and Wall Street is in a state of ignorant bliss. But it's a wager that the party will end. More importantly, it's a wager that when the party ends, the real investing begins.

As the oft-quoted Warren Buffett has said, "Be fearful when others are greedy, and greedy when others are fearful." If the prophecies of today's pessimists bear fruit, the market may soon experience a tumble. And if you have cash under the mattress at that moment, you'll be in a great position to put it to work.

Run Your Own Race

The market is confusing right now. Those who say they know what's coming have little more knowledge than the average investor -- the pundits simply take advantage of the fact that we almost never hold the media's market prophets accountable for their many wrong guesses.

But if you limit your exposure to the endless fountain of data, focus on companies, invest in undervalued emerging markets, and keeps some cash in hand to capitalize on the next bear market, you can keep the world's craziness and volatility from having too painful an effect on your portfolio.

Michael Lewis is a contributing writer to The Motley Fool. Try any of our newsletter services free for 30 days.

Originally published