How to Prepare for a Stock Market Pullback

After getting slammed by a sharp post-election stock market pullback, many investors are trying to figure out if this is the beginning of a market crash or simply a needed correction.

Either way, legendary investors, hedge fund managers, and some of the largest investment firms are calling for a decline through the end of the year and possibly into 2013, depending on the resolution of the fiscal cliff.

On Monday, Goldman Sachs Group Inc. (NYSE: GS) Chief U.S. Strategist David Kostin restated his 1,250 year-end target for the Standard & Poor's 500, which is roughly 10% below yesterday's close.

"Uncertainty swirling around the 'fiscal cliff' that must be resolved by year-end, the pending jump in capital gains taxes at the start of 2013, and the debt ceiling that will be reached in late February represent clear and present downside risks to the market in the near-term," Kostin wrote to clients, effectively summarizing the bears' case for a continuation of the recent downturn.

Besides Goldman, Marc Faber has predicted a 20% market plunge will occur during President Barack Obama's second term. Peter Schiff recently called QE3,"Operation Screw" because "everybody's pretty much screwed if they own dollars," and even technical indicators are hinting at an upcoming slide.

This doesn't mean panic or run - in fact, those are the worst things you could do. Instead, follow these steps to prepare for a stock market pullback.

Prepare for a Stock Market Pullback

Money Morning's Chief Investment Strategist Keith Fitz-Gerald has a strategy that will protect your investments should a steep stock market decline occur. It will allow you to capture any upside growth in the market.

By implementing tight trailing stops, and structuring your portfolio with varying degrees of risk, you can make the best of a bad situation.

Here's how:

• Go Glocal: Fitz-Gerald loves "glocal" companies, a portfolio must-have for investors. Fitz-Gerald says that large, mega-cap stocks will remain the most stable, defensive and opportunistic choices. These are companies like McDonald's Corp. (NSYE: MCD), The Procter and Gamble Co. (NYSE: PG), General Electric Co. (NYSE: GE), ABB Ltd. (NYSE ADR: ABB) and Raytheon Co. (NYSE: RTN). All of these are global brands with the experience needed to manage real growth despite challenging economic conditions around the world.

• Keep an Eye on Gold: Fitz-Gerald says that during President Obama's second term the need to preserve your value will only increase, and investors will flock towards gold. He warns that gold could pull back in the short term as investors sell to take profits, or traders who have used it to collateralize other investments will sell it to raise cash. This will create a buying opportunity for gold, which will not only protect your money, but enable it to grow in value.

• Hedge Bets with an Inverse Fund: Inverse funds that offset market volatility are a viable alternative to simply hanging on and hoping for the best. Not only can you protect the value of your income and dividends by smoothing out the volatility, but specialized choices like the Rydex Inverse S&P 500 Fund (RYURX) can help investors stay in the game and generate gains that take the sting out of otherwise problematic losses.

• Watch for a Drop in Defense Stocks: If Congress doesn't take any action, the fiscal cliff will result in dramatic spending cuts to defense companies. This will surely cause a drop in defense stocks - meaning another buying opportunity. As the world continues to grow, becoming more complex, defense companies will continue to prosper. And with the uncertainty in the Middle East and China escalating, defense companies will quickly recover from any fiscal cliff fallout.

For even more investing advice that will guide you through difficult economic times, check out Private Briefing. This service provides you not only with Keith-Fitz Gerald's investing wisdom, but gives you access to all of Money Morning's financial experts and their recommendations.

Best of all, you'll learn investing tricks of the trade as you profit. For more info, click here.

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