Thanksgiving

With economic woes dominating the headlines, we sometimes forget about all we have. As you sit down with your families tomorrow to celebrate Thanksgiving, try to put aside talk of recession/depression/deleveraging/credit crisis/reduced bonuses and recall all of the gifts in our lives.

On balance, most of us are fortunate to have what we have. We live in the best country in the world, where we are free to dissent with those in power and which just experienced a historical election. Most of us have decent jobs that allow us to provide shelter, food and a pretty nice lifestyle. We may not be making a ga-zillion bucks, but we are blessed. My advice for you as we enter the heart of the holiday season is to remember all that is good in your life, not what is lacking.

My Aunt H likes to recount the following prayer: "Thank you God (you can replace with goddess, energy force or just say thanks to the universe) for giving us every single thing we need and most of what we could ever want."

Believe me, it's how I feel on a daily basis.

Thanksgiving Blessings to you and all your loved ones.

This will be the last daily “StrategicPoint of View” column. Going forward we will be consolidating our written communications into a weekly investment analysis each Monday, which will be supplemented by special articles and updates as necessary.

Crying Like It’s 1931

Despite the last two trading days and the gains seen in stocks, here is a bit of sobering news: according to the Wall Street Journal’s Jason Zweig, over the last two weeks ending November 20, the Dow Jones Industrial Average fell 16%. Over the two weeks ended November 20, 1931, the Dow fell 16%. Over in the broader S&P 500, the news is worse: only twice before this year has the S&P 500 lost more than a third of its value in calendar year—both of those previous instances occurred during the Great Depression, down 41.9% in 1931 (there’s that year again!) and 38.6% in 1937.

With these kinds of statistics, it’s hard not to think that we are once again facing a Depression. More rational heads will point out that in 1931, the US economy, as measured by gross national product, plunged by 14.7%, while this year, the economy contracted by 0.5% in Q3 and then probably by something in the range of 3-4% in Q4, which is not good, but it sure is a far cry from losses in the teens. In 1931, one of every six Americans was unemployed, while today one out of sixteen is unemployed.

This is not to say that all is well. This is shaping up to be the worst recession since the nasty bugger in 1981-2. More jobs will be lost, companies will go out of business and some families will lose their homes. For those who look to capital markets to find a clue about the future, the news is not much better. The US bond market now expects that the world’s largest economy will suffer deflation for the next decade; as noted above, the S&P 500 is on pace to suffer its worst decline since 1931; and for the first time in 50 years, the dividend yield on the S&P 500 now exceeds the yield on the 10-year Treasury bonds. Of course, if you have a strong constitution and an even tougher stomach, you might note that when fear trumps greed to the extent that we can see at present, it often provides opportunities for contrarian investors to buy cheap.

Perhaps you do not trust global markets to guide you. If that’s the case, you may try a different indicator: a psychic. According to the New York Times (11/23/08), many investors are eschewing trading cards for tarot cards. “Psychics say their business is robust, as do astrologers and people who channel spirits, read palms and otherwise predict the future…after all, the nation’s supposed experts on the economy…have not exactly been reliable.”

Maybe the psychic won’t be able to tell you whether it’s 1931 all over again or not. Even without tarot cards the end of year period is likely to see more “deleveraging”, “disintermediation” and “forced selling”, meaning that as losses mount, investors or institutions that have borrowed money will sell to avoid further losses or even bankruptcy. Unfortunately, unleveraged, long-term investors (like most of the sane world) will continue to be forced to suffer through further mark-to-market losses, but will likely be rewarded over time as markets return to more normal behavior. 1931 may or may not come back to haunt us, but one factoid that drew my attention from the year: Frankenstein, starring Boris Karloff was the top grossing film of the year. Now that seems appropriate.

A Rally for Andy

My friend Andy used to be completely obsessed with the stock market. He rode the dot-com bubble all the way up and felt the crushing blows on the way down. He found himself right back in the fray until a little over two years ago, when his 40 year old wife died suddenly. Since then Andy admits that he has become a much better investor.

How could such a tragedy transform his financial acumen? The answer lies in the deep emotional current that swirls in every investor’s mind and belly. In the past, Andy would watch each position, tick for tick. He would often experience a kind of euphoria when a trade went well, only to second-guess himself when it went sour. He knew that it was a debilitating cycle, but he could not get out of it.

Then the unimaginable occurred, putting him and his whole family through a nightmare. After his wife’s death, Andy did not have the same passion for investing. He stopped watching CNBC every day and monitoring his accounts on a minute-by-minute basis. Instead, he would call me every quarter or so to discuss the overall economy and asked for advice about general market trends. He no longer purchased individual securities, turning instead to index funds and even began to use bonds and commodities in the portfolio to help diversify some of the risk. Interestingly enough, his performance improved, both on the upside and the downside.

When we met for lunch on Friday, he said that he was not worried about the stock market or even the economy. “Of course it’s terrible for people to lose jobs and for families to suffer, but I am convinced that we’ll get through this period. This country has been through worse—heck, I have been through much worse and you know what I found out? That I can survive the worst and still wake up the next morning to see the sun shining and the world turning. Tell your blog readers, radio listeners and everyone on TV that Andy says that everything is going to be OK.”

It seemed fitting that when Andy and I were having lunch, the stock market was down a touch, but by the end of the day, it reversed course and experienced a powerful rally. The Dow closed 494.13 points higher, up 6.5%, at 8046.42 and the S&P 500 was up 6.3% to 800.03. Yes, it was a terrible week, but for at least one day, Andy was right: everything was OK. It’s not a bad lesson for the rest of us: a little distance might help everyone get through this with more of our wits about us.

1997 All Over Again

Ah 1997…it seems like only yesterday when Jewel was on the Billboard charts, Frasier dominated network television, the movie Titanic swept the Academy Awards and the dot-com bubble had not yet fully inflated. 1997 was also the last time that stocks were at these horrifying low levels. Yesterday investors continued to sell stocks as fears mounted that commercial real estate would be the next shoe to drop as the economic outlook darkens.

The S&P 500 plunged to its lowest level since 1997, sliding 6.7% to 752.44, under the low point of 776.76 reached during the bear market nadir in October, 2002. The index extended its 2008 year to date loss to 49% and is poised for the worst annual decline in its 80-year history. The Dow Jones Industrial Average sank 444.99 points, or 5.6%, to 7,552.29. The Nasdaq Composite decreased 5.1% to 1,316.12. Financial companies led the way again, with Citigroup down another 26% to $4.71 (yes, that’s Citi under a fin!), JPMorgan Chase lost 18% to $23.38, Bank of America tumbled 13.86% to $11.25 and Morgan Stanley was off 10.24% to $9.20.

Yesterday’s catalyst was more of the same—data that indicated that we are in a bruising recession. Weekly jobless claims approached the highest level since 1982; the index of leading economic indicators fell for a third time in four months; and the Federal Reserve said manufacturing in the Philadelphia area shrank at the fastest pace in 18 years. As investors rushed for the exits, they poured money into US Treasuries, driving prices to historic highs. The yield on the two-year note fell below 1% for the first time, while ten year yields fell to 3%...my friends, you can now lend the US government money for ten years and earn a whopping 3% for your troubles!

A client asked me, “How do you know when to just get out?” My answer is that when fear is shaking you to the core and it feels like all confidence is lost is usually when long term investors should be dipping their toes into the water. I am not suggesting that you sell the farm (how much could you actually get anyway?) and jump into stocks, but there are some compelling values out there. It is likely to remain pretty messy in this period, but that does not mean that you should throw in the towel on capitalism. Gather your thoughts, chug a little Pepto Bismol and don’t run for cover just yet.

Slip-Sliding Away

Remember when we thought the financial system was on the precipice of disaster? Well, fears of widespread systemic failure may have passed, but investors are now worried about the economy—big time. It seems that all of the TARPs, EESAs, rate reductions and bailout plans have left us exactly where we were a month ago—at the depths of market lows with little confidence that relief is coming.

Despite massive government interventions, stock prices fell to 5 1/2 year lows yesterday as fears of a deep recession plague the investment horizon. The Dow plummeted 427.47 points, or 5.1%, to 7997.28, the lowest close since March 31, 2003; the S&P fell 6.1% to end at 806.58, well-below this year’s previous low of 840 and on pace for its worst year since 1931; the NASDAQ was tumbled 6.5% at 1386.42; and the small-stock Russell 2000 fell 7.8% to 412.38. I don’t know how many days that I have written “ouch” in response to these types of numbers. Suffice to say that the pain is actually becoming less acute and more chronic, as we all get used to these massive sell-offs.

Some said deflation was the catalyst for the selling—the Consumer Price Index fell by 1% in October, the biggest one-day drop in the 61-year history of the index. I don’t buy the deflation explanation as the reason for the fall. I think that investors are realizing that things will not turn around any time quickly and as a result, many are throwing in the towel and waiting it out. Maybe that’s why Henry Paulson essentially took a mulligan on the TARP and will let the next administration play out the round.

It’s probably a safe bet that the government wishes that it could go back in time and save Lehman Brothers – indeed, it was that company’s failure that sparked the massive slide. Since then, the Dow has plunged 30%. Yesterday, selling in the financial sector once again led the way. Citigroup in particular ran into a brick wall, falling 23.4% to $6.40, a 13-year low, after announcing that it will purchase the final $17.4 billion of assets still in structured investment vehicles; Bank of America dropped $2.13, or 14%, to $13.06; and Goldman Sachs fell $6.85, or 11%, to $55.18, the lowest close since the company's initial public offering in 1999.

Additionally, there was selling pressure in some of the larger insurers, many of which are busy buying banks so that they can tap the TARP. Lincoln National plunged 40%, the steepest decline in the S&P 500, to $7.31, after saying that it expects a charge of as much as $300 million because of declining equity markets last month; Hartford Financial dropped 24%; and good ol’ AIG fell 15%. Adding market woes is the uncertain fate of the automakers -- GM fell 9.7% to its lowest price since the 1940s, while Ford lost 25%.

Here is what I think is going on: everyone is waiting for some good news and it’s just not there. Every time we turn around, there is more disappointing data about housing or retail sales or confidence. At some point, people are going to examine the valuations of companies and realize that not every single one of them should be tossed aside. Until then, we are slip-sliding away.

Three Blind Mice

There they were yesterday, testifying before a Senate panel -- Ford's Alan Mulally, Chrysler's Robert Nardelli and GM's Richard Wagoner. They were on bent knees, arguing that without $25 billion, the US auto industry would die forever. As I watched them in their natty suits, crying the blues, I thought that they are our own version of “Three Blind Mice,” the leaders of an industry that seemed blind to improving innovation and the challenges of globalization.

Two of our mice say that their companies, GM and Chrysler, are on the brink of disaster and without government handouts, they will fail. Perhaps you are sick of hearing about corporate failures and their disastrous effect on the broader economy—I know that I am, but this is where we are -- no amount of wishing it weren’t so will get us out of this mess, so let’s talk about what we can do now.

The first question to ask is whether a bankruptcy might help the auto industry get its act together after 25 years of fighting the larger trends of globalization (which created enormous competition, especially in the form of cheaper labor) and fuel efficiency/smaller cars. The pro-bankruptcy camp cites the ability of the airline industry to file, reorganize and renegotiate long-term contracts (slashing pension plans and health benefits for the large union employee base). Many airlines successfully re-emerged from bankruptcy stronger and better able to compete. The bankruptcy advocates note that handing over $25 billion to the Three Blind Mice would lead to the same conclusion—bankruptcy, but in the bailout scenario, taxpayers lose $25 billion for the same outcome.

Those who support helping the automakers with government aid note that the industry is vital to the national interest as both an employer and as the base of the nation’s manufacturing sector. GM Chairman and Chief Executive Richard Wagoner said that "This is about much more than just Detroit, it's about saving the U.S. economy from a catastrophic collapse."

On this point, it is important to understand where we are in the economic cycle. In more normal circumstances (i.e. if we were simply experiencing a mild recession), I would probably be in the “let them fail” crowd, but these are not normal circumstances. The economy is fragile from the effects of the housing and credit busts and after already losing 1.2 million non-farm jobs this year, my concern is that the failure of GM and Chrysler (it looks like Ford is going to survive) may simply be too much for the economy and perhaps of greater importance, the national psyche, to handle.

It seems reasonable to help the Three Blind Mice see their way through for another couple of quarters, so that they can restructure accordingly. This may mean a government-orchestrated bankruptcy down the line, whereby the companies can reorganize and potentially survive. This middle ground might mitigate some of the obvious near-term economic ripple effects, while allowing the Three Blind Mice to see their way through the crisis.

Adios Carrie Bradshaw

Watching re-runs of “Sex and the City” seems so retro amid the financial melt-down of 2008. The program that debuted in 1998 and concluded in 2004, followed the lives of four single women in New York City, as they obsessed about men (well, that’s actually not retro, that is thoroughly now) and spent hundreds of dollars on shoes. The program that put shoemakers Manolo Blahnik and Jimmy Choo on the map (see Season 6, Episode 9: A Woman's Right to Shoes, original air date 8/17/03) now seems positively passé as Americans alter their spending patterns to meet the new reality of a recession.

Last week, the Commerce Department reported that retail sales fell by 2.8% in October, surpassing the old mark of a 2.65% drop in November 2001 in the wake of the terrorist attacks. It was the largest drop on record and the fourth consecutive monthly decline. The weakness in retail sales was led by a 5.5% plunge in autos, the biggest drop since August 2005. Carmakers said that last month was the worst in 17 years as potential buyers were spooked by the financial crisis and tightening credit conditions. Even without cars, sales of everything from furniture to clothing dropped off a cliff. Excluding autos, retail sales fell by 2.2%, also a record decline, underscoring the widespread weakness. Sales at general merchandise stores like Wal-Mart and large department stores fell by 0.4%, while sales at specialty clothing stores (the kinds that the women in “Sex and the City” used to frequent) were down a bigger 1.4%.

There were only slight glimmers in all of the gloomy data: mega-discounter Wal-Mart has fared better than most as its massive size allows it to pressure vendors for even cheaper prices. According to the International Council of Shopping Centers, for every dollar spent on goods other than cars in the US over the last twelve months, 8.2 cents went to Wal-Mart or its warehouse sister store, Sam’s Club. That is a staggering market share, but it’s certainly not surprising that with house prices in the toilet, the stock market down 40% and 1.2 million jobs lost in 2008, that consumers are in full-fledged retreat. These folks are seeking the cheapest possible alternatives and thus far, they are finding those values at Wal-Mart.

Here is another glimmer of hope: the data confirms that consumers have woken up from their drunken stupor and have FINALLY stopped spending. With all due respect to the characters on Sex and the City, one has to wonder how a struggling freelance writer like Carrie Bradshaw could afford the $495 pair of shoes. If Carrie were with us today, she would be paying down debt and saving money to rebuild her balance sheet. Of course that is not the stuff of a particularly entertaining series, but it would help curb the excesses of the past two decades and allow our start to take control over her financial destiny. The never-to-be-produced sequel to “Sex and the City” would be “Parsimony across America”…not too catchy, but indeed, the bitter medicine that will help cure the nation’s economy. Adios Carrie Bradshaw!

Priority Number One

As the global recession gathers steam, pundits are opining how the Obama administration will address priority number one, the economy. Clearly over the next sixty-plus days before the inauguration, President-elect Obama and his advisors will be busying themselves with analyzing the economic options that lie ahead for the nation.

Some of Obama’s team from President Clinton’s tenure may be noting something that I have considered: perhaps in retrospect, the US economy has been in a bear market for over ten years, starting with the 1997 Asian crisis and exacerbated by a deflationary spiral. Considering that bear markets often have strong bull spikes along the way, this would not be a crazy notion. If so, then the 2008 credit crunch and asset sell-off does not constitute the beginning of the process, but the final salvo that puts an end to global deflation and asset bubbles. Additionally, it would also argue for a continuation of the unprecedented global government intervention that is occurring under President Bush.

Regardless of where we have been, one thing is clear: the American people want action, but what form might that take? It looks like a centrist tone will prevail as the new administration faces the giant hurdles of a rapidly deteriorating economy and the overwhelming effect of the previous administration’s actions on the nation’s balance sheet. The effect of both of these factors should focus the President-elect’s attention on addressing economic concerns and could impede or postpone progress on addressing other long-term goals, like education and health care.

If the revival of the US growth engine is numero uno, then we should expect a significant stimulus plan immediately. Some are talking about $200 billion set aside to satisfy Mr. Obama’s desire to provide the middle class with tax cuts. For high wage earners, expect that the top tax bracket will increase to 39.6% and that capital gains and dividend rates will return to 20% from the current 15% level. The additional revenue raised from these increases is likely to help cover Alternative Minimum tax relief. On the good news side of the ledger for wealthier individuals, the plan would also extend the 2009 rates for estate taxation ($3.5 million indexed per spouse exemption and a 45% top rate). Many are also proposing infrastructure investment and direct grants to states for foreclosure mitigation.

What’s all of this going to cost? Estimates are for deficits to run from $1.5-$2 trillion next year, or at least 10% of the nation’s GDP. For deficit hawks, some of whom are among Mr. Obama’s closest advisors, this number is staggering. The rationalization for the massive spending is that government issuance of debt to help recapitalize the shaky financial foundation, is not spending, but should be seen as a necessary and massive re-fi. That does not mean that longer term interest rates will react as such—expect them to rise in reaction to these kinds of deficits. In the economic triage that is occurring, there is not much time to worry about those issues right now as we muddle through this unchartered territory. Bottom line: be prepared for the economy to be the number one issue for quite some time.

The Gurus Speak

For the past five years—before the housing and credit bubbles burst and everyone was making money—the so-called “Masters of the Universe” (aka Wall Street CEOs, Congressional leaders and federal regulators) fed us an almost daily helping of good news. Risk was nigh; profits were practically sure and if you did not join the party, well then you were a kill-joy. Now that the script has been re-written, the group as a whole seems to be among the most frightened of the current state of affairs.

Perhaps they should be, because while the growing economy allowed many participants to earn a decent buck, these guys were amassing fortunes. We need not recount the stories of airplanes, boats and “Lifestyles of the Rich and Famous” to know that these guys probably made a heck of a lot more money than any of their clients or shareholders. And so it was a grain of salt that I took their comments at this week’s Merrill Lynch Financial Services Conference.

The host of the conference, John Thain, Chairman and CEO of Merrill Lynch started it off with a not-so-reassuring assessment of the current economy. He noted that “This is not like '87, it's not like '98, it's not like 2001. The contraction that's going on is bigger than that. I think we will in fact look back all the way to the 1929 period to see the kind of slowdown we are experiencing now. And the great degree of uncertainty in the marketplace is how deep, how long and what are the governments around the world going to do to try to provide a stimulus to the environment." Hmmm…he skipped right over the 1981-2 recession and brought us to 1929—nice. Still, the 1929 environment creates “opportunities” for Merrill Lynch and Mr. Thain is “cautiously optimistic that things are starting to get better in financial services.” Does anyone else see inconsistencies in these statements?

Next up at the conference was Bank of New York’s Chairman & CEO Robert Kelly, who made this breakthrough statement: “We need a securitization market to get started again where you have simpler instruments, where you have stronger underwriting standards than the past.” That’s funny because I would bet that Mr. Kelly and his cohorts were not singing this tune a few years ago. In fact, most of these guys told us that the products that were being created were disseminating risk and that the counterparties all understood them, so no need for regulation.

And finally, the current Goldman Sachs wonder boy, CEO Lloyd Blankfein said that Goldman was not changing its long-term strategy and that he is happy with the current lines of business that Goldman has. Really? That’s not what the rest of us are seeing, but hey, you guys at Goldman are really different, aren’t you? At least that’s what you have told us, before this year convinced us that you were mere mortals.

In the end, the Gurus spoke and a day after their horrendously downbeat comments, the US stock market soared by over 6%. It was a wonderful reminder that the weight of the Gurus’ words must be diffused through a more realistic prism…it’s about time.

Best Bye-Bye?

This has been a sobering week for the nation’s retailers and only three trading days have passed! It started with a double-shot of grim news: Starbucks reported that its net income dropped 97% from a year ago and the Circuit City filed for Chapter 11 bankruptcy protection. Then yesterday, Best Buy’s Chief Executive Brad Anderson said
"Since mid-September, rapid, seismic changes in consumer behavior have created the most difficult climate we've ever seen." Ouch!

As everyone gears up for the 2008 holiday season—it is crazy to see the decorations appearing in the windows this early—the question is whether beleaguered consumers will dramatically reduce their spending as they face a serious economic downturn. The answer is likely to be a resounding yes and evidence is clear wherever you look—in the auto industry, where sales of new vehicles have dropped 32% in the third quarter or in surveys that indicate that consumer spending is likely to fall in 2009 for the first year since 1980. In fact, last week, retailers reported the worst monthly sales decline in over thirty years, prompting them to kick off the season earlier than usual and with more dramatic discounts than previously expected.

America’s Research Group (ARG)/UBS Christmas Survey asked consumers what they intend to do for the holidays and the results were rough: 40.1% of consumers interviewed said they will spend less this year than last and 35.3% said they will buy fewer gifts. ARG Chief Executive C. Britt Beemer predicts that retail sales will be negative compared to last year for the first time in 23 years of conducting these surveys.

Downbeat forward-looking data is prompting retailers like Best Buy to batten down the hatches and quickly. The nation’s largest consumer electronics chain warned that its revenues would suffer and lowered its future profits as it retools operations to adjust to the new consumer reality of tighter purses. Best Buy’s President and Chief Operating Officer Brian Dunn said, "In 42 years of retailing, we've never seen such difficult times for the consumer. People are making dramatic changes in how much they spend, and we're not immune from those forces."

There is some good news buried in the bad stuff. The first is that consumers will benefit from lower prices this season. If you are lucky enough to have a steady job and the money available to purchase a flat screen TV, the best bet is to shop around, compare prices and wait for the drastic mark-downs, because they are sure to come. The price pressure is likely to be intense, especially among electronic retailers because failures like those at Circuit City and Tweeter will create large inventory levels throughout the sector. The other interesting benefit of these bankruptcies is that the survivors like Best Buy and even Wal-Mart, should benefit from shoppers who want to purchase merchandise and gift cards from stores that they believe will survive the current downturn. For now, I am hopeful that Best Buy will not morph into Best Bye-Bye.

I Heart Sheila Bair

My love of regulators is newly found. After all, I work in an industry that is often at odds with the folks who are supposed to oversee us. I have been frustrated in the past because sometimes these folks make a huge deal out of something pretty puny, but then miss the elephant in the room. Not so with my most favorite regulator of all, Sheila Bair, the Chairman of the Federal Deposit Insurance Corp (FDIC). Ms. Bair is the cream of the crop and I want to be the first to say it in public: I heart Sheila Bair.

My infatuation developed when she spoke articulately about what she perceived as the problem with TARP: it did not go to the root of the problem at hand, that is, the collapsing real estate market and the rapid advance of foreclosures. She noted in an interview with the Wall Street Journal (10/22/08) that she was frustrated that the government was providing “massive assistance at the institutional level” to the lenders (i.e. the financial institutions) but not enough help to the borrowers who were in trouble and potentially facing foreclosure. Ms. Bair had hoped for relief to come in the form of how she managed the loans that failed IndyMac Bancorp Inc. held. After the FDIC took over that bank in July, Ms. Bair said it would halt foreclosures on the mortgages it owned and would try to modify loans for struggling homeowners.

Well it only took four months, but it looks like there are others who are seeing the wisdom in Ms. Bair’s approach. Yesterday Fannie Mae and Freddie Mac, along with U.S. officials, announced plans to modify hundreds of thousands of loans held by the massive entities in order to prevent foreclosures. The effort will be available to those borrowers who meet certain criteria: the homes must be owner-occupied, escrows for real estate taxes and insurance must be established, the loans must be 90 days or more past due; the borrowers would need to owe 90 percent or more than the home is currently worth; and they would have to provide a statement or affidavit showing that they have encountered some sort of hardship that has impacted their ability to pay their mortgage. The program would only apply to loans made on or before Jan. 1, 2008, and borrowers will be disqualified if they file for bankruptcy.

The goal of the program is to reduce the ratio of mortgage payments for these homeowners to 38% of their income by modifying interest rates, extending the life of the loan and in some cases forgiving portions of principal debt. While officials did
not have an estimate of how many people would qualify, estimates range in the hundreds of thousands. According to the most recent data from the Mortgage Bankers Association at the end of June, more than 4 million American homeowners, or 9% of mortgagees were either behind on their payments or in foreclosure.

The Fannie/Freddie program would augment similar plans announced by Citigroup, JP Morgan Chase and Bank of America. Citigroup plans to not only renegotiate loans that have already reached a critical point, the bank also plans to contact 500,000 homeowners, or 1/3 of all mortgages that it owns, who are on the verge of falling behind. The bank will create a team of 600 salespeople to assist the targeted borrowers by adjusting their rates, reducing principal or increasing the term of the loan. Late last month, JPMorgan Chase & Co expanded its mortgage modification program to an estimated $70 billion in loans, which could aid as many as 400,000 customers and Bank of America, meanwhile, has said that starting Dec. 1, it will modify an estimated 400,000 loans held by newly acquired Countrywide Financial Corp. as part of an $8.4 billion legal settlement reached with 11 states last month.

It looks like the industry has caught on and realized that Ms. Bair was right on in her assessment of what needs to get done. Yes, it was important to secure the financial system, but it is equally important to focus on where the problems began and address them head on. The world is catching on to my great admiration of Ms. Bair—on Monday, the Wall Street Journal named Bair the Number One Woman to Watch in 2008. I think that I speak for the WSJ when I say that we all heart Sheila Bair!

Ninety Years Later

With the election over, we are now left with a certain feeling that I can only describe as emptiness—gone are the cool graphics and techno-maps of red and blue, not to mention the nightly parsing of each of the four candidates’ days. All of the sudden, there is no distraction from the plain truth: the global economy is feeling a world of hurt.

Proof of the damage was seen yesterday in the action of General Motors. Analysts at both Deutsche Bank and Barclays set a downbeat tone when they cut their target prices and investment ratings on the stock-Barclays is anticipating that the company will trade at a buck, while the more dour Deutsche Bank thinks that GM is heading out of business quickly due to the fact the company is burning over $2 billion month. The two reports drove down the price of the US automaker 23% to $3.36, after hitting a 62-year low of $3.02 in the trading session.

Did you catch that? We are talking 1946—the year that “It’s a Wonderful Life” lost the Academy Award to “The Best Years of our Lives”. I know that you may be thinking that life just doesn’t seem so wonderful right now. Well, don’t tell that to anyone who actually lived through the year 1946 and the ten or fifteen years that preceded it. While we obsess about the gyrations of the stock market and the problems in the economy, which are of course serious and significant, I fear that we may forget about an important milestone: today is Veteran’s Day.

World War I, known as “The Great War” or “War to End all Wars,” officially ended when the Treaty of Versailles was signed on June 28, 1919, in the Palace of Versailles in France. However, fighting ceased seven months earlier when an armistice (a temporary cessation of hostilities) between the Allied nations and Germany went into effect on the eleventh hour of the eleventh day of the eleventh month. For that reason, November 11, 1918, is generally regarded as the end of the war. As a result, President Woodrow Wilson proclaimed November 11 as the first commemoration of Armistice Day with the following words: “To us in America, the reflections of Armistice Day will be filled with solemn pride in the heroism of those who died in the country’s service and with gratitude for the victory, both because of the thing from which it has freed us and because of the opportunity it has given America to show her sympathy with peace and justice in the councils of the nations…"

The purpose of Veterans Day was to set aside a day to honor America's veterans for their patriotism, love of country, and willingness to serve and sacrifice for the common good. Ninety years later, as the United States fights wars in Iraq and Afghanistan, today is a reminder that we owe our soldiers a debt of gratitude. And so for just a moment today, please take the time to put aside your concerns about your 401(k) account or the value of your house and send a blessing to our servicemen and women who are currently serving and who have served our country so honorably.

Obamarkets

Before the election, someone argued that one of the reasons that stocks had lifted from the October 10th lows was that it was becoming clearer that the President would be Barack Obama. I countered that despite the excitement about the election on both sides I did not think that the stock market was trading on politics. Others contended that if McCain were to pull out a come-from-behind victory, that there would be anarchy, an idea that frankly demeans the American people.

Now that we have elected Mr. Obama, I am more convinced than ever that while traders like to know presidential outcomes, last week’s action did not jibe with the clarity of the Presidential and Congressional victories. Indeed, the biggest Election Day rally ever faded quickly, as the subsequent two-day drubbing supplanted “yes we can” with, “maybe we can’t”. Was it disappointment with the Obama victory or a more visceral reaction to the dour economic news and massive hedge fund redemptions? I put my vote on the latter.

In addition to a new president, last week saw additional proof that the economy has continued to deteriorate. This fact was confirmed by retailers whose October same-store sales fell more than they have any time in this decade; the Institute for Supply Management, whose index dropped to its lowest level since 1980; the auto industry which reported that sales skidded to their worst pace since February 1983; and the Labor Department which said that the jobless rate spiked to a 14-year high of 6.5% in October, and another 240,000 jobs were lost, bringing the total number of jobs lost to 1.2 million for the year. It is likely that the convergence of bad news rather than the election spurred net selling on the week for stocks, with all of the major indexes closing down approximately 4% for the five trading sessions.

I am sorry to say that the outcome of the election will probably not calm markets any time soon, rather the antidote to the extreme moves is likely to be found in something simpler: sheer exhaustion could set in. As the excellent Jason Zweig noted in the Wall Street Journal over the weekend, “In the 10 years ended Dec. 31, 2007, the Dow never once swung by more than 9% during the course of a trading day. So far in 2008, with less than eight weeks to go, there have been six such giant swings. Over the entire decade through the end of last year, the Dow bounced around by more than 5% in a single day a total of 14 times. So far this year, that has happened 20 times; what used to take place barely more than annually has occurred once every 11 trading days in 2008.”

Zweig notes that there have been previous times of extreme price movement, but US stocks have not “been this volatile, day after day, since the 1930s.” Like a winded ballplayer, markets will need to take a break from the action to recover. Clearly the election was not the much-needed half-time show.

The Governor’s Economic Forum

On a rainy day in New England while stocks were falling on Wall Street, something great happened. Over one hundred politicians, union leaders, businesspeople, non-profit employees and academics gathered for one reason: to help the state in which they all live. I was lucky enough to serve as the moderator of Rhode Island Governor Donald L. Carcieri’s Economic Forum and it was truly inspiring.

The guests listened to three speakers who provided an excellent backdrop to the current RI economy. John Rhodes, the Senior Principal of Moran, Stahl and Moyer helped us understand what variables are weighed by companies that are undergoing site selection, Professor Paul Harrington of Northeastern University provided illuminating data with regard to the state’s labor force and Jim Eads, the Executive Director of the Federation of Tax Administration discussed the intersection of tax policy and economic development.

The speakers warmed up the room for the main event: an open exchange of ideas to help the state navigate the financial crisis at hand. To introduce participants to the process, I began with two quotes:

1) “You meet your destiny on the road you take to avoid it.” Psychiatrist Carl Jung was talking about the human psyche, but the application to our current financial crisis is particularly apt. How each individual, business, organization and municipality faces the current economic challenges can define future success. I urged participants not to avoid hard truths and instead to confront the situation with candor and create solutions that would help the state achieve its goals.

2) "It is not necessary to change. Survival is not mandatory." W. Edwards Deming, a statistician who is known as the father of the Japanese post-war industrial revival was a man who understood that if nothing changes…then nothing changes. The Governor, as well as all of the participants, recognized that the state and the nation face tremendous challenges. Those who are creative will not only survive, but thrive when the eventual recovery takes place.

To that end, the Governor asked participants to consider three relatively simple (but not easy) questions:
1) What can be done to stimulate the RI economy in the short term?
2) What can be done to stimulate the RI economy in the long term?
3) What are the obstacles to economic development in the state?

After one hour of thoughtful consideration, the participants delivered insightful and interesting ideas to the Governor, who will synthesize the information so that he can adjust the 2009 economic and growth plan for the state. The Forum was community at its best—no mess, no politics, just hard work. I was truly honored to be part of the day.

That was quick

Yesterday both Democrats and Republicans alike were savoring the fruits of democracy. I knew this election was going to be different when a close family friend who used to work for the ultra conservative Heritage Foundation confided to me that he not only planned to vote for Barack Obama, he had also given money to the campaign. And so, for the first time ever, the United States will have a black president.

That was all well and good until the stock market opened at 9:30 and suddenly, the post-election afterglow faded quickly. That sure was quick! After enjoying a strong Election Day rally, stocks gave back the previous day’s gains and then some. With the results of the election set in stone, investors were reminded that the economy is still in a precarious state. Data indicated that the service sector contracted and a weekly employment report portended at least a 200,000 job loss when Friday’s employment report is released.

The damage was broad-based: the Dow Jones Industrial Average, which had spiked 305 points on Election Day, fell 486.01 points, or 5.1%, to 9139.27. It was the biggest one-day loss for blue chips since Oct. 22, the twelfth worst point loss in history and the lowest close since Oct. 29. The S&P 500 fell 5.3% to 952.77, led down by the financial sector, which fell 9.2%. The Nasdaq Composite Index snapped a six-day winning streak, finishing down 5.5%, at 1681.64.

Of course we all knew that one day, one election, even a historic one, could not change what we know: the globe continues to be plagued by deleveraging and a widespread economic slowdown driven by lower consumption, investment and trade flows. Investors continue to wrestle with the right prices for stocks amid what could be the most significant recession since the early 1980’s. The depth and length of the recession will determine fair value, but of course it will only be known in retrospect.

For that reason, it is imperative for investors not to get too caught up in either the high-highs or the low-lows over the next few weeks or even months. This is going to take some time to work out and you might drive yourself crazy if you get sucked into the daily movements. If you do sucked in, remember that any extreme feeling is likely to fade when the next day starts…and you just might find yourself thinking, “Gee, that sure was quick…”

Finally Here

It has been an exhausting two-year campaign and today it will finally end. Two months ago, before the financial system nearly collapsed, the race felt different. We were all concerned about taxes and the economy, but there were other issues as well. Today the polls tell us what we already know: it’s the economy stupid!

Last week underscored the main issues that voters are confronting: the US economy finally went negative in terms of GDP and is likely to get worse, the housing market continued to contract and the stock market closed out a horrible month (October was the worst month for the Dow since August, 1998 and the worst month for the S&P 500 since October, 1987 -- yes, the October of the 22% one-day crash).

During the month, there were panic-driven sell-offs amid fears of a total systemic melt-down. The stomach-churning gyrations pushed stock indexes in massive swaths from day to day as the collapse of investment grade financial companies triggered a run on the financial system. In normal times, swings of more than 4% in a day are rare (there were 3 such days throughout the 1950’s, 2 in the 1960’s and none from 2003-2007), but in the month of October alone, there were nine. Until last month, September, 1932 held the record for the most days with big moves at eight.

And so the voting public starts today knowing that stock prices are at higher levels than the October lows, but they are not likely in a better frame of mind when it comes to considering the global economy. Many have already made up their minds as to which candidate is better equipped to navigate these treacherous times, but even to those, there is an understanding that we have never been here before.

The Wall Street Journal noted yesterday that there “are two relatively recent historical precedents for the current election, where a new president will take office amid a serious financial crisis. Whether John McCain or Barack Obama is elected, he will confront ugly economic challenges like Franklin D. Roosevelt did after his 1932 victory and Ronald Reagan did in 1980… the market posted big gains during their overall tenures, though it is unclear whether the main cause was their policies or the steep declines the market suffered before they took office.”

And that’s probably the most confounding issue for any voter: we can’t truly know which candidate will be better, or lucky or unlucky. The best we can do is gather the information and make the most informed decision possible when we enter the voting booth. Of course no matter what, the darned thing will be over and we can get back to obsessing about our investment accounts or future economic data. Yes, it is finally here.

Carry On

The sky is clearing and the night
Has cried enough
The sun, he come, the world
to soften up
Rejoice, rejoice, we have no choice but
To carry on
-Crosby, Stills, Nash and Young

Well maybe rejoice is not tops on investors’ minds, but one thing is certain: they sure have had enough of the carry trade. The carry trade was simple: borrow money from a country with low interest rates and reinvest the proceeds to one which provides a higher yield. Seems simple enough, so hedge funds and trading desks around the world put the trade on—specifically, they borrowed from the Japanese, who kept interest rates close to zero for some time, and invested the money into emerging markets where returns were dizzying.

And so we enter the next phase of the financial crisis: the moment when the music stops playing and everyone scrambles for an empty chair. In this case, managers were busy unwinding the carry trade at an aggressive pace. As the process started, it then triggered margin calls on traders, amplifying the pressures on them to sell. Add to this fact the underlying flight to quality amid market turmoil and you can see how a massive trade that had taken years to build up (some say there was $500 billion tied up in the carry trade), could unwind in a matter of months.

As a result, the Japanese yen has soared in value—up approximately 30% against the euro over the past month (a 6-year high). While these kinds of moves may have become the norm for stock and commodity markets, they can wreak havoc when they occur in currency markets, because it becomes nearly impossible to price exports or imports. Additionally, investors have to unwind both sides of the trade, which means that as they are re-purchasing yen, they need to sell those assets that were intended to deliver the outsized returns. In this case, the deleveraging and panic that has caused the Japanese, as well as many emerging markets, significant damage. Earlier this week, Japan’s Nikkei index was at its lowest since 1982 and the MSCI index of non-Japanese Asian stocks was down 33% in October. To stop the currency panic, there could be government intervention on the horizon.

The good news out of all of this is that ultimately, the currency revaluation process should lead to a more solid system. It is likely we will hear calls for intervention and oversight of currency trading, but for now, if you are getting gloomy, just hum a few of those lyrics noted above…Rejoice, rejoice, we have no choice but To carry on…”

Deflation Formation

After more than a year into the rate cut cycle, the Federal Reserve announced that it was cutting short-term interest rates again yesterday. The US central bank pushed its benchmark federal funds rate down half a percentage point to 1% and signaled that more rate cuts are a possibility, noting that "downside risks to growth remain." Joining the Fed in the action was China, which cut rates for the third time in six weeks, amid a worsening growth outlook for its export-dependent economy and Norway, which cut its benchmark interest rate for the second time in two weeks. The European Central Bank and the Bank of England are expected to follow next week and Japanese authorities signaled they too might cut rates from ½ point to ¼ point.

Now that US rates are at levels not seen since 2002, fears are re-emerging that deflation will haunt the economy and keep us buried in a stagnant state for years to come. Simply stated, deflation occurs when consumer prices fall broadly. The problem with deflation is that it can lead to a vicious cycle: falling prices diminish corporate profits, which can lead corporations to reduce headcount. When consumers are worried about the job market, they are less likely to spend, which hurts profits once again. The most recent example of deflation was seen in Japan in the 1990’s. After that country’s real estate and stock market boom and bust, its economy ground to a halt. While the Japanese central bank lowered interest rates to zero and held the rate there, the economy still did not respond. In fact, only when officials there recapitalized banks, did the economy revive.
According to a number of analysts, the chances that the US will avoid deflation are pretty good. The primary reason is that the Fed is on the case much more aggressively than the central bank in Japan was. In addition to cutting short-term rates, the Fed has an arsenal ready to deploy in order to fight potential deflation. It can conduct operations to bring Treasury or private securities’ rates down, they can finance fiscal stimulus and they can undertake “quantitative easing” of monetary policy, which simply means that the central bank floods the system with liquidity. So while it is true that the Fed can only cut short term rates to zero, it is not constrained in how much it can increase its own balance sheet by making loans or acquiring assets. It can create new bank reserves at will and use those reserves to make loans itself or take on distressed assets.

Other reasons to believe that deflation may not be coming on the horizon include: while home and commodity prices are in fact falling, the current decline represents a reversal of the major spike that occurred leading up to this time; companies will quickly cut capacity to balance supply and demand; and some of the emerging global declines in goods prices are declines in relative prices, not prices generally. This is not to say that the credit crunch is not deflationary in nature or that prices are not coming down. Nor does this line of reasoning rule out the idea that deflation could envelop the US economy, but at this stage, it seems less likely to occur in the near term.

Confidence, the Julie Andrews Way

I have confidence in sunshine
I have confidence in rain
I have confidence that spring will come again
Besides which you see I have confidence in me

-Rodgers & Hammerstein in “The Sound of Music”

I know that I have used this lyric previously, but any chance to hum along to “The Sound of Music” is fine with me, especially amid the tumultuous economic times in which we live. With that said, there is a connection between Broadway and Wall Street, which parenthetically, do actually physically intersect in lower Manhattan.

Yesterday, the Conference Board, a not-for-profit organization that provides and disseminates research, released its monthly survey of consumer confidence. Like many of its peers, this index attempts to gauge consumer attitudes on present economic conditions and expectations of future conditions. In other words, they want to know how we feel. The answer as of October 21 from the 5,000 people surveyed is that they feel glum. The Conference Board reported that last month’s index fell to a historic low level of 38.0, down from 61.4 in September and far worse than the average forecast of 51.5 (the index is measured against a bogey of 100, which was the 1985 level).

Why were market-watchers initially fretting about these results? The answer is that consumer spending accounts for more than two-thirds of the economy, so investors want to know what consumers are up to and how they might behave in the near future. The more confident consumers are about the economy and their own personal finances, the more likely they are to spend—and in the current state of the dismal economy, the opposite is also true. With this in mind, it's easy to see how this index of consumer attitudes gives insight to the direction of the economy and potentially, to the stock and bond markets. There is a caveat (isn’t there always?!). While the level of consumer confidence is associated with consumer spending, the two do not move in tandem each and every month -- sometimes people say one thing, and do another.

By the end of the day, investors had decided that the confidence measure was not as bad as thought. After all, don’t we already know that people feel rotten? In fact, the reasoning goes, the stock market is in the process of discounting all of that negative stuff, which is why stock prices have dropped off of a cliff in October. You could almost hear people convince themselves of this fact throughout the day as stock prices increased. The final hour was crazy as the buying reached a frenzied pace. When it was over, the Dow and S&P 500 had soared nearly 11%, while the NASDAQ surged by 9.5%.

In other words, as of yesterday, investors were clear that while they were confident in the Conference Board’s results, they were less sure that the horrible numbers indicated anything new and trade-able.

Tips for Surviving the Unstable Job Market

The housing market is in the tank, the stock market was soon to follow—what’s next, you ask? Look no further than the jobs market. Although the unemployment rate stands at 6.1% nationally, the figure is likely to increase. Some economists believe that the rate will increase to nearly 8% before this is all over, while others believe that we are headed much higher.

Currently, the state with the highest unemployment rate is none other than little Rhody—that is, Rhode Island, whose 8.8% rate puts it atop of a most dubious list. Meanwhile at the epicenter of the housing crisis, California, the rate is 7.7%. These numbers pale in comparison to the Great Depression, when unemployment reached a staggering 25%. Even as the decade of the thirties was ending, the rate was still close to 15%. Since then, the highest unemployment rate nationally was seen in November and December of 1982, when it reached 10.8%.

These are sobering facts and if you have a job, you are indeed fortunate. But everyone should take his or her job with a grain of salt right now and instead prepare for the worst. To that end, here are seven tips for surviving the unstable job market that the nation faces.

1. Stockpile cash: In normal economic times, financial planners recommend maintaining 3-6 months of your general living expenses. These are obviously not “normal” times and in fact, we are facing a nasty recession ahead, therefore, it is preferable to have 6-12 months of cash available in cash equivalents, like savings and checking accounts, short-term CDs or money market accounts.

2. Create Cash flow: Although it would be great to always know what you spend, it is even more important to create a detailed analysis of your expenses and to identify what can be cut or reduced. Considering that everyone feels out of control right now, the simple technique of identifying what is coming in and what is going out can help you come up with short, intermediate and long term game plans. The process is hard, but well worth the effort.

3. Explore a home equity line of credit or a re-finance while you still have a job. As you probably know, it is easier to qualify for a loan when you have an income. This is only possible if you have a high credit score.

4. Health Insurance: review your current benefits and explore your alternatives. It would also be advisable to understand the rules of COBRA (you can pay for 18 months of extended coverage) and you should use any deferred money that you have set aside.

5. Review your company policy on unused personal, sick and vacation days.

6. Prepare your resume, update your contact list and learn how to use the web for networking.

7. Print out any personal documents that may be on your work computer and take home personal papers from the office.

Trimming the Hedges

In July, 2007, I wrote an article about hedge funds. Way back then, when everyone and his brother was just dying to work for, start or invest in a hedge fund, I noted that
“Only the cream of the crop end up in the big leagues, while the rest of the heap slug it out in the minor leagues.” Well over a year later, it appears that there are problems in both the big leagues and the minors. Hedge funds are on track to have one of their worst years ever.

Louise Story noted in the New York Times (10/23/08) that “The gilded age of hedge funds is losing its luster.” Storied names in the industry have seen portfolios halved this year and smaller ones have been forced to close as once-aggressive investors run to the sidelines. I have heard a familiar story from many sophisticated investors: “My love affair with hedge funds is over!” No longer can hot-shot managers promise 1% per month with low risk, because it is simply impossible to deliver. One family friend noted “I could save the 2+20 (referring to the average hedge fund fee structure which amounts to 2% annual fee plus 20% of the profits) and lose the money myself or with a buy side manager for only 1%!” This guy had invested in six hedge funds as of last quarter, but now has just one.

Of course this type of thinking creates a vicious cycle: the massive number of investor redemptions puts more pressure on managers to unwind trades, forcing sales across every asset class, which in turn causes everything to drop in value and thus perpetuating more redemptions. And when people decide enough is enough, they throw the towel in on everything, even the stuff that is doing well.

As a case in point, my pal started a currency hedge fund at the beginning of the year and is actually in the plus column through yesterday’s close. Yet he is fearful that his major investor will not be interested in assuming any more risk when the redemption window opens early next year. While they have no complaint about performance, it is simply a decision to reduce risk. Of course my friend knew that this was a risk that existed when he started out, so there are no sour grapes, but it does beg the question, does the world really need over 10,000 hedge funds? Probably not, but it will be interesting to see which ones survive and how the pension and endowment world will view the world of “alternative investments” when they no longer are making easy money.

Like most booms and busts, there will be talk of the entire industry disappearing, but those predictions are usually overblown. Even the dot-com meltdown resulted in a few strong and profitable companies that thrive to this day. The more sobering question that smaller managers will ask is where can they go? With layoffs escalating on Wall Street, many of these guys may be left to make money by simply trading their own investment accounts -- at least until the process of hedge trimming is complete.

Bearing Down

As the investor roller coaster ride continues, some are wondering if they can just get off the dizzying ride. For those who can’t deal with the pain any more, no amount of data that is trotted out about going to cash will change their minds. With that said, there are a bunch of investors who are hunkering down and making peace with the bear market.

Let’s start with yesterday’s dismal performance. Now that investors are not consumed with the melt-down of the entire financial system, they are turning their attention to the economy. Given the past year, you can’t blame people for fearing the worst—and the worst would be a lengthy and deep recession accompanied by massive job losses (unemployment rate is projected to reach at least 7.5-8%). As a result, the Dow Jones Industrial Average posted its seventh-biggest point drop in history, plummeting 514.45 points, or 5.7%, to close at 8519.2, a level not seen in nearly five years. The Dow re-tested previous lows, but rallied before the bell. Still, the index has given back 746 points over the last two sessions. The day followed steep losses overseas, as many emerging markets tumbled 10%.

The recession fears spilled into commodities markets, led on the downside by crude oil. The reasoning is simple: if economic growth is going to slow, then the demand for raw commodities will fall. Crude dropped $5.43, or 7.5% a barrel to $66.75, its lowest point since June 2007 and drop of 54% since July 3. Gold futures declined sharply on the back of a strengthening dollar. Gold dropped below important technical chart levels, which accelerated selling pressure. December gold fell $32.80, or 4.2%, to settle at $735.20 an ounce. Other metals that are more sensitive to economic cycles—copper fell to its lowest level since 2005.

So where does that leave those who are still on the investment roller coaster? Well a bit nauseous, but still breathing. This tireless bunch is able to look to the future and recognize that when the government puts massive dollars into the system, it will eventually help out. The two trillion plus dollars (the bailout plus AIG, Bear Stearns and the commercial paper facility) as well as rate cuts should resuscitate the system -- eventually. Once banks are revived from their lending comas, they will actually lend again. Long term investors know that stimulus takes six to 18 months to have its effect on the economy. Additionally, there is a bunch of cash (estimates run over $10 trillion) sitting on the sidelines as investors take comfort in money market funds and T-bills. This money needs to grow and in a zero interest rate environment the money is likely to find itself back into the stock market.

None of this will happen immediately, but as we become more accustomed to the daily gyrations and the Dow Jones Industrial Average firmly ensconced below that 10,000 level, long term investors are bearing down and hunkering down for a long haul. They are likely to be rewarded for their patience.

Get Over It

Question: Who is happy about the travails that have swept through Wall Street and Main Street? Answer: Absolutely nobody. And while we need to review how we got to this place so that we do not return any time soon, the blame game does not serve our national interest at this critical point.

Yet there seems to be a need to point fingers: it’s the government’s fault-why is homeownership inextricably linked to the American Dream anyway?; it’s the Democrats’ fault for empowering Fannie Mae and Freddie Mac to act imprudently and getting too big; it’s the Republicans’ fault for easing the regulatory environment; it’s Wall Street banks’ fault for creating highly complex securities that utilize massive leverage; it’s the lender’s fault-under what system is it a good idea to hand over piles of money to folks who have low/no income and no asset base?; it’s the borrowers’ fault-these folks could not manage to buy a house that they could afford. Bottom line: there is plenty of blame to go around.

One group that feels highly indignant is those Americans that acted responsibly throughout the boom period. These good eggs were forced to listen to their neighbors’ crow about rising real estate values of their Florida condos. They are probably the same group that did not purchase internet stocks in a big way, but instead trudged along with good, but not over-the-top returns. These are the silent majority of taxpayers – they also seem to be seething about the current crisis facing the financial system.

The questions/comments that I have heard from this group are: “Why should I bail out Wall Street fat cats who earn millions of dollars?”, “Why does my tax money have to help a stupid borrower refinance his loan when nobody cares about the rate that I have for my loan?”, “we have to stop saving everyone. Only when the careless risk takers pay the price will they learn the hard lessons that will prevent stupid behavior in the future.” The last sentiment is the “moral hazard” argument, which strict ideologues trot out to underscore that “the free market system will take care of everything in the end.”

I understand and even identify with these core beliefs, but not enough to watch our gorgeous, flawed system end up in the toilet for a decade. We have seen the results of the free market in the aftermath of Lehman Brothers’ failure—a crippled financial system and a stock market in free fall: is this what we want or need? I don’t think so.

And for all of the prudent folks out here—you know, the ones that live within their means, put down at least 20% when we purchase real estate and diligently maximize their retirement contributions, as Joe Nocera pointed out in the New York Times, these people “need to get over themselves. If housing prices keep falling, many millions of additional homeowners will find themselves, through no fault of their own, with underwater mortgages. Besides, foreclosures damage property values for everyone, not just those losing their homes.” Finally, the best part is that those who have lived their lives responsibly will be the ones who can profit when the recovery occurs.

Buffett Bounce

Just because the stock market rises on any given day does not mean that the bad times are done. In fact, I will be the first to point out that one day does not amount to a trend, but these are trying times, so we’ll take it! Chalk it up to sheer exhaustion, more buyers than sellers or perhaps a “Buffett Bounce,” but stocks actually increased in value yesterday without the government announcing a new zillion dollar rescue plan.

Yes the stock market continues to be oversold on a technical basis, but this article is about Mr. Buffett, a guy who is used to putting his money where his mouth is. In Friday’s New York Times, Buffett wrote an Op-Ed entitled “Buy American. I Am.” Although the title seems patriotic at first glance, country is not what prompted Buffett to pen this article—greed was his motivator. As Buffett likes to say “Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors.”

Buffett was not suggesting that buying in this particular moment would amount to instant riches. Indeed, the stock market actually fell on the day that Buffett’s article was published, so my “Buffet Bounce” is a stretch. Additionally, his two recent investments in Goldman Sachs and GE are under water, which may be why he admitted that he “can’t predict the short-term movements of the stock market.” But in his personal account (not Berkshire Hathaway), where he has been parking money in government treasury bonds, he is now selectively adding to his stock position. Buffett anticipates that his non-Berkshire net worth will “soon be 100 percent in United States equities.”

What would prompt someone like Buffett to encourage the masses in such a way? My guess is that he sees himself as a teacher, a market Yoda, if you will. Buffett is a cool head that is prevailing amid panicky investors, both individual and professional. He sees green in a sea of red: “fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.” There is a disclosure that accompanies Buffett’s advice: “I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over…bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price…over the long term, the stock market news will be good.”

OK, so maybe we can’t all be Warren Buffett—we don’t have billions, nor do we have a perpetual time horizon. But he does make valid points about valuation and emotions surrounding the current period. He specifically calls out those who have succumbed to the pressure and bailed out of the market all together. Buffett notes that “Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts. Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.” A billionaire who invokes the Great One? It sure is hard to argue with that!

A Superlative Week

It was the best of times, it was the worst of times…it was simply a superlative week. Highs, lows, record moves and of course a healthy dose of hope, fear and dashed expectations were the highlights. It is indeed understandable if you are a bit unnerved by the roller coaster action of the week.

Last Monday, US stocks saw their biggest one-day percentage gain (11-12%, depending on the index) since the Great Depression on the heels of the government’s historic plan to restore confidence and strengthen the US banking system. By Wednesday, the plan lost luster as investors quickly shifted from systemic fear to the problems that exist in the core economy. As a result, stocks had the biggest one-day percentage loss since the Crash of 1987. In between, volatility, as measured by the VIX, reached its highest level EVER. By the end of the week, most were happy that it was just over and some may have noticed that stocks were higher for the first week in five. In fact, it was the Dow’s best weekly gain since March, 2003 and the first weekly gain since Lehman Brothers collapsed, but that is tempered by the fact that it followed the worst week ever for the Dow, which ended the previous Friday (Oct 10) with the lowest close since April 2003.

A Victorian commentator once noted that “Every genuine business panic springs from the same root, which is rank speculation.” Add to that idea that every panic is marked by a sense that the financial system is close to complete collapse and you can guess that the unwinding of speculation becomes super-charged when fear is added to the equation. These are times when loss aversion supplants profit potential as the dominant investor motivator.

In other words, the inverse of a speculative boom is a fear-driven panic, when as Edward Chancellor in the Financial Times, (10/14/08) noted that “excessive confidence is replaced by extreme fearfulness and a nervous distrust takes the place of blind trust.” Or as James Stewart noted in the Wall Street Journal, a panic resembles a bubble: “Just as in a bubble, price/earnings ratios were now irrelevant, because earnings were going to be so much lower than forecast. (In a bubble they're going to be higher.) People were saying confidently that the Dow Jones Industrial Average was going to 6000. (It was 20000 in the bubble.)”

In times of extreme price action, I always come back to the same theme: there are two dominant emotions in this business: fear and greed. For the sane investor, the challenge is to avoid getting caught up in either extreme. On the way up, you need to shut down the cheerleaders, stick to your game plan and not get sucked into buying the speculative top of any asset class. Conversely, on the way down, you need drown out the Cassandras, adhere to your long-term strategy and not get suckered into selling the fear-based lows. This does not mean that you should not adjust your portfolio as conditions change, but not succumbing to extreme emotions is likely to keep you out of trouble, especially during superlative weeks.

It Ain’t Over…

The action of the past two days is more evidence that extreme volatility remains in play for investors. Unfortunately, we have no idea when the fat lady will sing to mark the end of it. In times like these, it is advisable that you try not to make too many big decisions and instead patiently await the return of sanity to infuse the markets.

So what happened over the course of two days? On Wednesday, investors realized that the financial crisis is not the end of the process. People turned their attention to the fundamental economy and the news was a bit spooky, even for October. Evidence is mounting that the downturn could be more significant than the 2001 or 1990-1991 recessions. While we all knew this was coming, it was confirmed by the release of September Retail Sales, which dropped 1.2%--the worst reading in two years. Considering that 70% of the US economy is powered by consumers, a retrenchment in their consumption is going to have a dramatic effect on the economy. Additionally, a more esoteric report underscored the pull-back in global growth. The Baltic Dry Index, which measures the cost of shipping bulk commodities, tumbled to its lowest level in almost six years as recession fears intensified. The index has fallen 49.8% since the end of September and has fallen 86% from May’s all-time high amid weakening demand.

These recession fears were exacerbated in the last hour of trading on Wednesday. Some said it was mutual fund liquidations or hedge fund puking after margin calls. In the end, there were just more sellers than buyers and US stocks saw their worst percentage loss since the crash of October, 1987. The Dow tumbled 733.08 points or 7.9% to close at 8577.91; the NASDAQ dropped 8.5% to 1628.33; and the S&P 500 was down 9% to 907.84. The damage amounted to approximately $1.1 trillion in value in ONE DAY.

Then something neat happened yesterday: investors realized that maybe the world was not ending just yet. The readings on inflation demonstrated that indeed prices are falling—crude oil traded below $70 a barrel for the first time in over a year; interbank lending rates improved; the VIX broke through an intraday record above 80, but finished down 3.2% at 67.06; and stocks partially recovered from Wednesday’s debacle. The Dow swung in an 816-point range, finishing in the black by 401.35 points higher, up 4.7%, at 8979.26, a more than 50% retracement of the previous session's damage.

So what have we learned from the two-day roller coaster? There is now a consensus that we are in a recession on top of significant financial market stresses that have wreaked havoc over the past month. What is less clear is how bad it’s going to get. The best way to think about the massive swings is to translate them into a conversation. On Wednesday, Mr. Market said: “this is going to be a really bad recession and it’s going to last a very long time—maybe forever!” Then yesterday, Mr. Market said: “this is going to be a bad recession, but there are still companies that will make money and maybe they are worth owning.” This will likely be a conversation that continues for some time, so be prepared for more of these wild gyrations.

TAP the TARP

Treasury Secretary Henry Paulson was seen as the US government’s front man as the credit crisis escalated. But then the whole debate on the rescue bill tainted his image as the financial wonder-boy from Goldman Sachs. As investors stared into the abyss and contemplated the “Second Great Depression” a new hero emerged—it was Federal Reserve Chairman and Depression-expert Ben Bernanke.

Yesterday, it was Ben’s turn to explain the government’s new plan to the world. He penned an opinion piece for the Wall Street Journal called “We're Laying the Groundwork for Recovery -- The necessary policy tools are in place.” (With all due respect to Bernanke, he is an economist, not a tabloid headline writer!) The article was published a day after the US announced a sweeping plan to stabilize the banking system.

Following the lead of the UK and other countries in Europe, the government said that it would TAP the TARP this week to bolster the banking industry. Uncle Sam will invest $250 billion into the nation’s banks in exchange for preferred stock. Half of the lump sum was directed towards large banks- Bank of America, Citigroup, JP Morgan Chase and Wells Fargo and all will get $25 billion, Goldman Sachs and Morgan Stanley, the country’s newest bank holding companies, will pocket $10 billion, Bank of New York and State Street are due to receive $2-3 billion. The government will also guarantee all senior debt issued by banks over the next three years and will provide unlimited FDIC insurance to all noninterest-nearing accounts, which are used primarily by businesses.

Mr. Bernanke assures us that these actions, combines with all of the previous efforts, will be able to meet the challenges in the
markets and in the economy. “We will not stand down until we have achieved our goals of repairing and reforming our financial system, and thereby restoring prosperity to our economy.” Time will tell if he is right, but as we entered last weekend, it was clear that the government’s previous efforts were not working fast enough, as interbank lending was under increasing strain, equity market volatility was reaching all-time highs and credit markets were making new lows. In Bernanke’s words, “clearly the time had come for a more comprehensive and broad-based solution.”

The global action was needed to reduce systemic risk and to restore the functioning of global financial markets. Indeed the plan may eventually accomplish this lofty goal, but it will be a long process. Mr. Bernanke himself acknowledged that “at the root of the problem is a loss of confidence by investors and the public in the strength of key financial institutions and markets.” Confidence is a funny thing—it takes a lifetime to establish and a moment to evaporate. The coordinated global effort was necessary to stabilize the financial system, but it will now take time for investors and citizens to trust that we are on the road to recovery.

The Mother of all Rallies

For those who panicked last week, take heart…the stock market may have lurched forward yesterday, but it just as easily could have dropped once again. It only took Mitsubishi backing out of its investment into Morgan Stanley or maybe another hesitating weekend of inaction by the world’s finance ministers. That said, many investors learned a painful lesson yesterday: for relief in the moment, you may have chosen a path that could (or could not) have long term ramifications.

In Ron Lieber’s recent New York Times article “Switching to Cash May Feel Safe, but Risks Remain,” (October 8, 2008), he cites 2005 research conducted by H. Nejat Seyhun, a professor of finance at the Ross School of Business at the University of Michigan. Seyhun “tested the long-term damage that investors could do to their portfolios if they missed out on the small percentage of days when the stock market experienced big gains. From 1963 to 2004, the index of American stocks he tested gained 10.84 percent annually in a geometric average, which avoided overstating the true performance. For people who missed the 90 biggest-gaining days in that period, however, the annual return fell to just 3.2 percent. Less than 1 percent of the trading days accounted for 96 percent of the market gains.”

Let’s take a look at this in real time. Friday capped the worst week ever for US stocks. The major indexes plunged over 18% in just five trading sessions. Then yesterday, the Dow Jones Industrial Average soared 936.42 points, or 11.1%, to 9387.61. The S&P 500 soared 12% to 1003.35, with all its sectors climbing. The Nasdaq Composite Index rose 12% to 1844.25 and the small-stock Russell 2000 jumped 9.2% to 570.55. Stock markets around the globe put in similar performances. Of course stocks are still mired in a serious bear market, with the Dow still down 29% year to date and off 34% from its record close of 14164.53 hit just over a year ago on October 9, 2007.

Indeed, a good night’s sleep is a precious commodity. But it is also important to remember that emotional decisions often can have a payback. You may have felt better over the weekend after going to cash, but how are you doing now? Are you still comfortable knowing that you missed the biggest percentage gain in US stock history? As Lieber notes, “some retirees, or those close to leaving the work force, may be well-off enough to leave stocks behind for now. If the tumult in the economy and the decline in the markets have altered your risk tolerance, then it may make sense to move to a portfolio of Treasury bills, certificates of deposit and money market funds.” But if you are a long-term investor, you should try to avoid the herd mentality that is associated with bull and bear markets.

Burton Malkiel, the legendary author of “A Random Walk Down Wall Street,” reminds us that “the herd instinct works exactly the same way in bear markets. Nervous investors convince themselves that every "light at the end of the tunnel" is a train coming in the opposite direction. Panic is just as infectious as blind optimism. During the third quarter of 2002, which turned out to be the bottom of a punishing bear market, investors redeemed their mutual funds in droves. My own calculations show that in the aggregate, investors who moved money in and out of equity mutual-funds underperformed the buy-and-hold investors by almost three percentage points per year during the 1995-2007 period. Look at history: The market eventually bounded back from the damaging stagflation of the 1970s and the savings-and-loan crisis of the early 1990s, when a whole industry had to be rescued. Stocks also recovered from the Asian crisis of the late 1990s. Similarly, investors who held on after the more than 20% one-day stock-market decline in 1987 were eventually well rewarded.”

Whether or not last week was the bottom of the stock market move will only be known in retrospect. One way that you may know that your asset allocation is consistent with your risk tolerance is if you felt as calm last Friday and you are today. If that’s the case, the “Mother of all Rallies” was just another Monday.

Hedonists and Risk re-raters

People are scared by the tumbling markets and in some cases, they should be. They made decisions over the past three or four years that have made them less equipped to deal with the current market and economic situation. In fact, I can actually pinpoint those who are in full freak-out mode while the majority of others are clearly concerned, but not spinning out of control and making rash decisions.

The two categories of people that seem to be in full-fledged hysteria are: the hedonists and the risk re-raters. Let’s start with the former. Over the course of the past decade or so, hedonism had made a revival in America. There was the hyper-focus on living it up, enjoying the best there is and even a resort called “Hedonism.” The good times were fueled by two asset bubbles -- the stock and housing markets -- and were super-charged by ultra-low interest rates.

The hedonists lived beyond their means—they chose to purchase homes that were too expensive; went out to dinner, bought fancy cars and vacationed instead of saving more in their retirement accounts; decided to retire too early; and simply spent too much money. I spoke to a couple who never would have considered themselves as hedonists, but indeed they are. Three years ago, they started to talk about their longer term goals. They planned to work for 5-10 years, leave the Northeast and relocate down south.

But then the housing market exploded and all of their friends were buying land and condos and they wanted in on the action. They called me after they had placed a $70,000 down payment on a piece of land and informed me that they intended to rent out the place down south until they were ready to retire. Flash forward to today and you know the story: the $600,000 house is almost complete, nobody is interested in renting and they are now carrying two homes with two mortgages and are that much closer to retirement. Is it any surprise that this couple is not sleeping as they watch their portfolio drop from $1,000,000 to $850,000? Believe me when I tell you that they do not want to hear that they are “only” down half the amount of the overall stock market. They are paying for their desires now and it hurts badly. Chances are hedonists would feel far better about the value of their investment accounts if they had not overextended themselves in the period prior to this one.

The “Risk re-raters” are a different genus. These are the investors who were happy to assume risk in their portfolios as long as the market was moving in the “right” direction. They tended to be among the more annoying clients in a rising market environment ---“Can’t we do better? I think we should own more (fill in the blank of the asset class that was up the most in the prior year) to improve our returns!” The dutiful advisor would talk about what happens when the market goes down, warning that while it is great to assume more risk when things are going well, it doesn’t feel so hot when the markets move in the opposite direction. This is usually met with a nodding head and then a rush to sign new paperwork and increase the risk levels.

As the down market turns into a raging bear market, these are among the first people we hear from—they are worried that their growth (what exactly did they think “growth” meant?) portfolios are down “so much.” Forget trying to explain that they are not down nearly as much as the market, or even to remind them that they had made this decision against all better judgment. These are among the first people who want OUT immediately and who say that they will get back in when “things settle down.”

This occurred with a client I will call “Jane,” who retired from working full time four years ago at the age of 58. At the time, she had a pile of money and I advised taking a less risky approach to her portfolio, because she could—meaning that because she had done the hard work of accumulating $4,000,000, she did not have to go beyond being a balanced investor over the next thirty years or so. After the first year, she came in for a meeting with one goal in mind: she wanted to earn more on her investment account so that she could stop working part-time. She recounted how friends of hers were doing much better with their money and that she wanted in on the action. She pushed all of the warnings aside, quit her job, increased the risk and then when the September massacre occurred, she pulled out of everything—completely!

The moral of this column is not to make people feel bad about losing money in the markets—we are all in the same boat on that front. Rather this is an important reminder that the decisions we make in our lives can often be the difference between being able to weather the storm and enjoying a good night sleep and succumbing to emotions and making another set of bad decisions. That is perhaps the silver lining for those of us in the advice-giving business…maybe this current cycle of lessons will finally help shift behavior in the future and prompt people to make more prudent financial decisions in our next phase.

Nine Survival Tips for the Crash of 2008

The have strange and eerie examples of symmetry in this stock market crash of 2008. On Wednesday, the Dow Jones Industrial Average dropped 508 points—the exact same point drop as the crash of 1987. Then yesterday, on the one year anniversary of the all-time high of the Dow Jones Industrial Average, stocks plunged in the last hour of trading, leaving the blue-chip measure is down 39.4% from its record a year ago.

The day did not start off so bad, despite global big sell-offs that preceded the opening bell. Then at about 2:30 or so, the selling accelerated as hedge funds had to sell holdings to raise collateral and reduce leverage, mutual funds had to execute redemptions as smaller investors reduced exposure or bailed out completely and computerized trading kicked in as stocks traded below specific benchmarks. The damage was severe and intense: the Dow Jones Industrial Average dropped 678.91 points, or 7.3%, to close at 8579.19, the S&P 500 shed 7.6% to end at 909.92; the Nasdaq Composite Index fell 5.5% to 1645.12, the small-stock Russell 2000 tumbled 8.7% to 499.20. No sector was spared in the broad-based selling.

What’s an investor to do in the midst of this mess? Here are nine survival tips for those who want to take action right now to help control their destinies:

1) GET PERSONAL: Sure the market is in turmoil and it is scary, but your personal situation should guide decisions made in this very emotional time. The first step is to figure out where you stand and more specifically, you should understand the status of your "BIG THREE": 1) Emergency cash reserves 2) Current level of debt 3) Current retirement contribution. If you have very little cash on hand, consider stockpiling your reserves so that you have 3-6 months of living expenses--this is especially important if you think that your job is at risk (i.e. EVERYONE). If you have consumer debt, make sure that you pay off higher interest loans first. For some, this may necessitate making some tough decisions--but the exercise will lead you to...

2) DEVELOP A CASH FLOW: This is an empowering part of the process. Considering that everyone feels out of control right now, the simple technique of identifying what is coming in and what is going out can help you come up with a short, intermediate and long term game plans. The process is hard, but well worth the effort and should leave you understanding that which is in your power to control.

3) RETIREMENT: If cash flow can afford it, DO NOT PULL-BACK ON RETIREMENT CONTRIBUTIONS. I know, this is hard one, but you can identify choices within your retirement plan that may have somewhat reduced levels (fixed accounts, bond funds). Your specific time horizon and risk tolerance will help you come to a proper allocation.

4) REVIEW YOUR ASSET ALLOCATION: For some people the process of selecting investments was not well thought out. It's time to see how much money is allocated to stocks, commodities, bonds and cash. If you need your money within two years and all of the investments are in stocks, this is going to hurt...you MUST reduce your exposure and bite the bullet. Unfortunately, if you needed your money within that time horizon, you probably should not have had an allocation that was heavily invested in risk assets. Now that mistake is behind you, so you are going to have to fix it.

5) IDENTIFY YOUR RISK TOLERANCE: During years when the stock market is rising, I have seen clients gloss over the question, "How would you feel if your account dropped by 30% in a given year? Of course now you know exactly how you feel and maybe you aren't so able to assume risk. That said, remember if you shift your allocation, maybe from growth-oriented to more balanced, you can't second-guess yourself and switch back to Growth when things smooth out. This is so hard, because as human beings, we always get greedy at the top and fearful at the bottom. But if you choose a portfolio with a lower risk level, you must assume that when the market recovers, you will not participate as fully in the upside. The idea of sleeping at night is pretty important, so if your accounts are keeping you up, rake action. MOST RETIREMENT PLANS OFFER A RISK ASSESSMENT ON LINE--TAKE IT!!!

6) WHERE TO HIDE NOW: Cash or cash equivalents may seem great (hey, they are not going down, right?) but of course over the long term, staying in cash will not help you grow your money faster than inflation. That said, remember that FDIC insurance recently kicked up to $250K per account and that the government is backing up money market accounts. You can also buy bills, notes and bonds directly from the US government at http://www.treasurydirect.com/

7) BEWARE BIG SALES PITCHES: When we are fearful, we tend not to make the greatest decisions. So if someone (a broker, salesman, etc) is pushing something right now that "guarantees your principal," you should understand that most guarantees come at a cost. Try not to tie up your money for a significant length of time right now.

8) TURN IT OFF SOMETIMES: The current crisis is replete with scary music and graphics. Once you have assessed your personal situation and made some choices, its OK to tune out from the 24/7 coverage.

9) And my personal favorite: Y & A: During tumultuous times, try to find ways to relax...for me, it's yoga and alcohol, but not at the same time!

Day of Atonement

Today is the holiest day of the Jewish calendar—Yom Kippur, or the Day of Atonement. While you are reading this, I am sitting in temple trying to ignore the growling in my stomach. (One of the rituals for Yom Kippur is fasting.) In honor of the day, it is worthwhile to think about things we might have done better over the past year. Although I am sure that this is sacrilegious in some way, this article is devoted to those things that we could have done better in our financial lives over the past year.

1) Be more patient with clients who are reluctant to do the things that they should. Perhaps it’s a sign that I care a great deal about my clients, but I tend to become a little anxious when they do not proceed with the planning items that are important. This can range from the big stuff, like estate planning and insurance coverage, to smaller issues, like making adjustments to withholding to improve cash flow. I sometimes forget that it often takes people a while to act and that a gentle nudge every now and then is all they need, not a speech.

2) Try not to be exasperated when repeating important concepts. Recently a long-time client told me she was listening to the radio show and finally understood how bonds worked. I said, “Alice, haven’t I gone over that with you in the past?” She said, “Of course, but it just really sunk in for real last Saturday!” Many of the concepts that I talk about with people have never been fully explained to them. Additionally, there is so much shame around not knowing, that people may not even tell you when they do not really get it.

3) Be more patient with prospective clients who are having difficulty deciding what to do. There have been occasions when I am so sure that I can help someone that I can’t understand why they will not proceed. The reason is that wealth management is an extremely emotional issue that weaves some of our biggest fears in with our most glorious hopes. Some people need one meeting to unravel the issues, some need two, and some need a longer time to sit with an idea before coming to a decision.

4) Try not to second-guess every trade. You would think that after twenty plus years doing this, I would know that you just can’t get it right on every decision. Still, I find that in the moment, I can beat myself up for not getting it spot-on. This does not mean that I ignore mistakes, but I have to be a little more forgiving in the process.

5) Be more compassionate. Let’s face it -- these are trying times for everyone. I am sure that there has been more than a few times over the past month, when I may have not been quite as understanding as I could have been with clients who are really scared. It doesn’t matter whether I think that they will be OK—they really need to feel it. In fact, as we move through this time, maybe it wouldn’t be so bad if we could all be a little nicer to each other…

508…an eerily familiar number

In my office, I have a photo of an old Quotron machine from the eighties. On it, the following jumps out at the trained eye: DJIA -508. The photo was taken on Monday, October 19th, the day that the Dow Jones Industrial Average fell 22.6%. Yesterday, it was déjà vu---another 508 point drop, but this time the point total did not amount to 22%, but 5.1% was plenty, thank you very much!

The selling was not prompted by anything new—same old credit crisis which has now morphed into blind fear. After gains at the start of the session, stocks turned down steadily and the losses accelerated, leaving the Dow down 508.39 points, or 5.1%, at 9447.11, its lowest close since Sept. 30, 2003. The Dow shed nearly 13% in the past 5 trading sessions, the largest drop since September 2001. The 1403.55-point decline was the Dow's biggest 5-day drop ever, and that doesn't include a 778-point drop on Sept. 29. The Dow is now down 33% from its record high reached almost exactly a year ago.

The damage was worse for the S&P 500, which closed yesterday below the psychologically important 1000 level for the first time since Sept. 30, 2003. The S&P fell 60.66 points, or 5.7%, to 996.23. Its 14.6% five-day decline is the biggest since the five days that included the October 1987 stock-market crash and the index stands 21% lower than it was just one month ago. The S&P 500 is now down 36% from its peak a year ago, almost to the day, on October 9, 2007. The NASDAQ fell 108 points or 4.3% to 1862.

If you woke up early this morning, the news did not seem much better. But then at 7:00 am, history was made: in a coordinated global effort, the world’s central banks announced cuts in target interest rates. The US Fed, the European Central Bank (ECB), the Bank of England, the Bank of Canada, Sveriges Riksbank and the Swiss National Bank all reduced their respective policy interest rates by 50 basis points or a half of a percentage point. The Fed's open market committee voted unanimously to cut its target to 1.5%, the ECB to 3.75%, the Bank of England to 4.50% and the Swiss to 2.5%. The dramatic action was intended to help stem a growing global financial crisis. The Fed noted that “The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability."

The unprecedented action is a good step forward, leading me back to October, 1987. At that time, fear gripped investors and everyone bailed out simultaneously. While our crash was not as dramatic because it took place over the course of weeks, not in a single day, this period will likely be seen as what academic Charles Kindleberger called the “revulsion stage” of a crisis---the indiscriminate and contagious selling of distressed assets that leads “banks to stop lending on the collateral of such assets.” When such fear grips the markets, investors (and speculators) are quick to generalize-punishing many for the sins of the few. That’s the most dangerous phase of any crisis—when market implosions start to take on a self-reinforcing life of their own. It is worth noting that sometimes the painful “revulsion” stage sets up the next phase of the process, where investors and markets remember how to breathe.

In 1987, the stock market regained its footing after October 19th and the crash marked the low point for stocks in 1987 and by year-end, the Dow actually showed a gain for the year! Within nine months, stocks recovered all of the losses incurred on October 19th and the US economy never went into a recession as a result of the crash. Given the unwinding that is occurring, it is doubtful that we will avoid recession this time around, but sometimes it is helpful to return to other turbulent periods to help us put our current situation in context a bit more.