“That Party is Over”

Here is a most unpleasant fact: February was the fourth consecutive losing month for US stocks. After trying to rally in the beginning of the week, investors could not get out from underneath the deluge of bad news, whether it was disappointing results from financial giant AIG, tech bellwether Dell or flat out fear over exploding commodity prices. Many threw in the collective towel on Friday, hoping that a weekend would soothe their frayed nerves.

Perhaps you thought that you would dive into the financial news with words of wisdom from billionaire investor Warren Buffett, who released the much-anticipated annual letter to Berkshire-Hathaway shareholders late Friday. Mr. Buffett is not only known for his investment acumen, but his wonderful cheeky investor letters. You have to love a guy who comes right through the front door and says “that party is over” for the insurance business. (Berkshire posted an 18% drop in fourth-quarter net income on lower investment gains and a drop in insurance underwriting fees.)

If these are trying times even for the most sophisticated investors like Mr. Buffett, how are the rest of us mere mortals expected to weather the storms? When I find myself confused about a situation, I return to the basics about financial markets. The most important thing is that it is nearly impossible to determine the true inflection point of a market or economic move. That means that you should probably stop trying to figure out the top or the bottom and be content with simply making the most informed allocation decisions based on the information that you have.

The next thing that I always do is to constantly test my thesis. If you are feeling wildly optimistic or down-in-the-dumps pessimistic, find someone who can articulate the exact opposite opinion that you hold and listen to him/her! Markets are not static, they evolve and there are people who may see the landscape differently than the way you have surveyed it. Be willing to weigh the contra-argument to yours and allow yourself to say, “what if he is right and I am wrong? How would my portfolio perform if his thesis plays out?” You may actually find yourself reducing/increasing risk based on this process.

Of course, don’t go out and blow up your portfolio just because someone says, “the world is falling apart!” because you know that there is another smart person who can argue that “everything is coming up roses.” You should constantly question your assumptions. It sure would have been great if more homeowners were able to ask, “Wait a second…what if the value of my house were to fall, not rise? Would I still want this fat mortgage?” That simple moment of introspection may have been able to prevent disaster. Just ask Mr. Buffett, who noted that the housing recession has turned into a full-fledged crisis where “a huge amount of financial folly is being exposed…You only learn who has been swimming naked when the tide goes out - and what we are witnessing…is an ugly sight.” Yes, it is ugly and indeed Mr. Buffett is correct, that party is over. Of course experience tells us that there will surely be another out-of-control bash around the corner…commodities anyone?