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.
Friday, October 17, 2008
Wednesday, October 15, 2008
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.
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.
Tuesday, October 14, 2008
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.
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.
Monday, October 13, 2008
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.
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.
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