Time Will Restore Confidence

In our August market update we stated that we felt the financial stocks had more surprises like that of Lehman Brothers, but the fall out here and abroad has been much worse on the financial markets than originally expected.  In my thirty years in the wealth management business, this is by far the worst financial crisis I have ever seen. However, I am optimistic that the worst is behind us. Time will restore confidence and successful testing with higher lows will stabilize our markets going forward. We are witnessing history in the making with this market. As a result, the economy has increasingly become the main issue facing our presidential candidates. Here is a quick rundown of the main events that have occurred during this turbulent time:

 

• Sept. 7: Government takes control of Fannie Mae & Freddie Mac
• Sept. 11: Lehman Brothers says it is looking to be sold
• Sept. 14: Bank of America purchases Merrill Lynch for $29 per share
• Sept. 15: Lehman Brothers files for Chapter 11 bankruptcy
• Sept. 16: Government provides $85 billion emergency loan to rescue AIG
• Sept. 17: Barclays buys Lehman Brothers’ North American banking division for $250 million
• Sept. 19: President Bush stresses need for a bailout plan to confront the financial crisis
• Sept. 21: Goldman Sachs and Morgan Stanley become bank holding companies
• Sept. 24-27: President Bush, Barack Obama, John McCain, and other Congressional leaders work to create an acceptable bailout plan
• Sept. 26: Washington Mutual becomes the largest thrift failure and bank operations are subsequently acquired by JP Morgan for $1.9 billion
• Sept. 29: Citigroup makes bid to acquire Wachovia’s banking operations for $2.1 billion in stock; Bailout package is rejected by the House of Representatives; The Dow falls 777 points, which is the largest one-day point drop in history
• Oct. 1: SEC bans short selling against 800 financial companies until bailout pact enactment
• Oct. 2: The US Senate votes in favor of the Wall Street bailout plan
• Oct. 3: The House of Representatives passes an amended bailout plan and President Bush signs the historic $700 billion Troubled Asset Relief Program; Despite Citigroup’s previous offer, Wells Fargo acquires Wachovia in $15.1 billion all-stock deal that includes no FDIC assistance
• Oct. 6-10: The US stock market has its worst week ever, falling 18.2% in five trading days
• Oct. 9: The International Monetary Fund announces emergency plans to bail out governments affected by the financial crisis, after warning that no country would be immune from the ripple effects of the credit crunch
• Oct. 10: The Dow falls nearly 700 points to 7882 in the first few minutes of trading, rises over 1000 points, and falls again to close down 128 points
• Oct. 13: The Dow rises by 936 points to 9387, its biggest one-day gain by points and largest daily jump in percentage terms since 1933

 

Over this time period, we have surely seen our financial markets tested and the media has been quick to equate this downturn with that of almost Great Depression-like proportions.  The good news is that this is no Great Depression and while the economic situation is not ideal, the United States will recover stronger than ever with better values. We feel we are currently seeing the final capitulation needed to bring us back to a stable stock market. This term refers to when investors log in to their accounts to sell everything across the board, market orders, current price, wherever – just get me out!  When people say they’ll never touch the stock market again, that is when we have capitulation. This activity, though, generally occurs at the bottom because it both exhausts selling pressure and causes bargain hunters to enter the market to buy stocks that are deemed to have tremendous value.

Of course, having access to cash is exceptionally important during any type of market.  As a good part of a balanced financial plan, we recommend keeping any money you might need in the next year or two in low risk investments, such as our Tellone Mortgage Fund. Conversely, having too much cash because of a stock market downturn has its downsides, including missing out on any opportunity that comes when the market recovers and paying additional transaction costs to make the switch.  Most of the stock market gains lately have come from big one-day rallies, so if you have already made up your mind and plan to sell shortly it is best to wait until the markets get overbought or at least above the Dow 9000+ threshold, which will provide a much better opportunity to sell underperforming stocks.

In general though, for the long-term investor, it is a good idea to remain calm throughout the financial turmoil (see “The Case for Stocks as a Long-Term Investment“).  Know that these periods of extended pullbacks are not uncommon and represent about 12% of the markets history over the past 75 years.  Additionally, markets tend to revert to their long-term averages, so the best strategy during rough times is to ensure that your portfolio is properly diversified in order to capture any rebound.  The market is currently anticipating a recession, so we are focusing on stocks that are oversold and will do well through the recession. We believe that holding what is already way down is a good idea.  You should also take advantage of undervalued stocks that have a great future, as the investment outlook is much better today than it has been in several years.

We have been taking advantage of the extreme volatility to enhance our short-term trading strategy by utilizing Ultra Short Proshares to hedge our portfolios and make money on the downside. However, we have not been happy with the performance of mutual funds (about 10% of our total assets) because they have not protected principle the way they should. We are sticking with stocks so we can protect our downside. It will take several months for this financial turmoil to pass, but America will be better and stronger and the world will be more united.