Dear Investor,
You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready, you won’t do well in the markets. —Peter Lynch
There’s an old saw on Wall Street that the best—and the worst—trades are the ones you never made.
Of course, missing out on a rising market leads to the kind of recriminations that drive bad investment decisions, just as “missing out” on a declining market should trigger the kind of relief, reflection and self-examination that breeds good investments decisions. Either way, the recent volatility on Wall Street amidst talk of a $700 billion bailout has me thinking about similar “what if” scenarios. Specifically, how “what if” scenarios can expand dangerous financial bubbles and lay the foundation for the kind of financial crisis that we’re facing today.
I’m not the only one tying the two together. In an article in the August 8th issue of Seed Magazine entitled “A New State of Mind” by Jonah Lehrer, the author cites a study that researcher Read Montague published on the link between brain and social behaviors. Montague, director of the Human Neuroimaging Lab at the Baylor College of Medicine, describes the “what if” learning signal and why he believes it’s a main cause of financial bubbles.
Montague’s point is this: Wall Street investors are constantly comparing their actual returns against the returns that might have been, if only they’d sold their shares before the crash or bought Google stock when the company first went public. Montague concludes that when the market keeps going up, people are naturally inclined to make larger and larger investments in the boom. Consequently, just when investors are most convinced that the bubble isn’t a bubble —many of his study participants eventually put all their money into the booming market — thus triggering the bubble’s burst. As the financial markets collapse, investors race to dump any assets that are declining in value, as their brain realizes that it made some very expensive prediction errors. That’s when you get a financial meltdown.
Today, some of the best economic brains in America are equally unsure of how the U.S. financial infrastructure imploded and what to do about it next. On one level, who can blame them? After all, we now tread nervously on unfamiliar turf. Russia halts trading. Fannie Mae and Freddie Mac collapse. Huge, historic Wall Street icons like Bear Stearns, Lehman Brothers, and Merrill Lynch are no more. AIG runs out of money and begs Uncle Sam for an $85 billion bailout (and gets it). Hundreds of bank failures, money markets breaking the buck—all happening in a few short days. In short, near panic. What I’m hearing from other wealth managers is that many investors are throwing in the towel and doing it at any price.
Unfortunately, there is no quick fix. In fact, the only thing that throwing in a towel will accomplish is to leave you without a towel when you might really need one. We didn’t get into this mess overnight and we won’t be done cleaning it up overnight, either. More firms are going to merge, more banks are going to fail, and new events will transpire that we can’t predict.
Ultimately, what you did not do, or what you should of done, or what you wanted to do is not important…what matters is what will you do next?
A Path to Stability
What do we do now that we are experiencing a serious financial crisis? First, we need to get a grip. I am a glass-half-full guy to the extreme, so much so that even if there is only one gulp left, that’s enough for me to quench my thirst. Of course, I’m a realist, too. Like everyone else, I have bouts of optimism and bouts of negativity depending on the latest financial headline.
Ultimately, though, I think we’re going to be okay—and that our glass will eventually be fully replenished. Let’s examine some reasons why…
- Over $3.4 trillion in money market balances: This capital should come in handy when some of it gets redeployed in equities, as it eventually will.
- Corporate balance sheets: Certain sectors directly affected by this mess are very clean and they hold over $1 trillion in cash type instruments (Exhibit “A” is Microsoft’s move to buy back $40 billion of its own stock). I expect that more corporations will be either buying back their own stock and/or buying up other attractive companies.
- The functionality of the financial system remains solid—even when a bank, broker or financial firm fails.
- Valuations are not very high historically—compared with price to earnings levels of stocks in previous bubbles like the dot.com explosion in 2001.
- The bedrock of our economy is strong: Second quarter GDP was over 3%, unemployment has been better than expected, and global growth is slower but still expanding.
- Global injections of capital from central banks are at record levels and ready to add more if needed.
- Bernanke and the Banks: When it comes to the Federal Reserve, it’s best to go with the flow. If approved the $700 billion rescue plan will free up the banks and they will start lending again.
Room to Maneuver
In the end, it’s helpful to remember that capitalistic societies are designed with flexibility in mind. When we get into a mess like this, we find ways to get it fixed. Between government, the Federal Reserve, and our abundant private sector, we still have many tools available to help us out, like a tax credit or favorable capital gains tax on new secondary home purchases that would help dry up inventories and stabilize home prices.
Plus, we now know what has made our economy ill, and we also know the medicine we have to take to get us better. We must now take our medication and wait for it to work.
Past that, time, experience and knowledge are the way back to good economic health. At WrapManager, I believe we have some of the most experienced and most talented money managers managing your investments. We take concrete steps to customize your portfolio to your specific risk and objectives before you invested with us. In times like this many investors are questioning their initial plans, if you are one of these, it is OK. Let’s go through those steps again and get you to a more comfortable investment plan.
Feel free to tap into that investment expertise and give us a call—even if it’s just to talk. We recognize that times are tough, and that in times of great market uncertainty you have questions.
At WrapManager, we’re here to answer those questions and guide you through turbulent times.
In your interest,
Gabriel F. Burczyk, CEO
WrapManager, Inc.
Toll Free: (800) 541-7774
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