Remaining Calm While Stock Prices Plummet

“If you can keep your head when all about you
Are losing theirs and blaming it on you” – Rudyard Kipling.

Based on today’s results on Wall Street, it looks like we are in for another roller coaster ride this week. Even though we emphasize long term investing, it is difficult to ignore such wild swings in stock prices.

According to a recent column in the Wall Street Journal, “The U.S. financial system last week was rocked by the biggest crisis since the 1930s — and the federal government responded with a multi-pronged intervention that is the most sweeping since the New Deal.”

We do not yet know how much the bail-out plan will ultimately cost the American taxpayer, nor do we know how it will be implemented or how it will all turn out in the end. There are, naturally, dissenters who question the plan or at least some of its ramifications, especially the issue of moral hazard. (More about that later).

That said, I would like to take a moment to recognize Brett Arends, a columnist, who counseled calm and restraint, before and during the stock market’s turmoil. Brett Arends writes R.O.I., or Return on Investment, daily for the Online Journal. On the evening of September 17th, after the Dow Jones Industrial Average had fallen by 450 points, when most people were extremely nervous, Arends put out a video called Reasons to Stay in the Market.

He advised investors not to overreact, and that after such a fall in prices, it is a better time to be buying, rather than selling.

On the morning of September 18th, before the new U.S. government intervention was announced, he followed up with a column called Ten Reasons Not to Sell Your Stocks.

“I’ve seen this sort of panic enough times to have a little perspective. I’m certainly not urging you to rush out and put all your money into the stock market. Your investments should be based on your own financial situation first, and the situation in the markets second.”

Arends added, “If you are panicking and getting ready to sell everything and hide under a rock, here are ten reasons why you shouldn’t.”

1. Oil prices just slumped.
2. Mortgage rates have tumbled.
3. A measure on Wall Street known as the “Vix” just went through the roof.
4. Uncle Sam is finally waking up and getting involved in the crisis.
5. There’s an old Wall Street saying: The time to buy is when there’s blood on the streets.
6. Even one of the most notorious bears is starting to concede some shares are reasonably valued.
7. Big money managers are bearish.
8. If you sell everything and move your money into “safe” places like cash or bonds, you will be running right smack into another risk: inflation.
9. The housing market is about to get two big doses of help.
10. America is finally getting the wake up call it needed.

I’d like to highlight and comment on a few of his “reasons.”

4. Uncle Sam is finally waking up and getting involved in the crisis.

Better late than never. If Mr. Bernanke and Mr. Paulson had taken strong, clear action a year ago, maybe some of these blow ups might have been averted, or minimized. But it’s good news that they stepped in during the AIG debacle, and it’s good news they are letting other firms swap illiquid assets for cash.

Arends wrote these comments before the big bailout proposal was announced. While it is true that the details have to be worked out and agreed upon, on the table (finally) is a comprehensive plan that aims to restore confidence and allow banks to do what they are supposed to do – raise money from investors and lend money to consumers and businesses.

As mentioned in a previous post, we have been going from one crisis to another, using a case-by-case approach that just has not worked.

5. There’s an old Wall Street saying: The time to buy is when there’s blood on the streets.

How about now? Blood isn’t just on the streets – we’re hip deep in the stuff.
There are no guarantees, but history has usually been pretty kind to those who invested after the market had plunged this far and just hung on for years. Sure, there may be plenty more bad news to come. But the collapse in share prices has already priced plenty of that in. Investors are, at long last, getting paid something for taking the risk of owning equities.

Fair enough. By the way, it was Baron Nathan Rothschild, an 18th century British financier, who has been quoted as advising, “The time to invest is when there is blood in the streets.” In other words, buy when everyone else is selling out of fear. This maxim may be easier said than acted upon.

We have definitely gone through a very rough patch, when fear was endemic. At a minimum, it is usually not a good time to sell when everyone is panicking. And after stock prices have fallen, the expected return in the future is higher, not lower.

8. If you sell everything and move your money into “safe” places like cash or bonds, you will be running right smack into another risk: inflation.

Savings account are a great place to keep ready money, but not for long term investments. They are only paying maybe 3% before tax. As for long-term Treasuries? These so-called “safe” investments are fool’s gold. They’re yielding barely 4%, again before tax. I wouldn’t buy them with counterfeit money.

In my opinion, this is a bit of an exaggeration, but I can see his point. Preserving purchasing power is just as important as preserving capital. But bonds do have a place in a properly diversified portfolio. In any event, research shows that short-term bonds have a better risk- return profile than long term bonds.

10. America is finally getting the wake up call it needed.

We’ve been living in a funny-money economy for years. Everyone from college kids to the federal government has been surviving on credit card debt and pretending it could go on forever. It was impossible to get really positive again until that came to an end. It takes a real shock for that to happen. Like this one.

Yes, we are all paying attention now, which is a good thing. Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson have turned themselves into the new 21st Century version of the “Dynamic Duo,” impressing upon Democrats and Republicans the importance of working together as a team, for the good of the country.

We’ve had other financial crises in the past, so it helps to have some perspective. When you are living through a tough time, it always seems unprecedented. (This one sure does!) But we have solved serious problems before. From past experience, it is realistic to be a long term optimist.

Conclusion

I advise clients not to follow the stock market on a short term basis, but how can you not, when the evening news leads with it almost every single night? It’s as though the news consists of the stock market/credit crisis first, and then everything else. It almost makes you wish for a good old fashioned political sex scandal, just for a change of pace.

Could things get worse yet? Yes, but, then again, maybe not. If you have a diversified portfolio, based on a sensible long-term plan, stick with it. Talk to your advisor about rebalancing and possible tax loss harvesting. If you have a very concentrated position in one stock, irrespective of which stock it is, consider selling some of it and investing in a more diversified portfolio.

photo credit: Vibrant Spirit