Archives for October 2008

Understanding the Financial Crisis in Less Than 3 Minutes

Here is a nice video via Enspire Learning that provides an explanation for the financial crisis:

Obviously, it is more complicated than a 2 minute and 17 second video can explain. However, the video is well-done and tackles the root of the problem.

I like short and simple explanations like this. How about you? Have you found videos or visuals that explain the current financial crisis in short, simple, and easy to understand terms? If so, feel free to post your links in the comments to this post.

New Stock Market Terms

Some Friday afternoon fun originally posted by Barry Ritholtz at The Big Picture:

A fun email circulating trading desks, worthwhile as an informal measure of sentiment:

CEO — Chief Embezzlement Officer.

CFO — Corporate Fraud Officer.

BULL MARKET — A random market movement causing an investor to mistake himself for a financial genius.

BEAR MARKET — A 6 to 18 month period when the kids get no allowance, the wife gets no jewelry, and the husband gets no sex.

VALUE INVESTING — The art of buying low and selling lower.

P/E RATIO — The percentage of investors wetting their pants as the market keeps crashing.

BROKER — What my broker has made me.

STANDARD & POOR — Your life in a nutshell.

STOCK ANALYST — Idiot who just downgraded your stock.

STOCK SPLIT — When your ex-wife and her lawyer split your assets equally between themselves.

FINANCIAL PLANNER — A guy whose phone has been disconnected.

MARKET CORRECTION — The day after you buy stocks.

CASH FLOW — The movement your money makes as it disappears down the toilet.

YAHOO — What you yell after selling it to some poor sucker for $240 per share.

WINDOWS — What you jump out of when you’re the sucker who bought Yahoo @ $240 per share.

INSTITUTIONAL INVESTOR — Past year investor who’s now locked up in a nuthouse.

PROFIT — An archaic word no longer in use.

The Worst Week Ever

Last week was the worst week ever in the U.S. stock market. For the week, the S&P 500 and the Dow both crashed -18.20%! I survived! If you are reading this, then chances are…you survived too!

The Facts

Let’s review what just happened:

  • Last Friday, stocks endured the widest intraday swing on record. For the first time ever, the Dow traded in a range of more than 1,000 points in a single day.
  • Trading activity hit new records on Friday. The New York Stock Exchange composite volume hit 11.6 billion shares, a new record. Nasdaq trading also hit a record, as 4.18 billion shares changed hands.
  • For the week, the Dow dropped 1,874.19 points, or 18.2%. This was the worst week in its 112-year history.
  • The Dow closed the week at 8451.19, the lowest finish since April 25, 2003.
  • Stocks indexes have closed down 8 days in a row.
  • Stock market losses (in the DJ Wilshire 5000 Index) now total $8.4 trillion since the market peak one year ago.
  • The Dow is now down 40% from its October, 2007 peak.
  • The VIX, a measure of fear based on options trading, rose to 69.95, its highest level since it was introduced over 15 years ago.

Sources: Wall Street Journal, Investors Business Daily

How Did This Happen?

Do you wonder how we got here? Read this article which appeared in the New York Times on September 30, 1999. Here are a few highlights from the article:

Fannie Mae, the nation’s biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates — anywhere from three to four percentage points higher than conventional loans.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.

”From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. ”If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”

From about 1998 to 2006 home prices grew at an 8% annualized rate (source: Robert Shiller). Many in America began to operate under the assumption that house prices would always go up. Well, as we found out, that’s not true. The housing bubble popped! As the housing market has declined, over leveraged families and banks holding assets related to home mortgages have suffered significant losses. As a result of these losses, many banks lack the capital or the confidence in each other to make new loans. This has now led to frozen credit markets.
The bottom-line is that massive leverage is what got us here. The problems resulting from years of growth in the amount of debt relative to the size of the overall economy has now infected the global financial system. Financial institutions, hedge funds, and households are being forced to reduce debt (deleverage) all at the same time. This results in forced sales because as asset values start to decline, leveraged investors must raise more capital. To do so, they sell what they can putting more downward pressure on asset prices. Another consequence this has created is a lack of capital in the banking system.

What’s The Solution?

At the moment, credit is essentially frozen and a world-wide recession seems almost inevitable. However, we won’t have a 1930s style depression if we look forward and tackle this crisis head-on. The solution to the present crisis will involve substantial deleveraging and a recapitalization of our financial institutions.

Beyond the immediate problem, we need to see a bottom in housing prices. A key problem in the housing market is inventory: The supply of homes simply exceeds demand. And as a result, home values have declined. Once supply and demand balance out, our housing market will be able to recover, and that will help our broader economy begin to grow.

Finally, we will need lots of patience as it will take some time to fix these problems. Will this process be easy? No! But, can we fix it? Yes!

Let’s Get Bullish On America: Remember…It’s AmeriCAN, not AmeriCAN’T

Turn on the TV or read the newspaper and you are overwhelmed with negativity and a sense of panic. Sentiment is terrible and satisfaction is at an all-time low. According to CNNMoney.com, 60% of Americans think a depression is likely. Time magazine’s latest issue has a picture of a soup line from the Great Depression era on the cover. You know there’s panic when Jim Cramer says its time to get out of the stock market. There’s even a new blog out: Sad Guys on Trading Floors. I agree with Barry‘s thoughts on this new blog: “Its funny and sad and poignant, but for our purposes, its a yet another in a list of contrary indicators that suggests things are getting overdone, and that sentiment is moving towards an extreme. A blog such as this could only be conceived of during times of extreme market stress.”

We must change the mood in America. Without a doubt these are extraordinary times, and America is facing a crisis. Let’s respond with optimism! I am bullish on America, and you should be do. We have faced times of crisis and uncertainty before and we’ve not only survived, but we’ve thrived.

To get you started thinking more positively take a look at Barry Ritholtz’s recent post: 10 Bullish Charts, Signals, Indicators.

What To Do Now?

We don’t have any evidence yet that we have hit a bottom in the stock market. However, with the Dow now down 40% from its peak we should be getting close. It is certainly possible for this market to go lower and trends often last longer than you expect. However, the best opportunities in the history of the stock market came during periods of crisis and panic. As Warren Buffet has said, “good investors are fearful when everyone else is greedy, and greedy when everyone else is fearful.”

Just because the stock markets have panicked doesn’t mean you should. Now is not the time to abandon your investment strategy. You do have a strategy, right? If not, now is the time to develop one. Some great opportunities lie somewhere ahead. Crisis creates opportunity. This crisis is in the process of creating some “once in a lifetime opportunities.” You won’t want to miss out. Don’t quit now. If you do, you will regret it.

If you are young and stashing money away on a regular basis, then stay the course. If you are approaching or are in retirement, then now is not the time to decide to get more conservative with your asset allocation or investment strategy. Don’t let an emotionally driven decision destroy your retirement prospects.

Don’t fall into panic mode as many others already have. To succeed you will need to be 1.) PATIENT, 2.) DISCIPLINED, and 3.) CONFIDENT.

Are you overwhelmed by “the worst week ever”? Are you unsure of how you should respond to the current crisis? Have you wandered if your investment strategy is sound? Maybe you’re just tired of managing your own money? Or, do you find that there’s simply not enough time or desire to do the work? If you have $100,000 or more of investable assets, then I can help! My firm can manage your money for you. Contact us to see how we might be able to help you.

Cash is King…For Now!

Fear has spread throughout Wall Street and Main Street. One consequence of all the fear on the Street is the lack of sustainable positive trends.

As the heading on this blog states I believe that “There’s always a bull market somewhere!” In other words, I believe that at any point in time there is always a broad market index, a sector, an industry group, a country, an asset class, a commodity, or a currency that is in a rising trend. For instance, the first six months of this year stocks in the U.S. and across the globe were down. However, the price of oil was up, commodity prices were up, and precious metals were up. You could have generated some nice returns during the first half of 2008 by avoiding stocks and investing in USO (oil), GSG (commodities), GLD (gold), and SLV (silver). However, in July the trends in all of those asset classes turned bearish. Trend followers would have exited those positions only to find a lack of sustainable trends elsewhere.

The third quarter of 2008 was marked by fear and panic as the credit crisis and collapse of financial institutions roiled the markets with uncertainty. But remember, fear and panic is what it will take to establish a bear market bottom that lasts. Everyone would like to know where the bottom of this market is or how long the bear market will last. The answer is: no one knows. Changes in market trends and the duration of those trends can not be predicted in advance. As a trend follower, all I can do is identify current trends and follow them. What I do know is this: CASH IS KING…FOR NOW!

Here are a few trend following principles to keep in mind:

  1. Don’t fight momentum; embrace it! Trends often last longer than people expect. It is more likely that a trend will continue rather than reverse. The path of least resistance is most often the current path of the trend. Always assume a trend will continue until you have proof (from charts and technical analysis) that it has reversed.
  2. Trends reverse quickly. Just review the charts for the ETFs I mentioned above. You will see that although they were all in rising trends during the first half of this year, they all reversed sharply in July and August. The trend is your friend…until it isn’t! You must have an exit strategy. Know your sell rules and follow them.

With those principles in mind it’s important to remember that the current trend for almost everything is DOWN. Until there is more certainty related to the credit crisis and problems in the banking industry, don’t fight the downside momentum. If you’ve been executing a trend following strategy, then by now you should be in cash and you should stay in cash until new trends are established.

[DISCLOSURE: Clients of Freedom Financial Solutions, LLC that are invested in the Global Trends Strategy currently have a cash position that ranges from 90% to 100%.]