The Day After Tomorrow...

Markets around the globe, from Japan to Germany, fell dramatically this week.  While Iceland was going about nationalizing it's largest bank and suspending all trading in their stock market, Russia was busy formulating a bailout plan of their own.  Faced with the possibility of the global credit markets coming to a standstill, central banks around the world simultaneously lowered their interest rates in an attempt to provide emergency relief.

At home, the DJIA fell over 18% and the FDIC added two small banks located in the midwest to their growing list of bank failures. Meanwhile, the SEC continued investigations into possible fraud by large financial institutions, and even positive earnings reports for a small number of companies was met with trepidation by investors.

Q: I get it already.  How long until the world explodes/implodes?

A: While it is pretty certain that the world is not about to end, we are certainty looking at a global climate change in the financial markets.  Speaking of which...

I almost feel as if I'm watching the movie The Day After Tomorrow right now.  First, we had a number of major (financial) disasters across the United States.  Then, almost overnight, we found ourselves engulfed in not only a countrywide (no pun intended) crisis, but a worldwide ice age (frozen credit markets) as well.  Now, we are witnessing unprecedented co-operation with countries around the world to try and preserve as many lives (financial markets) as possible.  

To complete the story line, I'm sure there is some math genius out there that has been accepted to an Ivy League school, but due to the frozen credit markets, is unable to obtain the student loans he needs to pay for tuition.  As a result, he is being forced to live in the New York Public library while his dad searches for a way to send him to college.  Throw in a romantic subplot just for good measure and I'm certain that this could turn into a successful made for TV movie that rivals likes of The Odyssey, Sabrina: The Teenage Witch, and The Stand.

Q: First the Titanic and now The Day After Tomorrow.  What's next?

A: Well, the presidential elections are coming up... how about Dumb and Dumber?

Q: Really now?

A: Just kidding... 

Q: Right.

A: Anyways...

Q: Okay, moving on.  Have we bottomed out yet?

A: What we saw on Friday of last week was that when the DJIA briefly dropped below 8,000 investors seemed to view that as a bottoming out point and the index stayed above that point for the rest of the day.

If the drops in the stock market is the result of a lack of investor confidence, it is very hard to imagine that confidence can go any lower right now.  That could indicate that 8,000 is indeed the bottoming out point.  Then again, it might not be...

Q: Assuming this is the bottom?

A: We could see investors start coming back into the market, but it is highly doubtful that the markets will recover to anywhere near the levels we saw a year ago when the DJIA topped out just above 14,000.  Best case scenario, we are probably looking around 10,000 over the next year.

Q: Worse case scenario?

A: We continue to drop...

Q: Those don't seem like very great alternatives.  Why not stay out of the market?

A: Agreed, those are not great alternatives.  Still, that doesn't necessarily mean that you should not continue to follow an existing long-term investment strategy if you are already invested. 

What we do know, is that markets recover.  If you examine all of the recessions that the US went through over the last 100 years, most of them recovered to the same level they were at prior to the recession in under 12 months.  There were a few cases where it took longer than this, but in all cases, the markets recovered eventually.

To take a slightly different perspective, there are a few ways you can loose money right now. One is if you own stock in a company that goes under, such as Washington Mutual.  If this happens, you are left with nothing and have no chance of recouping your losses.  

A second way you can lose money is if you have money in a money market mutual fund that is unable to hold it's value of $1 per share.  If this is the case you might lose some of your investment, but not all of it.

Third, if your bank fails and you have depository accounts that exceed the $250,000 insurance (per account) provided by the FDIC, you could lose any amount that you hold above that level.

Lastly, you can lose money if you sell an investment at a loss.  By doing so you eliminate the possibility of the investment recovering it's value. 

To sum this up, if you have a long-term investment strategy that is well diversified, you do your research on any money market funds you are in, don't keep over $250,000 in cash in any one depository account, and don't sell everything in a panic to cut your losses, you will eventually recover from this.

Q: Is that it?  

A: Of course there are some cases in which you may want to sell things...

1) To harvest losses in order to offset future gains and avoid paying capital gains taxes.

2) Rebalance a portfolio to target allocations in order to better reposition your portfolio.

3) If your current investment strategy is not one that suits your long-term goals and/or risk tolerance.  In this case you may need to change your target asset allocations.  Still, this isn't necessarily a great time to make a change in an investment strategy...

Also, if you are not currently invested and have a large amount of cash sitting around, the bottom is never a bad time to buy... that is, if you think we have reached the bottom.

Q: Thanks for the...

A: Did I mention that this should not be taken as financial advice and you should consult your financial advisor before making investment decisions?

-dunkie