Mon, September 15, 2008
Hitchhiker’s Guide to September
Douglas Adams' Hitchhiker's Guide to the Galaxy described a fictional intergalactic travel manual of the same name. The guide had the words "DON'T PANIC" written "in large friendly letters" on its cover. Investors could use a copy of the Hitchhiker's Guide right about now.
Having reached the ides of September, we’ve experienced
- the Federal takeover of Fannie Mae and Freddie Mac in order to prevent their default on $5+ trillion in debt
- the bailout of 94-year-old investment bank Merrill Lynch via a sale to Bank of America (which is still digesting Countrywide Mortgage)
- the Chapter 11 bankruptcy filing of venerable Lehman Brothers Holdings.
The day’s biggest news is undoubtedly Lehman, which listed debts of of $613 billion in its bankruptcy filing. Among its unsecured debtors are Citibank ($275 million), BNP Paribas ($250 million), and a long line of Japanese banks.
Meanwhile, AIG, the largest insurer in the country, is struggling to raise capital to avoid further credit downgrades. The nation’s #1 savings and loan, Washington Mutual, joins other banks whose stock prices have been cut by half or more in the last year as fears of further mortgage defaults persist.
Years ago, I worked across the hall from an office where there was a poster of a large toad. Underneath the toad were the words, “Eat a live toad for breakfast, and nothing worse will happen to you all day.”
This is definitely a “live toad” day for Wall Street. What should investors do?
Investors should not be making sudden changes now in reaction to any of the aforementioned events. If you have a well-diversified portfolio that reflects your own tolerance for risk, there’s no reason to make drastic moves. If you haven’t reviewed your portfolio allocation or rebalanced in the last year, this is a good time to do that, but nothing more.
Investors who bought (for example) bank stocks several months ago, figuring that the stocks couldn’t possibly go lower, have learned otherwise. Those who followed Legg Mason’s Bill Miller by piling into Fannie and Freddie stock in expectation of a bailout have discovered that gambling on stocks looks a lot like gambling on anything else. As boring as it may seem, a slow and steady investment plan stands a better chance of winning the race – especially right now.
A common temptation in moments like this, of course, is to sell all your risky assets and put everything in cash. But doing so now would be selling into the panic. Besides, how are you going to know when to buy everything back?
Investors should be continuing to follow their long-term investment plans; no one can tell you whether the market will fall more or rally for the next year.
Buying value stocks for the long-term has always been one good strategy; for most people this strategy is best executed through a mutual fund. The one caveat in the present environment is that value investors (and the mutual funds they own) shouldn’t over-indulge in stocks that have heavy debt loads or significant exposure to mortgage-backed securities.
This week’s Barron’s carries an interesting short article on the performance of various asset classes during past recessions in the last forty or so years. The results include the “stagflation” years of 1973-75. The take-home message is straightforward: diversification across asset categories is the best long-term strategy. Yes, there were periods when you could have made a killing investing in oil, real estate, commodities, gold, or even long-term Treasuries, but it was only possible to know that for certain in hindsight. Lacking a crystal ball, you’re better off being diversified and keeping your portfolio in balance. I hope to do some quantitative what-if illustrations of this when I get time.
If you have an irresistible urge to pursue a “can’t-miss” investment strategy, do it with money that you can afford to lose. There’s no great harm in setting aside a small corner of your investment strategy to satisfy an itch to invest in (for example) a few individual stocks. Just do so judiciously, and keep track of your winners AND your losers so that you can assess your true investment prowess over a meaningful period.