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Sunday, 6 July 2008

Mean Street: Five Lessons for Financial Panics

Posted by Deal Journal

Baron Rothschild’s adage was to “Buy when there’s blood in the streets.” Mine is “buy when CNBC starts telling you to short the market.”

Last Tuesday, CNBC exhorted its viewers to consider shorting stocks. Jim Cramer followed up a few days later by urging his followers to “sell everything” except commodities stocks.

My gut says these are classic stock market “tells” that signal a contrarian buying opportunity, but I could be wrong. And that is the beauty of a financial panic–and our first lesson.

Lesson #1: Nobody knows where the market bottom is.

It may be hard to believe, but your guess on the stock market bottom is as good as anyone’s. That anyone includes Ben Bernanke, Hank Paulson, Bill Gross, George Soros, Warren Buffett, Lloyd Blankfein and even Jim Cramer.

In six months, the media will dig up some lucky market analyst who made a “remarkably prescient” call and turn them into a hero, a la Elaine Garzarelli, the analyst credited with predicting the Crash of 1987.

Lesson #2: Do not sell into a panic.

Anyone who sold their stocks on Black Monday, Oct. 19, 1987, came to almost immediately regret it. I know I did. I was a junior banker in London and watched the meltdown on our lone department Quotron.

My brain said, “Hang on, hang on.” My wallet said, “Run for your life.” With one phone call, I sold every Fidelity stock fund I had and promptly lost a quarter of my net worth.

The temptation to panic is primal. Be a man, not a monkey.

Lesson #3: Look forward, not backward.

Does anybody remember how negative sentiment was in October 2002? The S&P 500 was down almost 50% from its record of 2000. The Nasdaq Composite Index was off 75%. I had just returned from 10 years in Europe to run the UBS tech banking group.

What struck me when I first visited Silicon Valley was how negative everyone was. That was because my colleagues and clients saw the world through the distorted prism of the Internet boom. They couldn’t see the tech market getting better in the future, because the tech market couldn’t be any better than it had just been.

The market looks forward, but people like to look backward. A Cisco Systems shareholder that owned the stock at $77 has trouble forgetting that $77 price when the stock falls to $15. In time, it doubled to $30.

Is Citigroup at today’s closing price of $16.76 so different? Wall Street in 2008 is Silicon Valley in 2002. It will get better in time.

Lesson #4: It’s investing, not gambling.

Why do we obsess over our ability to pick the bottom or top of a stock price or the market? Statistically, it is a total crap shoot.

As Bernard Baruch said, “Don’t try to buy at the bottom and sell at the top. It can’t be done except by liars.”

Financial panics bring out the worst in these tendencies. All this weekend, I was chewing over whether or not it was the right time to buy the XLF, the financial sector ETF that is trading at nearly half its record high.

I haven’t pulled the trigger yet, but I know that picking a bottom is a mugs game. Admittedly, an awfully tempting one. Better to use common sense. Set price and allocation targets, space out investments over time.

Since the beginning of this year, I have made fund purchases on about 20 different dates with an average cost base equivalent to an S&P 500 level of 1346. On that money, I am down about 5%. There are mutual funds that charge that much for an up-front load. Investing like this won’t make you rich, but you won’t gamble yourself into the poorhouse either.

Lesson #5: It’s only money.

There is no point in fighting the tape or your emotions as the market is gripped by panic. Next time the Dow industrials are down 300 and heading down further, do what you make your children do: take a time out. Turn off CNBC, your computer and BlackBerry and leave the office. (Wall Street professionals, unfortunately, this doesn’t apply to you­. You will get fired.)

I am a believer in the equity markets and have most of my net worth tied up in the stock market. So every panic over the past two decades has cost me, albeit temporarily, big chunks of my net worth.

Does it hurt? Of course. Do I lose sleep over it? Occasionally. But I always keep in mind that it is only money.

I think of my dad, who would inspect my weary face after my exhausting banker trips to Japan, India, and Hong Kong. As he put it: “There’s no point in being the richest man in the cemetery.”

1 comment:

Anonymous said...

I doubt it.

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