First, Fannie & Freddie…

15 Sep, 2008

Posted by: earlhines In: Markets

Earl Hines

Now Lehman and Merrill too?

To put it mildly, last week was a highly eventful one for the financial markets. On the positive front, a continued fall in oil prices, the resolution of the Fannie Mae and Freddie Mac uncertainty that ended with the de-facto government takeover, signs of improvement in the mortgage market and improved technical factors (a contraction in the number of new lows) helped stocks to move higher. For the week, the Dow Jones Industrial Average climbed 1.8% to 11,422, the S&P 500® Index advanced 0.8% to 1,252 and the Nasdaq® Composite rose 0.2% to 2,261.

Still, the week featured escalating concerns over the future of some large financial institutions, which put pressure on the markets and ultimately came to a head over the weekend as Lehman Brothers announced a bankruptcy filing and Bank of America agreed to purchase Merrill Lynch. In my opinion, the U.S. Treasury’s decision to assume control over Fannie Mae and Freddie Mac was an important one, and represents a positive step in terms of restoring stability to the banking system by preserving the flow of lending activity to the beleaguered housing market. This event should also contribute to the lowering of mortgage rates, which should help the residential housing market. The more recent news surrounding the Lehman Brothers bankruptcy and the Bank of America/ Merrill Lynch transaction adds to the uncertainty afflicting the markets. Many of you have no doubt also heard negative press rumors regarding the nation’s largest insurer, AIG, and more locally, concerns about Washington Mutual Savings Bank. All of the uncertainty in our nation’s financial system will lead to greater volatility. The Dow opened today down about 300 points (about 2.5%) and the S&P opened down about 28 (about 2.0%). As bad as this feels, the market seems to be digesting this news in an orderly manner. On balance, the reduction in capacity in the financial services industry may be one of the components necessary to help solve the ongoing mortgage and credit crisis.

Some Recommendations

1) Breathe. Lehman Brothers and Merrill Lynch have come to an end; the world hasn’t. Our economy has survived large bank failures before, and returned to market prosperity, including the failure of hedge-fund giant Long Term Capital Management and the S&L crises of the 80s and 90s. Bear Sterns in March 2008.

2) Remember one of the cardinal rules of investing: Don’t panic. Fear robs us of our reason, and pushes us to sell into the pessimism; that’s how you ultimately lose money. Markets turn around fast, and studies show the smartest way to make money is to buy and hold; and not try to time market swings. Remember that you are managing your money for the long term. Keeping a diversified portfolio is the best risk management tool there is.

3) Manage your Cash Position: It’s always prudent to have three to six months of liquidity on hand, and if you are nearing the time when you will need distributions from your investments, it’s advisable to increase this up to a year or more. Having sufficient cash on hand prevents the need to sell assets during market down-swings which compounds losses, and should provide some peace of mind during turbulent periods.

Although recent financial losses have been painful, bear markets do eventually come to an end. The recent meltdown in oil prices should lead to an equity-friendly drop in inflation. In addition, recent economic developments in China have been encouraging; inflation has been falling which should allow the authorities to redirect their attention to economic growth. While it is not an exaggeration to say that the financial markets have been gripped by fear, anxiety and despair, these investor attitudes and pervasive bearishness typically have been signs of a coming market bottom.

Talk to your Personal Financial Adviser about your current investment strategy to ensure that your assets are allocated for the long term, and that you are not taking on any more investment risk than is appropriate for your own situation.

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Tags: Markets

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