Now Is Not The Time To Panic

If you read the newspaper, listen to the radio or watch TV, you can’t help but wonder if our financial system, as we know it, is coming to an end.  With record high oil and gas prices, falling real estate markets and bank failures, it’s no wonder that American consumer confidence is at its lowest level in 40 years.  In fact, many people now seem to be in full panic mode.

Now, however, is not the time to panic.  Why?  For a number of reasons.  First, there are protections in place against the failure of your bank or brokerage company, second, the government is being pro-active to try to prevent a full-scale meltdown and finally, the fact that this market will, as have others, rebound at some point.

Government Protections

Banks

In the middle of the Great Depression, in 1933, the Federal Government created the Federal Deposit Insurance Corporation (FDIC) to protect the depositors who kept money in banks.  The FDIC provides insurance of up to $100,000 per depositor, per bank to guard against bank failure.  In 2006, they increased the protection on IRA’s to $250,000, which is in addition to the basic $100,000 coverage.  Also, with the correct use of trusts, you can increase the insured amounts further.

When a member bank fails, the FDIC steps in to run the bank, ensuring that you will have access to the insured amounts.  That means that your checks won’t bounce (assuming you have enough money to cover them!) and that you’ll have access to your cash.  There may be a short period of disruption, but, if you have deposits under the limits, there’s no reason to go down to the bank and pull your money out.

Brokerage Accounts

On the brokerage side, your investments are protected by the Securities Investor Protection Corporation or SIPC.  The SIPC replaces missing cash and securities from failed brokerage firms.  The limits of SIPC coverage are $500,000, with a maximum of $100,000 for cash accounts.

If you’re sold a stock that becomes worthless, the SIPC won’t step in, however, if a broker steals your money, the SIPC will step in.

Not all brokerages are members of SIPC so you need to be sure to ask your advisor if the brokerage firm they used is or isn’t an SIPC member so you’re ensured that you’ve got coverage.

Current Government Action

The Federal Government is doing as much as it can to minimize the damage.  In order to calm the mortgage markets, which are currently still a large part of the current market turmoil, they have pledged to bail out both the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), which provide funding for a huge percentage of home loans in the market.

The stimulus checks issued in the earlier part of this year, were intended to pump some more money into the economy, in an attempt to avoid a recession.  There is some evidence that this is in fact working.

Markets Go Up, Markets Go Down – This One Will Eventually Go Back Up

Investing in the stock market is intended for the long term because over short periods, markets go up and markets go down.  By responding to each market gyration, the average investor almost always gets it exactly backwards.  Their emotions tell them to buy more when the market is up and to sell once the market drops.  Many savvy investors know that what the average investor thinks is, in fact, what’s called a ‘contrary indicator’.  Since most investors get it wrong, the logic goes that when the public is incredibly positive on the market, we’re near a top so the professionals sell, and when average investors are at their most pessimistic, we’re at a bottom, presenting a buying opportunity.

One of the key tenets of successful investing is not to let your emotions drive your investments.  Studies have show, time and again that the important thing to long term growth is not TIMING the market but TIME IN the market.

Now is the time to review your portfolio to ensure it’s still allocated the way you want, take some losses to lower your taxes and position yourself to benefit from the next bull market.

The moral of the story here is to not pay attention to the doomsday scenarios presented by the popular press, make sure that you live within your means and that you maintain a long time horizon for your investment portfolio.  If you do all three of those things, you’ll sleep better and ride out our current economic challenges.

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Media Accountability

The other morning, as I was preparing to go to work, I was watching a local morning news telecast when one of the newscasters, commenting on the IndyMac bank failure, said she thought that our current economic situation was similar to the Great Depression.  I have a bone to pick with non-experts making commentary on a market situation they cleary don’t understand.

First, given the fact that this woman, who shall remain nameless, was under 40 years old, she, like me, has no real idea of what the start of the Great Depression felt like.  Second, with people already nervous about our current economic situation, it’s my opinion that her statement was, to say the least, irresponsible.

The situation at IndyMac bank, after its takeover by the FDIC was chaotic.  Panicked customers lined up at their branches in an effort to get their money out.  News reporters on site made sure to pan through the large crowds and interview those people that were particularly panicked that morning.  Clearly the intent was to throw gas on the proverbial fire, not provide objective analysis.

The local station I was watching reaches hundreds of thousands of viewers (I would presume).  If the actions of these reporters and new anchors resulted in a even a few hundred more people pulling their money out of the bank immediately, ultimately this makes the failure of IndyMac more expensive and that tab, you guessed it, is borne by you, the taxpayers.  Instead of playing up the impending Great Depression crap, these people should have been discussing the exact opposite that, unlike the Depression, we now have have protections in place like the FDIC, that economic theory and governmental oversight skill have improved substantially in the last 75 years and that we haven’t even technically entered recession, let alone Depression.

I’m all for freedom of the press as it’s one of the cornerstones of our society.  What I’m against, however, is irresponsible newscasters, who have no real business making commentary on this situation in the first places, causing additional stress to people and ultimately costing me money.

Oh, by the way, shares of financial companies had their biggest day in 40 years yesterday.

Is Inflation Moderating?

The Labor Department earlier this morning reported that consumer prices rose .2% in April and a total of 2.3% year-over-year, a much tamer figure than most experts were expecting and much less than most people would think, given the high price of food, gas and other items.  That’s good news for those that thought we might be in the beginning stages of “stagflation” where we’ve got stagnant growth and high inflation, much as we say in the 1970’s.

The thing to remember about the consumer price number is that it’s reflective of all the goods and services sold in the economy.  The .2% number included a .9% rise in food costs and a 5.6% rise in gasoline but a reduction in the price of automobiles and lodging costs (hotels) as the demand for those items has dropped due to the higher cost of food and gas, among other things.  Gasoline prices ALWAYS rise this time of year in anticipation of the summer driving season and generally fall as the summer progresses.

The Fed has attempted to the delicate balancing act of cutting interest rates to keep the economy from falling into recession while at the same time not igniting excessive inflation and only time will tell if this month’s inflation reading was merely a statistical blip or if they’ve actually managed to pull it off.

From Ben Bernanke’s Mouth to God’s Ear

In his testimony before Congress, Fed Chairman Ben Bernanke admitted that the economy is slowing and that it could actually contract in the first half of the year, even conceding that a recession was “possible.”

That’s the bad news.

The good news is that he, and many other economists, feel that with the recent stimulus package (i.e. rebates to taxpayers), plus the moves the Fed has made to help alleviate the credit crisis, will grow in the second half of 2008, stating “Much necessary economic and financial adjustment has already taken place, and monetary and fiscal policies are in train that should support a return to growth in the second half of this year and next year.”

Although not directly stating it, Mr. Bernanke also hinted that the Fed might not act as quickly to cut interest rates again, instead opting to see how the stimuli in the “pipeline” will play out.

Let’s hope Mr. Bernanke and the economists at the Fed get it right so that if we are in “recession” it ends up being a relatively mild and short one.

Fed Cuts Rates Yet Again

 

After a week of market chaos, culminating in the fire sale of Bear Stearns, the Federal Reserve announced today that it was cutting its key interest rate, the Federal Funds Rate, by ¾% to 2.25%, the lowest rate in 5 years.

 

In its statement announcing the cut, the Fed cited the continued downside risk to the economy, suggesting it might be open to cutting rates further if necessary.

 

The stock market responded positively, even though many experts thought the cut would be a full 1%.

 

This rate cut is positive for many consumers in that it will lower the rate on things like Home Equity Lines of Credit and variable rate credit cards.  While you won’t see the results immediately, by the end of next month, the lower rate should have trickled through to your statement.  If you’ve been thinking about refinancing your home or you’re looking to buy, now might be the time to pull the trigger.

 

The flip side to this rate cut is that you’ll see the rate you get on your savings and money market accounts drop and the weakening dollar will increase the cost of imported goods to increase, so expect high gas and commodity prices to stay with us for a while.

Fire Sale

Yesterday’s announcement that JP Morgan Chase was purchasing Bear Stearns for $2 per share, or about $236 million was a great deal for JP Morgan and a lousy one for Bear Stearns shareholders.

The Federal Reserve helped negotiate and finance the deal in an effort to prevent widespread panic that the credit crisis was going to take down other financial companies, deepening the problems.  Had the Fed waited one day, however, the markets would have found that both Lehman Brothers and Goldman Sachs, two Wall Street powerhouses, had earnings that, although reduced by the sub-prime exposure, beat most analysts’ estimates.  It seems that the carnage on Wall Street might just be limited to a handful of companies that were particularly aggressive in this space.

So who wins in this situation?  Only time will tell if this, and other Fed moves, helped stave off or shorten a recession.  Certainly, JP Morgan stands to benefit TREMENDOUSLY.  Bear Stearns headquarters building, which they own, is worth TWICE what JP Morgan paid for the whole company.  Many analysts feel that the fair market value of Bear Stearns is somewhere around $40 per share.  Lawsuits are sure to follow so I guess, at the end of the day, the attorneys, as always will come out the big winners.

As I write this, we are less than 30 minutes from the Fed announcing what most people think will be a 1/2 to 1% cut in the Fed Funds rate.

I’ll keep you posted.

It’s Official

Well, it’s finally official. According to a Wall Street Journal economic-forecasting survey, conducted from March 7 to 11, a majority of the economists polled said that the U.S. has finally slipped into recession. This marks a huge change from the last poll conducted only 5 weeks before.

To add to the evidence, new data shows that retail sales dropped .6% in February, the result of the sub-prime credit crisis, falling housing prices and increased prices for staples such as food and gasoline.

According to Ned Davis Research and their study, 10 post-war recessions have lasted an average of 10 months. At the same time, during these recessions, the S&P 500 has seen the following returns:

Year Leading to Recession: -4.3%

Six Months After Recession Begins -4.8 %

One Year After Recession Begins +3.2%

Year After Recession Ends +14.4%

As you can see, the pain in the markets is short-lived and the recoveries are usually robust. Remember these are just averages and each recession has its own characteristics. Let’s hope this is a mild one with an ever better rebound!!!