The Fed has saved AIG, long live the Fed. Stocks may soar today, but what will tomorrow bring? Staying rational and looking a few years ahead are the priorities in these choppy times.
Such are the unprecedented events of the past few days, things are moving so quickly that there is a decent chance by the time you read this, it may be out of date.
As I write, the US Federal Reserve has just agreed to loan ailing insurance giant American International Group (NYSE: AIG) as much as US$85 billion in exchange for a 79.9 percent stake to save the country's biggest insurer from collapse.
US futures markets are pointing to a jump in the main indices when they open later today, coming on top of last night’s somewhat unexpected 140 point jump in the Dow Jones Industrial Average.
AIG was seen as one of those companies in the “too big to fail” category. A report on Bloomberg quoted RBC Capital Markets analyst Hank Calenti as saying a failure of New York-based AIG could result in $180 billion of losses to financial institutions.
In a word, the complete collapse of AIG would have been catastrophic. US Chairman of the Federal Reserve Ben Bernanke and US Treasury Secretary Henry Paulson just couldn’t allow it to happen.
As an aside, the employees of now bankrupt Lehman Brothers (NYSE: LEH) must be feeling particularly unfairly treated. Fellow investment banks Bear Sterns and Merrill Lynch (NYSE: MER) were saved, as were Freddie Mac (NYSE: FRE) and Fannie Mae (NYSE: FNM) and AIG has been seen as too big to fail, yet the market and the US government allowed Lehman to go bust.
Panic & Fear Like I’ve Never Seen
The markets are clearly in a state of panic and fear, the likes of which I’ve never remotely encountered before.
In the vast majority of cases, share price movements don’t reflect the underlying value of a company. It seems bizarre that a company like HBOS (LSE: HBOS) can be worth £7 billion less than it was valued at just last week, despite it coming out yesterday and saying it has a strong capital base and continues to fund very satisfactorily.
Mining giant Xstrata (LSE: XTA) has seen £10 billion or one third of its value wiped off in the last three weeks.
Many smaller companies have seen their share prices absolutely decimated, as investors bail out regardless of valuation and/or the deteriorating economy is being seen as badly hurting their business.
What Will Tomorrow Bring?
What will tomorrow bring? In this market, it is impossible to predict. It looks like world markets might jump today, but based on recent history, celebrations could be short-lived.
For example, in the light of the collapse of Lehman Brothers and the ensuing stock market carnage, there was a widespread expectation that last night, the US Federal Reserve would cut interest rates from their present 2%.
But they didn’t. The market generally reacts badly when its expectations aren’t met. Yet the Dow Jones Industrial Average closed the day up 140 points. In the blink of an eye, the market suddenly decided keeping rates at 2% was a good thing, as the major problem in the US is not one of the cost of money, but one of liquidity.
Looking Ahead A Few Years, Not A Few Days
Just because AIG have been saved, it doesn’t necessarily mean world financial markets will again function normally. It does however go a big way to helping, in the short-term at least.
But it’s definitely not all plain sailing from here. US house prices are tipped to fall further. The UK economy is in the poop. There are even doubts about Chinese growth amidst reports of factories closing and unemployment rising.
As usual, the big questions remain…what next and who’s next? And as usual, I don’t know the answers.
But what I do know is that history has shown that after virtually every sudden drop the market has experienced, it recovered within a few years.
I have emphasised the words a few years, because most investors can’t see past a few days and months let alone a few years. Take HBOS for example. It’s hard to imagine HBOS not being valued at significantly more than its current £9 billion in a few years time. Yet in a few days or months time, it could still be valued at less than £9 billion.
Warren Buffett and his teacher, Benjamin Graham have repeatedly said that over time, the market is a weighing machine. Even if the rewards aren't immediately obvious, in the long term, objective analysis of the opportunities and risks will prove superior to an emotional and quite possibly irrational reaction.
As ever, I wish you happy and profitable long-term investing.
More: How Lehman's Collapse Could Affect You
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> Of the companies mentioned in this article, Bruce Jackson has a small and shrinking beneficial interest in HBOS…in the short-term.
