Be prepared for further stock market losses. Be prepared for more shocks. It’s not a signal to give up on the stock market, rather to go back to basics.
There is no light at the end of the long economic tunnel. All we can see today is recession, falling house prices and negative equity, rising unemployment, company failures and deflation. It all adds up to a rather sobering Christmas period and a not so happy new year.
As I said in my Four Predictions For 2009, the recession is likely to last until the last quarter of 2009 at the earliest, and possibly into early to mid 2010. Unemployment won’t peak until 2010.
The global economy is starting a massive deleveraging process. The debt-fuelled excesses of the last 5 or more years are being purged out of the system.
Greed, Greed, Greed
Companies were greedy – they went on debt-fuelled acquisition splurges, trying to ‘manufacture’ growth. As they are finding out, acquired growth comes at a hefty price.
Consumers were greedy – they bought up new flat screen televisions, sofas, cars, holidays and computers, using the equity in their home as an ATM, a credit card or a personal loan. As they are finding out, debt needs to be repaid.
Investors were greedy – they kept piling into the stock market, sometimes even borrowing money in order to juice their returns, regardless of the risks and oblivious to the downside.
Property ‘investors’ were greedy – rising house prices and TV programmes like Property Ladder and Colin & Justin’s Million Pound Property Experiment lured ordinary people into trying to make it big in property. Like most get rich easy schemes, especially ones built on debt and on the predication of forever rising asset prices, when the wheels come off, the bust is spectacular.
Banks were greedy – they were the facilitators and manufacturers of much of the debt. Their executives let short-term bonuses block out the risks of lending 125% of the inflated value of a property to people who couldn’t afford the repayments, and ordinary shareholders have paid the ultimate price. Just witness the nationalisation of Northern Rock and Bradford & Bingley, and the collapsed and still collapsing share prices of Royal Bank of Scotland (LSE: RBS), Lloyds TSB (LSE: LLOY) and HBOS (LSE: HBOS).
Hair Of The Dog
The deleveraging will take years. Stating the obvious, it’s much more painful than the leveraging. Today, consumers and businesses are paying for items they bought months and years ago, some of which will already be worth less than the original price tag. Oops.
If all that is not enough, the shocks are still coming. The very real prospect of failure for at least 2 of the 3 US car manufacturers – General Motors (NYSE: GM) and Chrysler, with Ford (NYSE: F) in a not much better position – is casting a long shadow on jobs and the economy in the US and across the globe. Personally, I’d favour a root and branch complete restructuring of these companies, including a non-unionised workforce on significantly reduced wage and benefit packages, rather than letting them fail. But even that may not be possible.
Then there’s the failure of the New York financial advisor Bernard Madoff and his alleged US$50 billion fraud, with Nicola Horlick’s Bramdean Alternatives (LSE: BRAL), HSBC (LSE: HSBA) and Man Group (LSE: EMG) all having some exposure. It could spark a further bout of panicked hedge fund selling like we had in October, when stock markets were in freefall and companies were being sold off completely regardless of valuation or their underlying long-term prospects.
Be Prepared For Further Losses
One thing is for sure – we remain in uncertain times. For stock market investors, the one sliver of good news is that it share prices are unlikely to take off any time soon. That gives you time to pick off the very best companies at compelling long-term valuations.
For your existing investments, be prepared for further volatility. In fact, be prepared for a possible another 10% to 20% fall in the stock market. If you are invested in quality companies with excellent long-term prospects, the loss will be ‘quotational’ rather than real. On the other hand, if you are invested in more speculative companies, there is a chance of further permanent capital loss.
Buffett’s Two Investing Rules
Never before has it been so obvious that the name of the investing game is to first minimise your losses. Warren Buffett, the world’s richest investor, only has two rules…
Rule Number 1: Never lose money.
Rule Number 2: Never forget rule number one.
Many people have failed on both counts. It’s time for them to go back to the drawing board and reassess their portfolio in light of Buffett’s two basic rules.
Amidst all this doom and gloom, you could be easily forgiven for giving up on the stock market for the next 12 to 18 months. I think that would be a mistake, as I said in I’m Betting On Shares.
Believe it or not, there will be a light at the end of the economic tunnel. Low interest rates coupled with massive global government spending programmes surely must count for something, somewhere in the future, mustn’t they? Sure we’ll pay the price in the future with higher taxes, but that’s another cost of the massive debt-fuelled asset bubble of the naughties, a cost we’ll be paying for years and decades to come.
More: Four Predictions For 2009 | I’m Betting On Shares
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> Of the companies mentioned in this article, Bruce Jackson has a beneficial interest in HBOS. He clearly didn’t follow Buffett’s investing rules, and is still paying the price.
