Investment Intelligence – What to Do When the Market Tanks

Investment intelligence typically takes a backseat to emotion. Let me share a few examples and a few ideas to help you overcome this problem.

Since last Friday’s announcement that Timothy Geithner would be the top candidate for the President-elect’s treasury secretary, the market has responded very favorably. Unlike our current (and many past) treasury secretaries, Mr. Geithner is not a Wall Street insider.

He is a longtime public servant. But he knows Wall Street very well, and he is considered a very tough negotiator. The market’s reaction to Geithner’s nomination, while welcome, really illustrates the big problem investors face today. And you can learn from this. How we react to politics is probably pretty close to how we react to our personal financial situation — including spending, withdrawal strategies and investing.

We just don’t have a great deal of patience these days. We want a quick fix. We want the pain to stop and we want it to stop now. Even if you use good market timing strategies, it’s difficult.

The market’s strong reaction to the nomination tells me that some people think this is the magic bullet that will turn everything around. It won’t. I hope Mr. Geithner (if confirmed) is part of the solution, and I think he will be, but his nomination isn’t the cure-all.

We have problems which will take time to fix. I think we are much closer to the bottom than to the top but investors who expect an immediate turnaround are kidding themselves. This issue is at the root of why we see such great gyrations in the market now.

For example, when the bailout plan was announced several weeks ago, the market cheered. But passage of the plan only gave permission to allocate the $700 billion. It would take time to get that money working. Even now, five weeks later, only half of the money has been allocated. The day after the market cheered the passage of the plan, the market tanked because the problem wasn’t fixed. To quote my friend Homer Simpson, “Doh!”

It was unreasonable to expect that the passage of the plan would fix the problem in the first place. The same thing happened around the election of President-elect Obama and again with the economic summit attended by President Bush. Investors are demanding immediate fixes. When they get a glimmer of hope, the market soars. When reality sets in, the market tanks. It’s all emotion right now.

To be frank, the first example of sober and rational thinking was when Congress failed to immediately bail out the auto industry. Lawmakers have finally taken an adult approach to the issue. They understand that the problems won’t be solved just by throwing money at these companies, Even if these companies get a bailout, they are expected to enter bankruptcy in early 2009. They face two major problems. First, they make cars that few people want. Second, their workers make too much money.

It costs Detroit over $70 for every hour worked when you include benefits. Japan spends $47 per hour. This cost differential means Detroit can’t compete. Unless and until these two issues are resolved, throwing money at these companies is a waste.

If, on the other hand, these companies are allowed to fail, other companies will buy their factories and at that point the employees will have sustainable jobs – something they don’t have now. They’ll have lower benefits, but they’ll have jobs they can build their lives around. If they don’t accept changes, they’ll be looking for retirement jobs rather than vacation spots.

I actually feel that the delay and rational thought behind our leaders’ response to Detroit’s issues gives us reason to be optimistic. And there are many other issues to be optimistic about.

We are still the largest and most powerful economy in the world. Foreign countries buy 95% of everything we make. We are a huge exporter. In fact, exports are up 10% from a year ago. We produce 25% of all the goods in the world. Another piece of good news is that the price at the pump has fallen dramatically, and that acts as economic stimulus because it puts more money in our pockets to spend.

Some folks worry about the possible tax rate increases that President-elect Obama has spoken about. It may be something to be concerned about, but let’s not forget one thing. The stock market tripled between 1991-1996 and we had the highest tax rates ever during that period. I’m just trying to point out that those who only see gloom ahead are wrong and there are plenty of ideas to be excited and optimistic about too.

I am optimistic over the long-run, but I don’t expect all our problems to disappear overnight. I also don’t expect the stock market to go straight up from here on. I think we can expect continued gyrations. I think it’s realistic to expect more roller coaster action in the market in the short-term.

Our economic problems are not yet solved. But we have some evidence that efforts to revive our economy are starting to work.

At the same time, let’s not lose sight of the fact that the market typically precedes the economy by six to 12 months. The market fell before the economy did and will likely rise before the economy heals completely.

I’ve heard some people say that it will take 20 years for the market to recover. I understand that comment – it’s coming from an emotional standpoint. But in reality, nobody knows what will happen in the next 20 days, let alone 20 years. Also, the market tends to rise rapidly after bear markets. People remember that the market fell 30% in 1931 and in 1932 – very painful. But it rose 54% in 1933 and they forget about that. If there has ever been a time for rational thought – this is it.

The best way to make sure your logic is in charge rather than your emotion is to have the best investments for your particular situation and needs. This is something I’ll be blogging about in the future.

More important than any of the above, I wish you and your family a happy holiday together. At the end of the day, I believe we see our real treasure sitting around the table. Enjoy a holiday of peace, health and joy.