Worry, Anxiety & Fear

The whole economic climate is uncertain now that US facing financial crisis and sooner or later will effect the other part of the world. An excerpt on financial crisis to ponder on.

Source: Standard Chartered Bank 2008

1. Will Troubled Assets Relief Program (TARP) stabilize the financial markets?

The bailout plan is necessary but not a sufficient condition for market stability. The package appears to have been intended as a circuit breaker to the vicious downward spirals in falling credit securities prices, shrinking balance sheets and falling stock prices. It also appears to have been intended to curb the surging cost of funds on money markets. And over time, by taking troubled assets off the balance sheets of financial institutions, it should enable and orderly restructuring of the US banking sector. But the package will not necessirily stop the declines in US house prices. it will not save shareholders of troubled financial institutions from further erosion of share prices as equity is written off as a result of decling credit securities prices. And will not prevent banks, hurting from diminished balance sheets, from deleveraging further – cutting back lending and on the process further hurting the US economy. Indeed, hopes for an ‘olderly recession’ may have already been damaged by recent events. We cannot rule out the possibility of a prolonged recession in the US.

2. What about emerging markets? Why are stocks there being sold off so aggressively?

Emerging market equities and currencies are sensitive to global risk appetites. And while economic fundamentals in Asia are generally stronger that in the United States, we can only expect relative resilience and not ‘de-coupling’. That is, growth will slow in Asia in response to what is happening in the United States. Indeed, some of the more open Asian economies could suffer technical recessions. And, of course, there is instant financial contagion in reponse to spikes in global risk aversion.

3. Should we just sell since there is so much fear in the markets?

That is an individual decision, depending on the investor’s circumtances – such as when they bought, their liquidity requirements, their ability to hold on those investments, and whether they have hedges in their portfolios. But generally we think it is too late to be selling. We have been pessimistic on the outlook for equities since the start of the year and concede that the outlook remains highly uncertain. But given the size of the losses that have already been suffered by all markets from the cycle peaks, risk-reward considerations do not support selling at this late stage of the decline.

Unfortunately, retail investors have had unhappy history of piling into markets close to their peaks and bailing out of markets near their bottom. And once investors cut losses close to the bottoms, investor psychology suggests they are unlikely to ever get back into investing in equities to build long-term wealth.

4. But why should we continue to be in mutual funds or long equities positions in this environment?

As we said earlier, these are individual decisions, subject to individual investors’ circumtances. But historically, equities have outperformed other asset classes over a long term investment time frame. And for most markets, the number of positive years versus negative years for equities runs roughly in the ratio of 2 to 1. But that is over the long-term. Typically, what happens in equities markets is that fund outflows tend to be at their peak when markets are close to their bottoms. And trying to time the bottom of markets is an impossible task, even for professionals.

Historically, the biggets gains in stock markets tend to come in short and sharp bursts rather than in an even manner. And market timers who happen to be out of the markets during their short, sharp spikes will suffer greatly diminished returns over the longer term. At worst, traders who jump in and out of markets could find themselves whipsawed – ending up selling before rebounds and buying back before corrections.

5. Is this the bottom for equities markets and should investors bargain hunt?

The simple answer is we do not know. We fear there is more volatility and even losses ahead. But we also know that markets are in an advanced stage of decline. Bargain hunters should 1) know what they are buying – if they are buying banking stocks, they need to properly understand the banks exposures to the credit markets 2) have the ability to hold in the face of possible further downside 3) have a long investment horizon 4) cost average rather than put large bets at any one time 5) hedge their long equities positions through the traditional risk aversion plays – eg: US Treasuries, gold and safe haven currencies.

6. Are they any bright spots on the global economic and market landscape?

Yes. As a result of the panic on financial markets yesterday and today, we would hope that central banks around the world will become more proactive in dealing with the crisis by making more liquidity available and cutting rates to boost sagging economies. Also, note there is still a lot of liquidity sitting on the sidelines – particularly in Asia. Note that Asian international reserves total approcimately $4.3 trillion. And there is an estimated $2 trillion sitting in soveriegn wealth funds throughout the world, a large part of which is Asia.

Also note that, whilst waiting for the Paulson plan to be reconsidered by Congress, the Federal Reserve has already made available a massive amount of liquidity. Accoding to Bloomberg this morning, the Fed has said it would flood banks with cash, pumping an additional $630 bilion into the global financial system. The Term Auction Facility, the Fed’s emergency loan program for commercial banks, will be expended by $300 billion to $450 billion. And the Fed had increased its existing currency swaps with foreign central banks by $330 billion to $620 billion to make more dollars available worldwide, showing further coordination with counterparts including European Central Bank, the Bank of England and the Bank of Japan.

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Quote of the day (QOTD): Inaction breeds doubt and fear. Action breeds confidence and courage. If you want to conquer fear, do not sit home and think about it. Go out and get busy. (Dale Carnagie)

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