CLARITY. INSIGHT. PARTNERSHIP.

Friday, May 7, 2010

Freefall?

I received this e-mail from a client yesterday:


"Frank
What is your opinion on what has happened in the market this week? Do you see a very negative trend again or will this pass once Europe stabilizes? How concerned should we be?"

It has certainly been a scary few days in the markets. No one is happy to see such large declines over several days. This was only made worse by the apparent electronic trading glitch that caused the Dow to briefly drop by almost 1,000 points yesterday afternoon.

I would caution against using a few days of performance to determine what the trend may be going forward. Clearly, the situation in Europe, and Greece in particular, is troubling. Many people believe that Greece is only the tip of the iceberg, with Portugal, Spain and Italy soon to follow. This may or may not be true. In the summer of 2007, I went on record as saying that I didn't think sub-prime mortgage problems could bring down the entire US economy. Ooops! So I, nor anyone for that matter, really have no idea how serious the European government debt problems will become and how they will affect our clients' investment portfolios. If you spend some time trolling through the economics blogosphere, you will find such a wide variety of expert opinions, that it is clear no one knows how things will play out in the end.

In the short-term, we are always concerned about what may happen next. That is why we don't take much risk with money that may be needed within the next six years. However, in the long-term, investors are generally rewarded by not panicking during times of turmoil. Here is a quote from Warren Buffet's most recent shareholder letter:

"When it is raining gold, reach for a bucket, not a thimble... We've put a lot of money to work during the chaos of the last two years. It's been an ideal period for investors: A climate of fear is their best friend"

As I write this, the stock market is down significantly in volatile trading and could easily go down much further before reaching bottom. Or, we could see a huge rally next week. We could have a double dip recession, or the economy may continue its recovery despite Greece's problems. Only time will tell. My advice is not to panic, stay diversified, and remain conservative with money you may need in the near term.