After months of turmoil in the credit markets and exchange traded funds (ETFs), one can’t help but wonder: what’s next?
What’s Happened So Far
The markets were mostly down this morning ahead of the anticipated Federal Reserve rate cut – which didn’t happen. Then the markets sank even lower before turning around again and ending on a positive note. The Fed’s decision not to cut rates seemed to send a signal that the economy is not in dire straits.
Since the credit crunch began in August 2007, 13 banks have closed their doors, according to the Federal Deposit Insurance Corporation. This year alone, 11 of those banks have gone under. Among them:
- Silver State Bank in Henderson, NV
- Integrity Bank in Alpharetta, GA
- IndyMac Bank in Pasadena, CA
The real trouble began here in the United States when Bear Stearns‘ CEO resigned over subprime losses in January. The firm was bought by J.P. Morgan in March for $2 a share, and the deal was backed by the Federal Reserve, providing up to $30 billion to cover possible losses. In May, UBS AG announced plans to slash 5,500 jobs by the middle of 2009.
But this month has been the worst of it: On the 7th, the government took over Fannie Mae and Freddie Mac. On the 14th, Merrill Lynch was sold to Bank of America. The next day, Lehman Brothers filed for bankruptcy. And today, both Moody’s and Standard & Poor’s downgraded ratings on American Insurance Group’s (AIG) credit.
Suddenly, everyone’s looking around and waiting for the other shoe to drop, if it hasn’t already. Christopher Palmeri for Business Week wonders if Washington Mutual is next. All eyes are on the bank and its new CEO, Alan Fishman, who is working to restore investor confidence, much like Wachovia managed to do earlier this year. One analyst predicts that if Washington Mutual were to fail, it could cost taxpayers $24 billion.
Well, Now What?
If you’re like most investors, you’re probably not only wondering what’s next, but how this affects you and what you should do.
Ron Lieber and Tara Siegel Bernard address the issue of what action you should be taking at a time like this. Their take: no one can predict how this is going to pan out, but this market will hit a bottom at some point. If you’re wonderig if you ought to spend or save – saving in any climate is always a good idea, not just when we’re in crisis mode. In fact, it’s a whole lot easier to sock away emergency money when gas isn’t hovering around $4 a gallon.
Whatever happens with these banks, be aware of what’s covered and what isn’t. The Federal Deposit Insurance Corporation (FDIC) insures up to $100,000 per depositor (not per account). Owners of retirement accounts are insured up to $250,000 per owner, per insured bank. At the Securities Investor Protection Corporation (SIPC), your account up to $500,000 per customer is insured.
Watch your ETFs, too. As banks disappear or merge with other banks or are taken over, these funds could see some changes to their underlying indexes. Already, one index is making a change: the KBW Capital Markets Index (KSX) is dropping Lehman Brothers before the markets open on Wednesday. Lehman will be replaced with Stifel Financial Corp. (SF).
The Importance of Not Panicking
Jason Zweig in his excellent book “Your Money and Your Brain” says that often, people are most afraid of the least likely dangers. A survey of 1,000 investors showed that 51% of them believe that in any given year, the stock market might drop by one-third. But based on history, the odds of that actually happening are around 2%.
If investors were strictly logical, he says, they would judge the odds of a risk by asking how often something bad has happened in similar circumstances in the past. But unfortunately, they don’t.
There’s often an element of surprise in the markets and Zweig says that in his research, he’s discovered that what most people predict will happen is almost always incorrect. Embrace the unexpected by reminding yourself that everyone knows nothing and that having high hopes can cause big trouble.
How do you keep your cool? Zweig suggests:
- Take it off your mind. That doesn’t mean ignore what’s happening, but free yourself from the anxiety of a day like Monday, when the Dow lost more than 500 points. Go for a walk, hit the gym, anything that might ease your mind for a bit and get you to focus on something else.
- Break away from the herd. Sort out what your own gut feelings are and write them down. If you do this, you’ll be conscious of whether you’re changing your opinions to conform with the larger group.
We would also like to add:
- Have a plan. If you know ahead of time what your stop loss is going to be, you can better mentally prepare yourself to sell when the time comes to do so. Vague and hazy ideas of what you’re going to do when a fund you’re holding drops 15% is just going to make it that much harder to let go.
- Remember, buying is easy and selling is hard. When you sell something, let it go and don’t look back. If it drops further, you’ve just protected yourself from greater losses. If it turns around, you can get back in later or go somewhere else entirely.
A year ago, many of these financial companies were flying high. On Oct. 9, 2007, the financial sector represented 20.4% of the total stock market value. Less than a year later, their share of the total market value is 16.9.%.
The largest financial ETF, Financial Select Sector SPDR (XLF), has $7.7 billion in assets and it was even bigger before. It’s down 46.7% off its high. People who’ve managed to sit out the financials should be feeling good right now, knowing that they protected themselves from further losses. Having a sell point of 8% off the high keeps you safer on the downside.