The Top 5 Misconceptions Of 2008

This has been one of the hardest markets to stomach in a long time, unless of course you are one of those blood sucking shorts. The daily triple digit swings in the Dow (^DJI) and the volatility in this market has been unparalleled. Even some of the best money managers in the world are down double digits as people are left scrambling trying to figure out what happened with their money. That being said, there is no point in dwelling on your losses; instead we should learn from our mistakes, correct them and move forward. Easier said than done, I know, but I believe it is the job of every investor to see where they went wrong so that they don’t make mistakes in the future. Here are 5 things I have learned during this turmoil that should be beneficial for everyone to remember as we move on out of this market.

1. It’s Too Big to Fail

The age old adage, “It’s Too Big to Fail”, turned out to be a load of bologna. Evidenced by the largest bankruptcy filing ever by Lehman Brothers (LEHMQ.PK) and the fallout of Wachovia (WB) and Washington Mutual, clearly nothing is too big to fail. Even Merrill Lynch (MER), a century old symbol of Wall Street, had to be swallowed up by Bank of America (BAC) to survive. It seems like there is still a lot more consolidation that has to occur in the financial industry before we can return to any state of normalcy, as banks try to de-lever their balance sheets and unload assets into an already uneasy marketplace. With credit markets still basically at a standstill, it seems like there is still some time before firms can have access to even some of the shorter term debt instruments.

2. It can’t go any lower

Stocks have hit 52 week lows on practically a weekly basis and you still had some people come out and say “this market has bottomed” or “how much lower can the stock go?” The answer to that question is no one knows. Just because a stock is low, even a 5 year low, does not mean it can’t go any lower. Take Google (GOOG) and Apple (AAPL) for example, even I fell for it. I did not think they could go any lower, but guess what they did. Even the Dow Jones fell to a low it had not seen since 1999. Let’s just say I didn’t think it could go any lower, but alas it did.

Regardless of fundamentals, fear and greed still control the market, particularly during down periods and times of great uncertainty. No stock, whether or not the underlying fundamentals are solid, can avoid Mr. Market. If the Dow goes down over 400 points in one day, it’s very likely that everything you own will be down, thats just the way it goes. While staying with conservative stocks can be a good idea, don’t think for a second that they are immune to problems in the marketplace and don’t think that just because a stock is at its 52 week low it can’t go any lower; just look at how many  stocks like General Electric (GE) have repeatedly hit 52 week lows on a weekly basis and you will understand.

3. “We’re not in a recession, we have not had 2 quarters of negative GDP growth!”

If these past few weeks have not been any indication of this, I don’t know what is. Many like to claim a recession starts when we see 2 quarters of negative GDP growth. This is a big misconception because when the NBER determines whether or not we have a recession they look at 4 things: Unemployment, Retail Sales Activity, Industrial Production and Personal Income Net Government Transfers. Unemployment is at recessionary levels; retail sales have gotten worse and worse every month; the various industrial production indicators just hit new lows in the previous month and personal income is getting worse. I think it is safe to say we are in a recession. With the global credit markets at a standstill and credit spreads getting worse and worse by the day (just check out the spread between a 3-month T-Bill and the 3 month LIBOR), it is just a matter of time before the recession is officially announced.

4. “This is the bottom”

So many pundits and analysts clung to the fact that the collapse of Bear Stearns would be the bottom for the financial markets during this period of global slowdown. They said it again after Freddie Mac (FRE) and Fannie Mae (FNM) were taken over by the government. They said the same after Lehman Brothers declared bankruptcy and Bank of America (BAC) took over Merrill Lynch. Then again when AIG (AIG) was taken under government control. But guess what, they were wrong, every single time! I guess they just ignored the increasing tension in the global markets, particularly the Eurozone where it seems like the problems and consolidation within the financial sector is just beginning. So when someone tells you it is the bottom, don’t listen, unless of course you are some psychic.

5. The trend is your friend

Markets tend to move in one direction in excess. If there is one thing I have learned during 2008 it is this. Whether it be the run up in commodities that has suddenly reversed course, eg. oil has gone from $147 a barrel to under $90, or the three bear market rallies we have had during this period that seem to send us even lower in the end, or even the run up in 2007 before the credit crisis broke out, markets act out of fear and greed. During bullish periods they will move in excess as people act out of greed and during bearish periods, people will sell off everything they have in fear, stuff it under their mattress and wait until that day they can put their money back into market and start the process all over again. The market will do its best to correct itself as people realize what is going on, but the excesses of past periods will bite you in the butt.

But this just shows the genius of Warren Buffett: “Be greedy when others are fearful and be fearful when others are greedy.” Maybe his recent investments in Goldman Sachs (GS) and General Electric will further show the brilliance of this strategy, but only time will tell. Just remember to take profits when you can and don’t over extend your boundaries, otherwise Mr. Market will make sure you pay for your inability to resist fear and greed and think that the trend is your friend.

Disclaimer: The author is long AAPL. The mutual fund that the author is associated with is long GOOG and GS

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