The news just keeps getting worse.  Today it’s the announcement that one of Wall Street’s revered investment dealers, Bear Stearns, is being bailed out and shareholders are going to lose almost everything. 

Despite the fact that Bear was a poster boy for sub-prime mortgages and its problems are somewhat understandable, the news has given the overall market another shake (although I think it’s a positive sign that the stock of JPMorgan Chase, Bear’s acquirer, is up). 

The banking industry’s self-inflicted problems will obviously affect the companies that are directly involved in the capital markets.  But every business will be impacted if the market turbulence results in an even weaker economy, reduced consumer spending and/or tougher financing conditions.

Some of the wealth destruction is totally justified.  The profits, or alleged profits, generated by financial firms using extreme leverage and creative structuring are being revealed for what they were...financial engineering.

But some of the asset declines are not justified.  In a market like this, there are always stocks and bonds that fit in the ‘baby with the bath water’ category.  These are companies where the business model is as sound as ever and may even be stronger in light of the stresses their competitors are under.  Unfortunately, their publicly-traded securities won’t reflect the company’s value until there is some stability.  In the meantime, we will be presented with some fabulous opportunities.  We’ll see whether JPMorgan just got one with its Bear purchase.

Nobody, including me, knows when the markets will stop going down.  It could be a while, or the Bear Stearns bailout may be a sign of the end. 

But there are a few things we do know:

  • Markets are already down a bunch.  Canada has been one of the best, but even the S&P/TSX is down 6% this year (after being up 10% in 2007).  Elsewhere in the world it’s uglier.  The S&P 500 and the MSCI World index are now down over 20% from their highs.  Many European and Asian markets are down more than 20% since the start of this year alone.
  • Despite the numbers, it’s not the time to hide under your desk.  We can’t roll back the losses we’ve sustained so far, but we can make sure we make the most of the recovery ahead.
  • It’s not a time to change your strategic asset mix.  If you realize you need a more conservative portfolio in the long term - you can’t sleep at night when markets and headlines are like this - then now is not the time to do it.  Perhaps the markets will fall further and you’ll be glad you made a change, but history tells us that investors who make major changes at extreme times usually do themselves severe harm.  You’re best to put off the shift in your long-term asset mix until some time has passed and the emotion and fear is out of the decision.  Those are two ingredients that shouldn’t be in the mix.
  • On the other hand, it’s perfectly appropriate to do some re-balancing.  To get back to your existing target portfolio.  By definition, if you haven’t done any recent buying, you own less equities (as a percentage of your overall portfolio) than you did 6 months ago.
  • The markets will stop going down well before the bad news abates.  You should expect the indexes to bottom 6-12 months before the headlines start to look more upbeat.
  • Investors with a 20+ year time horizon have been given a gift.  Desirable securities have fallen in price, some of them substantially. 

We gave our firm its quirky name for a reason.  We always want to provide our clients with a steady hand.  It’s times like this that we all need one.