At this point, I think a 4,000 Dow is coming first. It pains me to write that, since I want to be an optimist. However, the reality is pretty grim and hard to ignore. Here is what convinces me the worst is to come:
- No visibility to the end of failures. More businesses and taxpayers are going to be asking for government help. Banks and homeowners were just the beginning. The auto industry is now making their case for government support, poorly I might add. Retail is coming next, due to the decline in consumer spending. Then it will be the banks again, when credit card debt defaults increase significantly. Retirement accounts which have now lost $8 trillion in value.
In the end, the government will provide the bailout, but won't solve the problem.
- Hedge funds deleveraging at the same time. Due to high withdrawals and high market volatility, hedge funds will need to sell assets. Since many hedge funds use similar decision making criteria, multiple sell programs will be initiated about the same time, exacerbating the market decline.
- We don't understand what we already know. It's pretty clear that this crisis is something no one has ever faced. There is no precedent and people don't understand the complexities and the interconnections of the problem yet. I have very low confidence in Ben Bernanke and the Fed since I believe they already demonstrated mishandling a simpler challenge with subprime debt in August, 2007. Also, I no longer believe Henry Paulson, the Treasury Secretary, is taking all the necessary actions to eradicate the problem.
Worse yet, we don't know what we don't know, which I fear will have issues that amplify the current problem.
At this point, almost no one expects a depression to occur. The conventional wisdom is that there will be a long and deep recession, but no depression. Conventional wisdom (and Warren Buffet) says to buy. However, I think conventional wisdom doesn't have a good track record in this financial crisis, since it also rated subprime mortgages and CDOs as low risk.
Here are the actions I plan to take:
- Withdraw about one third of the funds in the managed accounts. Hopefully, there will be a bear market rally in the next couple months, which will allow me to sell at a higher price. I will hold the funds in cash to be re-invested when the market declines further. I will keep the other two thirds invested in case I am wrong about a market decline.
- Buy inverse index ETFs. When the market rallies, I will buy inverse ETFs for the S&P, Nasdaq, Dow and financial indices. These will serve as a hedge against future market declines.
- Be patient on adding new money. With the exception of inverse index ETFs and or exercise of put options, I do not plan to add new money until the Dow reaches 4,000 or 12,000. It may take years for that to happen.
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This is not financial or investment advice. Please consult a professional advisor.
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