Financial institutions gasping for credit ‘oxygen’

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By Jeremy Gardiner

As fund managers, part of our role is to give some sort of indication to investors as to where we believe the world is going at any given time in order to facilitate investment decision-making. Our market predictions are generally the function of an enormous amount of fundamental analysis, both from our in-house analysts and from analysts from the world’s leading stock broking firms. Of course we are not always going to be right, but given the amount of work that goes into these predictions, we tend to be right more often than we are wrong, which is about as much as one can hope for.

Obviously, at times like these, short-term predictions are almost impossible. We live in a credit starved world; a world where – particularly for financial services companies – available credit is oxygen. Indeed, for the global economy, credit is oxygen. Run out of oxygen, and you are dead, as with Lehmans. Run short of oxygen, as is currently the case with most of the world’s financial institutions and consumers, and the world economy slows down.

Of course, if your country’s government decides that it is in the interest of their citizens that an institution doesn’t die, they can provide oxygen, as was the case with Fanny Mae and Freddy Mac. Each death is very traumatic to the system, particularly for those already short of breath, and the worst case scenario is that the contagion spreads and you have a string of collapses that threaten the health of the entire financial system. Fortunately, this is unlikely. What is more likely is that a lack of oxygen in the system will cause corporates, consumers and the global economy to slow.

So what should investors be doing? The answer is that there is not much you can do at this stage. You certainly shouldn’t be fundamentally restructuring your portfolio now. As we have written before, the time for portfolio restructuring is when markets are calm, not during a hurricane. Why? Because if you try and change direction now you will be acting largely on emotional rather than fundamental reasoning, and investment decisions made emotionally generally tend to be wrong. In situations like these investors tend to go against common investment theory, and instead of buying cheap and selling expensive, they sell cheap (out of panic) and buy back more expensively.

And therein lies the problem. It is very tempting to sell into cash at this point, and if you (or indeed anyone) were capable of calling the bottom of the market, this approach may be viable. However, research shows that when markets turn positive and rally, much of the gains are made in the first three months, a period during which most investors are waiting for confirmation that the rally is sustainable. Cashed-up investors in these phases face the unenviable quandary of piling into a rising market or holding back in the hope of a setback. They usually do the latter, which means that every mild setback is met with a storm of buying.

Waiting for the low before buying always looks attractive on the way down, but the problems with it are only apparent on the way back up. Selling now to buy back at a lower price is even more difficult – what if the assumption about lower prices is wrong? It is psychologically very difficult to buy back at higher prices, so such a strategy runs the risk of selling at a low and not getting back in.

There are indeed risks during times like this, but there are also significant opportunities starting to emerge. As we have written before, you can sit on the side until it feels more comfortable to invest, but when it does feel more comfortable, it may no longer be profitable to do so.

Source: Jeremy Gardiner, Investec Asset Management, September 16, 2008


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