Time to Panic? (or Why you Need an Advisor)

May 11, 2010  |   Insight   |     |   Comments Off on Time to Panic? (or Why you Need an Advisor)

by H. Brian May

Last week we experienced a selloff reminiscent of the days of Lehman Brothers’ failure in 2008. While some claim a trading error may have been responsible for a portion of the massive decline on Thursday, we know that fears of a European collapse and Greek contagion gave speculators and traders a reason to sell.

It’s clear the markets have risen substantially from the March 2009 lows, but we continue to live by the belief that it is valuations that drive markets in the long term and emotions and current news that drives markets in the short term. As much as we believe that there are real problems in Greece, and as much as we know that we have problems aplenty at home as well, still we don’t see the rationale behind the kind of market action we saw Thursday.

At the end of the day we don’t like this selloff any more than you do, but we are not doing our job as advisors if we simply try to beat the crowd by anticipating each maniacal move it makes. There is no question that stocks had risen pretty steadily for a long time and a pullback would be healthy for the market. Thursday’s action can’t simply be described as a “pullback” though, it was more like a “throwback” – to the ugly days. It is days like this when having a good advisor at the helm can protect your assets from permanent impairment.

The trading in the market late Thursday afternoon was like nothing we have ever seen. In a span of 15 minutes, the Dow Jones index went from being down about 300 points on the day, which was bad enough, to down 998 points at its worst moment - on essentially no news!

The market then quickly bounced back. There was no doubt in our mind that electronic trading by computers was behind the rout that caused some truly unbelievable prices. For instance, Accenture (NYSE:ACN) traded below a penny at the height of the craziness.

In response, the Nasdaq exchange said that certain trades that were made in excess of a 60% daily move would be canceled, but that still leaves a huge number of trades that will stand at incredible prices.

Yesterday, with all the troubles in Europe, and with the EU stepping up with a significant relief package for the Eurozone countries in need, world markets rallied. Once the situation in Europe is stabilized, US investors will begin to focus on our own economy again and we think, be met with some good news. For one, the economic recovery here in the United States continues to gain steam. The employment numbers from last week with those filing for initial unemployment benefits continuing to fall and companies starting to add jobs again, are a very good sign.

We don’t want to dismiss the real fears that are present in this market, but we think that Armageddon is not at hand.

To support this view we note that the current quarter will be the first time in years that no S&P 500 companies will cut or suspend their dividends.  If true, it would mark the first such quarter since the second quarter of 2004, and it is certainly a bullish statement by US corporations.  Earnings have steadily improved over the last year, and according to our data, trailing twelve month reported earnings on the S&P 500 have increased 89% over the past year.  Having heavily cut costs companies are flush with cash, and very few S&P 500 stocks are distressed or in need of a dividend cut to conserve capital.  As a comparison, S&P 500 companies decreased dividend payouts by a record $52 billion in 2009.

We don’t believe our economy is on the edge of collapse or setup for failure as it was two years ago. Many of the weaker financial institutions have already failed, and those that survived the first credit crisis have had nearly two years to raise capital and allow earnings to bolster their balance sheets. Bad loans have been cut back significantly. In other words, we have a very different situation today than we had in early 2008.

Morningstar’s Paul Larson used this apt analogy: “The first credit crisis came through and burned the underbrush and lower branches, sparing the tallest trees. And now if a second fire comes through, there is not nearly as much fuel to let it burn.”

We tend to agree.