The stock markets have taken a pounding lately. Stocks have apparently tanked, an eighty-five year old investment bank, Bear Stearns has effectively gone bankrupt, and everyone is predicting an American recession. So, we should hide and put our savings in socks, right? No, not at all – invest.
First of all, we must recognize that markets have always been subject to human emotions and fears. In fact, it was the human emotion of greed that fueled the crisis in the American residential real estate market, resulting in major banks substantially writing down their subprime securities and mortgages. It is important to realize that this crisis is going to take a long time to work through the system and, in the short term, things might be somewhat rocky.
Secondly, in response to the subprime fiasco, the U.S. Federal Reserve has lowered its short-term interest rate from 5.25% to 3% during the last six months. A lower Federal Reserve interest rate reduces the borrowing cost for banks and businesses, spurring new economic interest and activity. In addition, new rates for those carrying mortgages won’t be as high.
Fears that North American economies are entering a period of “stagflation,” where stagnant growth is coupled with high inflation rates, is also unfounded. ATB Investor Services has shown that, at the end of 2007, the unemployment rate in the U.S. was 5%, with an inflation rate of 4.1%. If food and energy are excluded from the inflation rate, it drops to 2.4%. These figures do not comprise a situation that is conducive to “stagflation.”
Another positive sign, according to ATB Investor Services is that the fundamentals of other industries and companies in the stock market have been fairly solid and resilient. In actual fact, seven of the ten S&P 500 sectors have shown higher earnings in 2007 than they did in 2006.
The challenge for all of us, as investors, is to stop focusing on the short-term market and to begin looking at the long-term market. It’s not easy to do. When the market tanks our first instinct is to get out, and panic selling becomes the norm. When prices are high, everyone wants to buy, on the supposition that prices can only go up. Both attitudes are mistaken. TD Mutual Funds recommends a long-term view and a financial plan. A recent TD Mutual Funds newsletter quotes Warren Buffet the well-known Berkshire Hathaway CEO. “To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insight, or inside information. What is needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework” In other words, have a financial goal and focus on the long-term. Markets are always going to go up and down; as long as the fundamentals are solid, an investor who stays the course will always have a positive return.
