I hope we can learn from this.
With the FTSE 100 down 40% in 2008, all investors will be feeling the pain. It’s a time for reflection, and a time for learning.
1. Leverage is evil.
People who borrowed money to invest in the stock market are finding out just how expensive and stressful those debt commitments can be in a massive bear market.
There is an old saying that the stock market can remain irrational for longer than you can remain solvent. It essentially means if you borrowed money to invest in company you thought was dirt cheap, like oil majors Shell (LSE: RDSA) or BP (LSE: BP.), if their share prices keep plunging, you’ll get a margin call from your broker and either have to send more cash or be forced to sell at precisely the wrong moment, likely incurring a significant loss.
Just about all the greatest investors of our time have not used leverage to boost the returns on their portfolio. The use of excessive leverage smacks of greed at the best of times. In this great bear market of 2008, it is now exposed as evil and wealth destroying. If you’ve used margin and survived, I suspect you’ve now learnt an expensive lesson.
2. Debt is evil.
One by one, or in this market, ten by ten, companies like Debenhams (LSE: DEB), Yell Group (LSE: YELL) and Enterprise Inns (LSE: EPI) have been exposed as carrying too much debt. They’ve been especially exposed because of the slumping economy.
You could argue that’s more due to bad luck than bad management, but for me, that would be a poor argument. Sure this downturn has caught almost everyone off guard due to its speed and intensity, but you need to manage your company for all times, not just the good times.
Investors who own shares in debt laden companies have found out, to their cost, how evil debt can be. Ideally, you want to invest in companies with net cash balances, or at the very worst, manageable debt commitments for all economic environments.
3. Cheap companies can get even cheaper.
Last week I wrote an article called Seven Bargains In This Crazy Market. Just one week on, and 6 out of the 7 stocks have fallen even further.
Another company on my watchlist is asset manager BlueBay Asset Management (LSE: BBAY). Its shares fell an astonishing 22% on Thursday this week for no apparent reason. The company has no debt, £44 million in the bank, and with the shares now around 105p, the total company is capitalised at £200 million. At that level, it trades on a price to earnings ratio (P/E) of around 5 and a dividend yield of around 8.5%.
Are they cheap? Apparently so. Could the shares fall further? Absolutely. Are they alone? Hell no.
4. The bottom of the market is impossible to pick.
I’ve tried it. Warren Buffett has had a veiled stab at it, as has Anthony Bolton. We’ve all been wrong. This market has continued to wrong-foot just about every investor, and although it might seem we are close to the bottom, similar calls over the past month have been wrong.
The global economy is truly in a mess, and mostly because of the massive debt bubble. Banks were lending to people who couldn’t afford to pay back the interest. Companies were leveraging up their balance sheets as they chased more and more growth. Consumers went on a credit-fuelled spending spree, buying up every plasma TV, new computer and iPhone they could get their hands on.
The chickens have come home to roost. The tide has gone out, and there are literally millions of people exposed as swimming naked. The reverberations are clear to see, and they’ve got further to go. We’re not out of the woods yet.
Despite all that doom and gloom, stock prices typically hit low points before the economy turns, so there is hope. Just don’t try to pick the bottom.
5. It’s emotionally draining.
The FTSE 100 is down 40% in 2008 alone. This week to date it has fallen 8.5%. With each passing day, share portfolios are hammered yet again.
It has affected many people, and not just the share traders and the City pin stripe brigade. Ordinary investors have seen their portfolios decimated. Pension funds have taken a 40% haircut, affecting the potential income of thousands of people nearing retirement. Those pensioners who are relying on income and capital growth from investments to fund their retirement must be hurting.
It hurts to see your hard earned wealth disappear before your very eyes. It’s stressful. It’s demoralising. It makes you question whether you should just sell up everything now, take the hit, and just preserve what capital you’ve got left. At times, it’s plain scary.
What Should You Do Now?
I wish I knew. All I can tell you is what I’m doing.
I bought some shares last week, and they are already down 10% and 20%. I thought they were cheap, but they’re now cheaper.
I continue to hunt for high quality, cashed up companies trading at low valuations. There are no guarantees with anything right now, but I can’t help but think from these low valuations, I should be well rewarded in 3 to 5 to 10 years from now.