Impact of property prices on the stock market

In general, property prices tend to move hand in hand with share prices.

Therefore, when property prices have risen too fast and too high, a wise investor might want to be cautious about the stock market as a property market crash would dampen sentiment on the stock market.

We could learn a lesson from Japan in the 1980s.

After excessive speculation -----> Property prices collapse

Nikkei average 39,000 ---------> Nikkei average 14,000

Reason:

• When property prices sky rocket, investors mortgage or sell their properties to buy shares ----> share prices sky rocket.

• When property prices collapse, investors sell shares to cover the house mortgage loan

or

• When share prices collapse, investors sell their properties to cover shares margin call.

Ref: Making Mistakes in the Stock Market by Wong Yee

Why is oil price important?

What is the impact of oil price on the stock market?

Generally, most industrial-motor-related things need oil as a means to generate power. Thus, oil has been one of the most important commodities to most countries.

Any adverse impact on oil price could bring chaos to the world as fear of inflation would surface. In such an event, the world economies could be drawn to a standstill.

For example, the oil shock in 1973/74 and 1980/81 caused the world stock markets to tumble. Again in 1990, the Gulf Crisis also contributed to the collapse of the stock markets.

Such external shocks could happen again. Therefore, it would be helpful if an investor spent some time monitoring the oil price charts as well as any world events that could lead to another oil crisis.

Event
1973/74 oil shock
1980/81 oil shock
1990 Gulf Crisis
--------> sudden rise in oil price -> increase price of Brent crude
--------> World stock markets tumble.

To observe:

• Brent crude chart
• World events regarding oil prices

Ref: Making Mistakes in the Stock Market by Wong Yee

Share prices have fallen sharply in a Recession

Question: The recession is a year old now and share prices have fallen sharply. Most of my friends are so nervous that they have sold all their shares, some incurring heavy losses. Are my friends doing the right thing?

Generally speaking when a recession is already a year old one should seize the opportunity to monitor share prices closely. Often, genuine bargains are secured during the worst time.

For instance, some shares could have fallen below their net assets backing or the PE ratio could be hovering below 10. Under such circumstances, the downside risk could be minimum.

Thus a share investor should seize the opportunity to analyse the stock market barometer e.g. the ST Industrial Index (or KLCI Index) to ascertain whether it is bottoming and has a potential to rise.

After all, one of the basic fundamentals of a stock market trend analysis is that it tends to foretell the economic recovery well in advance. Therefore you will be able to reap quite a substantial profit if your analysis proves right.


During a recession

• Do not panic
• Look out for bargains instead of cutting losses
• Monitor the Stock Market Index for bottoming formation

Ref:

Making Mistakes in the Stock Market by Wong Yee

http://tradingbursamalaysia.blogspot.com/2008/10/still-falling.html Where is the bottom? Ans: I don't know now but I will tell you when I see signs of bottoming.

Leading economic indicators

To-date, all kinds of tools have been engaged by economists to forecast the economic cycle. However, the most applicable tool used so far is the "leading economic indicators" composite index.

Accordingly, if the said index rises for 3 consecutive months in a row during a recession period, it augurs that the economy will be heading for a recovery in 6 to 9 months' time.

Conversely, during an expansionary phase, should the "leading economic indicators" composite index record a fall for 3 consecutive months in a row, it is an indication that a slowdown in the economy is possible within the next 6 to 9 months' time.

US Leading Economic Indicators Composite Index comprises a wide range of components:

1. Prices for raw materials
2. The average work week
3. New orders for consumer goods
4. New orders for building permits
5. Stock prices
6. Orders for plant and equipment
7. Unemployment claims
8. Vendor performance
9. Money supply
10. Total liquid assets
11. Consumer expectations about the economy

Leading Economic Indicators Composite Index

UP -> 3 consecutive months -> economic growth
DOWN -> 3 consecutive months - > slow down/recession

Ref: Making Mistakes in the Stock Market by Wong Yee

My recollection of the 1997 Asian Financial Crisis

In 1997/98 Asian Financial Crisis, the Malaysian Stock Market dropped from 900 in 1997 to 200 in 1998, and the Ringgit dropped by about 40 percent in a year.

Let me attempt to recall the crisis from memory. There was a period of uncertainty from the start of the Asian Financial Crisis. Thailand was the first country affected. The Baht was shorted heavily. The Thai government supported its currency initially but subsequently was unable. The next country to be affected was Indonesia and its currency, the Rupee. Malaysia was initially not affected but not for long. In fact, Malaysia was able to help Thailand and Indonesia in the onset of the crisis by extending billion ringgit loans to help them support their currencies.

When the crisis affected Malaysia, there was also an initial period of great uncertainty. The Minister of Finance and the central government implemented various policies. Many of these were however unable to stabilise the crisis. The Malaysian Stock Market continued its free fall. When the market fell to 600, many thought the market was trading at a bargain at that level. Many good and fundamentally strong counters were also down with the market.

Subsequent falls in the market proved those who bought to be wrong for the short term. The market was not reacting to fundamentals for that period. Those using "fundamentals" to guide their purchases caught the "falling knife/knieves". The market got pushed down further, 500, 400, 300 and eventually capitulated to a low of 200+. On that faithful day before the implementation of drastic measures by the central government, everyone wanted to get out of the market, at any price! It would seem that there was little or even no value in any Malaysian assets on that memorable day. Panic was obvious.

I recalled the ringgit was MR 2.20 to US 1.00 before the crisis. The ringgit dropped drastically. It was soon MR 3 to US 1.00. Soon, it was MR 3.50, MR4 and even MR 4.50 (?). The falling Ringgit affected those Malaysians who were supporting their children's education overseas. Some had to stop their studies. Others suffered greatly, having lost money in the stock market and now paying almost double for the education fees in ringgit terms. These were sums in the tens or hundreds of thousand ringgits. The hardship was real and painful.

The local banks were deemed not safe to put your money. Soon there were large numbers of withdrawals from the local banks. Depositors withdrew from local banks when rumours were rampant might collapse. These same depositors parked their money into Singapore and other foreign banks. Some opened foreign currencies accounts in Singapore. A lot of money flowed out of the country too. For short and long term deposits, the interest was a high of >10% for that period of uncertainty.

Economy was down. The traders and the businesses were in deep trouble. It was difficult to get new loans or financing. The banks were tight of liquity and was unwilling to extend credit. One would be lucky not to have one's credit facility withdrawn. Those carrying large loans or debts were particularly suffering as interest rate was very high indeed. How to make money? Contracting economy, poor business sentiment and high cost of doing business translated into losses for many businesses.

On hindsight, what would you have done differently during the Asian Financial Crisis?

Are there lessons here to guide the investors on the present Global Financial Crisis?


Visit this post to learn how Malaysia got out of the Asian Financial Crisis.
http://profitmaking188.blogspot.com/ : Malaysia's Self-Prescribed Rescue Debated

The Worst of Time and the Best of Time

It has been such a volatile week. The market has sunk so much in 1 week. It certainly is alarming for those who are holding stocks. For many this may be the worst of time. What should they do with their stocks?

On the other hand, this may be the best of time for some investors. It maybe the better time to pick up bargains in those good stocks one is eyeing for so long.

Some are waiting for the capitulation to pick up stocks. Above all, do not be the one who capitulates.

Who can predict the bottom? I can't. It is just a gut feeling that the bottom maybe near. Also the dogmatic conviction that the market is still the place to park some of my investment, however fearful it may seem at present. This soon will pass too.


Ref:
Stock Sale Considerations (Part 2 of 5)
WHY ARE YOU CONSIDERING A SALE?

The Bad News that creates a Buying Situation - Stock Market Corrections and Panics

VIX Index

Volatility Index (VIX)

What it Is:

The Volatility Index (VIX) is a contrarian sentiment indicator that helps to determine when there is too much optimism or fear in the market. When sentiment reaches one extreme or the other, the market typically reverses course.

How it Works:

The VIX is based on data collected by the CBOE, or Chicago Board Options Exchange. Each day the CBOE calculates a figure for a "synthetic option" based on prices paid for puts and calls. The computation of the VIX was changed in 2003 and is based on the S&P 500 option series.

The key question the Volatility Index answers is "What is the 'implied,' or expected, volatility of the synthetic option on which the index is based?" We already know the following variables:
-- The market price of the S&P 500
-- The prevailing interest rate
-- The number of days to expiration of the option series
-- The strike prices of those options contracts

What the equation solves is the "implied," or expected, volatility.

What is volatility?

One definition describes volatility as "the rate and magnitude of changes in price." In simple English, volatility is how fast prices move.

When the market is calm and moving in a trading range or even has a mild upside bias, volatility is typically low. On these kinds of days, call option buying (a bet that the market will move higher) generally outnumbers put option buying (a bet that the market will go down). This kind of market typically reflects complacency, or a lack of fear.

Conversely, when the market sells off strongly, anxiety among investors tends to rise. Traders rush to buy puts, which in turn pushes the price of these options higher. This increased amount investors are willing to pay for put options shows up in higher readings on the VIX. High readings typically represent a fearful marketplace. Paradoxically, an oversold market that is filled with fear is apt to turn and head higher.

Why it Matters:

The Volatility Index works well in conjunction with other "overall market indicators." By studying its message, traders will have a better understanding of investor sentiment, and thus possible reversals in the market.

http://www.streetauthority.com/terms/v/vix2.asp


VIX values greater than 30 are generally associated with a large amount of volatility as a result of investor fear or uncertainty, while values below 20 generally correspond to less stressful, even complacent, times in the markets.

The index is often referred to as the "investor fear gauge".

LIBOR - London Interbank Offered Rate

What is LIBOR?

The London Interbank Offered Rate is the rate at which banks will lend unsecured funds to one another. Based on a survey of global banks, it's the most widely used benchmark for short-term interest rates.

When are LIBOR rates determined?

The British Bankers' Association publishes rates Monday to Friday at 11:00 a.m. London time of varying maturities.

How is LIBOR determined?

Each bank determines how much they will have to pay to borrow money from each other. The number of contributing banks vary depending on the currency.

U.S. dollar LIBOR is determined by 16 global banks, and the final published rate is the average of the middle eight rates.

LIBOR and U.S. interest rates

Historically, LIBOR tends to track the Federal Funds Target Rate. However, as economic uncertainty over the global credit crisis continued and the initial U.S. government-sponsored financial bailout failed, the spread between the two rates widened as LIBOR spiked, indicating a lack of confidence among banks.

LIBOR's relationship to consumers.

LIBOR ultimately determines interest rates on everything from adjustable-rate mortgages and car and student loans to small-business loans and credit cards.


Additional notes

http://www.investopedia.com/terms/l/libor.asp

LIBOR

An interest rate at which banks can borrow funds, in marketable size, from other banks in the London interbank market. The LIBOR is fixed on a daily basis by the British Bankers' Association. The LIBOR is derived from a filtered average of the world's most creditworthy banks' interbank deposit rates for larger loans with maturities between overnight and one full year.

The LIBOR is the world's most widely used benchmark for short-term interest rates. It's important because it is the rate at which the world's most preferred borrowers are able to borrow money. It is also the rate upon which rates for less preferred borrowers are based. For example, a multinational corporation with a very good credit rating may be able to borrow money for one year at LIBOR plus four or five points. Countries that rely on the LIBOR for a reference rate include the United States, Canada, Switzerland and the U.K.


http://en.wikipedia.org/wiki/Federal_funds_rate

Federal funds rate comparison with LIBOR

Though the London Interbank Offered Rate (LIBOR) and the federal funds rate are concerned with the same action, i.e. interbank loans, they are distinct from one another, as following:

1. The federal funds rate is a target interest rate that is fixed by the FOMC for implementing U.S. monetary policies.

2. The federal funds rate is achieved through open market operations at the Domestic Trading Desk at the Federal Reserve Bank of New York which deals primarily in domestic securities (U.S. Treasury and federal agencies' securities).

3. LIBOR is calculated from prevailing interest rates between highly credit-worthy institutions.

4. LIBOR may or may not be used to derive business terms. It is not fixed beforehand and is not meant to have macroeconomic ramifications.

Federal Funds Rate and the Discount Rate

The discount rate, in contrast, is usually about a half to a full percentage point higher than the federal funds rate. The Federal Reserve does control that one. The discount rate is the interest rate the Federal Reserve charges other depository institutions for very short-term (usually overnight) loans.

The Bad News that creates a Buying Situation - Industry Recession

The second kind of situation that presents a buying opportunity is an industry-wide recession. In this case an entire industry suffers a financial setback. These situations vary in their intensity and depth. An industry recession can lead to serious losses or it can mean nothing more than mild reduction in per share earnings. Recovery time from this type of situation can be considerable, one to four years, but it does present excellent buying opportunities. In severe examples, a business may even end up in bankruptcy. Don't be fooled by too cheap a selling price. Stay with a well-capitalized leader, one that was very profitable before the recession.

Capital Cities/ABC Inc. fell victim to this weird manic-depressive stock market behaviour in 1990. Because of a business recession, avertising revenues started to drop, and Capital Cities reported that its net profit for 1990 would be approximately the same as in 1989. The stock market, used to Capital Cities growing its per share earnings at approximately 27% a year, reacted violently to this news and in the space of six months drove the price of its stock down from $63.30 a share to $38 a share. Thus, Capital Cities lost 40% of its per share price, all because it projected that things were going to be the same as they were last year. (In 1995, Capital Cities and the Walt Disney Company agreed to merge. This caused the market-revalued Capital Cities to upward of $125 a share. If you bought it in 1990 for $38 a share and sold it in 1995 for $125 a share, your pretax annual compounding rate of return would be approximately 26%, with a per share profit of $87.)

Warren Buffett used the banking industry recession in 1990 as the impetus for investing in Wells Fargo, an investment that brought him enormous rewards. Remember, in an industry-wide recession, everyone gets hurt. But the strong survive and the weak are removed from the economic landscape. Wells Fargo is one of the most conservative, well run, and financially strong of the key money center banks on the West Coast, and the seventh-largest bank in the nation.

Wells Fargo, in 1990 and 1991, responding to a nationwide recession in the real estate market, set aside for potential loan losses a little over $1.3 billion, or approximately $25 a share of its $55 a share in net worth. When a bank sets aside funds for potential losses it is merely designating part of its net worth as a reserve for potential future losses. It doesn't mean that losses have happened, nor does it mean they will happen. What it means is that there is potential for the losses to occur and that the bank is prepared to meet them.

This means that if Well Fargo lost every penny it had set aside for potential losses, $25 a share, it would still have $28 a share left in net worth. Losses did eventually occur, but they weren't as bad as Well Fargo prepared for. In 1991, they wiped out most of Wells Fargo's earnings. But the bank was still very solvent and still reported in 1991 a small net profit of $21 million, or $0.04 a share.

Wall Street reacted as if Wells Fargo was a regional savings and loan on the brink of insolvency, and in the space of four months hammered Wells Fargo's stock price from $86 a share to $41.30 a share. Wells Fargo lost 52% of its per share market price because it essentially was not going to make any money in 1991. Warren Buffett responded by buying 10% of the company - or 5 million shares - for an average price of $57.80 a share.

What Warren Buffett saw in Wells Fargo was one of the best managed and profitable money-center banks in the country, selling in the stock market for a price that was considerably less than what comparable banks were selling for in the private market. Although all banks compete with each other, as we said, money-center banks like Wells Fargo have a kind of toll brideg monopoly on financial transactions. If you are going to function in society, be it as an individual, a mom and pop business, or a billion-dollar corporation, you need a bank account, a business loan, a car loan, or a mortgage. And with every bank account, business loan, car loan, or mortgage comes the banker charging you fees for the myriad services he provides. California, by the way, has a lot of people, thousands of businesses, and a lot of small and medium size banks, and Wells Fargo is there to serve them all - for a fee.

The loan losses that Well Fargo anticipated never reached the magnitude expected, and nine years later, in 2000, if you wanted to buy a share of Wells Fargo you would have to have paid approximately $270 a share. Warren Buffett ended up with a pretax annual compounding rate of return of approximately 18.6% on his 1991 invetment. For Warren Buffett there is no business like the banking business.

In the cases of both Capital Cities and Wells Fargo, there was a dramatic drop in their share prices because of an industry-wide recession, which created the opportunity for Warren Buffett to make serious investments at bargain prices.

The Bad News that creates a Buying Situation - Stock Market Corrections and Panics

Stock market corrections and panics are easy to spot and usually the safest because they don't tend to change the earnings of the underlying business. That is, unless the company is somehow tied to the investment business, in which case a market downturn tends to reduce general market trading activity, which means brokerage firms and investment banks lose money. Otherwise the underlying economics of most businesses stay the same. During stock market corrections and panics, stock prices drop for reasons having nothing to do with the underlyng economics of their respective companies.

This is the easiest kind of situation to invest in because there is no real business problem for the company to overcome. If you let the price of the security, as Buffett does, determine whether or not the investment gets bought, then this is possibly the safest "buy" situation there is. Buffett began buying The Washington Post during the stock market crash of '73 - '74 and Coca-Cola during the crash of '87. While everyone else was caught in a state of panic, Buffett began buying these companies' shares like a man possessed with a deep thirst for value. He eventually acquired 1,727,765 shares of The Washington Post and 200,000,000 shares of Coca-Cola.

A market correction or panic will more than likely drive all stock prices down, but it will really hammer those that have recently announced bad news, like a recent decline in earnings. Remember, a market panic accents the effect that bad news has on stock price. Buffett believes that the perfect buying situation can be created when there is a stock market panic coupled with bad news about the company.

Any company with a strong consumer monopoly will eventually recover after a market correction or panic. But beware: In a really high market, in which stock prices are trading in excess of fourty times earnings, it may take a considerable amount of time for things to recover after a major correction or panic. Companies of the commodity type may never again see their bull market highs, which means investors can suffer a very real and permanent loss of capital.

After a market correction or panic, stock prices of the consumer monopoly type company will usually rebound withn a year or two. This bounce effect will often provide an investor an opportunity to pick up a great price on an exception business and see a dramatic profit within a year or two of purchasing the stock. Stock market corrections and panics have made Buffett a very happy and a very rich man.

One success can wipe out 10,000 failures.

Harness the stunning power of financial regret

Regret over past financial decisions can have a powerful hold on you.

At 23, you may regret running up $20,000 in credit card debt during college. At 35, you may regret never having gone to college. At 45, you may regret having never started that consulting business you always dreamed of pursing. And at 65, you may regret not having saved more for retirement. In recent days, many financial chickens have come home to roost.

Regret, financial or otherwise, can have a powerful grip on your life. For most, the question is not whether you have financial regret. The question is how you harness the power of that regret to make sound financial decisions today that you will not regret tomorrow.

Here are some ideas to help you do just that:

We all have made stupid financial decisions. Even Warren Buffett has made dumb investments, which he readily admits. We can spend a lot of time and energy lamenting those past decisions, but it will not help us make better decisions today. We need to stop obsessing about the past and, instead, use the lessons it can teach us to make better decisions today.

It is better to look ahead and prepare than to look back and regret. -- Jackie Joyner-Kersee

Regret for wasted time is more wasted time. -- Mason Cooley

Learn from that which you regret. If regret has any positive value, it comes from evaluating the decisions you made that caused the regret. Take out a piece of paper and write down your financial regrets in as much detail as possible. Think about not only regrets from things you did, but also regrets from things you chose not to do. It is the things we did not do that often cause the most pain. We will use this list of regrets to make new and fresh decisions today that can at least keep the regretful decisions from continuing.

Never regret. If it's good, it's wonderful. If it's bad, it's experience. -- Victoria Holt

Regret for the things we did can be tempered by time; it is regret for the things we did not do that is inconsolable. -- Sidney J. Harris

To regret deeply is to live afresh. -- Henry David Thoreau

It is never too late. Reread the quote from Sidney Harris above. Does it describe any of the financial regrets you wrote down on the piece of paper? In most cases, our most profound regrets come from things we were too scared or busy or distracted to do. Whether it was going into business, going to college, or investing in the stock market, what we chose not to do can be a major source of regret.

If you are reading this article, it is not too late. Many go to college during retirement, or start investing in their 50s (or later), or start a business only after retiring from a career. Sometimes we convince ourselves that it is too late to accomplish this or that because it eases the pain of regret. But it is a lie. Believing that it is too late to change may make us feel better, but it also causes us to repeat the same inaction that caused the regret in the first place. Look at it this way. If you are 45 and considering getting a college degree, you have two choices: turn 50 with a college degree, or turn 50 without one.

There is no old age. There is, as there always was, just you. -- Carol Matthau

Do not go gentle into that good night,
Old age should burn and rave at close of day;
Rage, rage against the dying of the light. -- Dylan Thomas

Change the bad habits. Many regrets are born out of a lifetime of small, insignificant bad money-management decisions. You may have lived for years spending just a little more than you make. But after a lifetime of such living, you find yourself in unimaginable debt, with little or no savings. It wasn't one big mistake, it was thousands of small financial missteps. If that describes some of the regrets you have written down, changing those bad habits will be much like breaking free from addiction.

People are addicted to eating out. They are addicting to shopping. They are addicted to their gadgets. Of course, nothing is wrong with any of these things if you are properly managing your money. But if you are not, these are some of the daily, weekly and monthly decisions you make that have added up over a lifetime to create the financial regret you now experience.

As a starting point, wipe your financial slate clean. Put your past financial decisions where they belong, in the past. The question now is what financial decisions are you going to make today. If regret is born out of uncontrollable shopping, put something else in your life to take the place of the shopping. Ask a friend to hold you accountable. Give your spouse your cash and credit cards to hold for you. Do whatever it takes so that tomorrow you will not regret the decisions you make today.

My one regret in life is that I am not someone else. -- Woody Allen

Focus on today and tomorrow, not yesterday. Take another look at that piece of paper that lists all of your financial regrets. That paper represents the past. Take stock of the regrets, and make decisions today so that those regrets do not repeat themselves. And once you have done that, throw the paper away. Make decisions today so that tomorrow you will look back without regret.

When one door closes, another door opens; but we often look so long and so regretfully upon the closed door that we do not see the ones which open for us. -- Alexander Graham Bell

All saints have a past; all sinners have a future. -- Warren Buffett

Regret is a stunningly powerful emotion. Allowed to run amok, regret can ruin a life and even a family. With some honest introspection, however, you can turn that powerful emotion into a motivator that helps you make better choices today. Whatever your past, make today great, so tomorrow can be even better.

One success can wipe out 10,000 failures. -- The Dough Roller

http://blogs.moneycentral.msn.com/smartspending/archive/2008/10/08/harness-the-stunning-power-of-financial-regret.aspx

Understanding FEAR and PANIC

October 8, 2008

Forget Logic; Fear Appears to Have Edge
By VIKAS BAJAJ

The technical term for it is “negative feedback loop.” The rest of us just call it a panic.
How else to explain yet another plunge in the stock market Tuesday that sent the Standard & Poor’s 500-stock index to its lowest level in five years — particularly in the absence of another nasty surprise?

If anything, the markets should have been buoyed by the Federal Reserve saying it would shore up another troubled corner of finance by lending money directly to companies. Stocks did open higher, but then quickly tumbled as rumors swirled about the viability of big financial firms like Morgan Stanley and the Royal Bank of Scotland.

Anybody searching for cause-and-effect logic in the daily gyrations of the market will be disappointed — even if the overarching problem of a crisis of confidence in the global economy is now becoming clear.

Instead, the market has become a case study in the psychology of crowds, many experts say. In normal times, it runs on a healthy mix of fear and greed. But fear now seems to rule, with investors often exhibiting a Wall Street version of the fight-or-flight mechanism — they are selling first, and asking questions later.

“What’s happening is people are crawling into a bunker and pulling an iron sheet over their heads because they think the sky is falling,” said William Ackman, a prominent hedge fund manager in New York.

And that bunker is getting very crowded, so much so that some analysts are starting to suggest the markets are showing signs of “capitulation” — another term of art to describe what happens when even the bullish holdouts, the unflagging optimists, throw up their hands and join the stampede out of the market.

Fear can be seen at every turn — in headlines raising questions about another Great Depression, and in the crowds gathered around office televisions to track stocks or to parse the latest pronouncements from the Federal Reserve chairman, Ben S. Bernanke, or the Treasury secretary, Henry M. Paulson Jr.

Even James Cramer, the voluble and long-bullish host of an investing show on CNBC, advised investors to sell some stock during appearances on the “Today” show Monday and Tuesday mornings.

To some, signs of capitulation can be read as an indicator that the bottom may be near. Indeed, Sam Stovall, chief investment strategist at Standard & Poor’s Equity Research, is among those who say the market may be close to a bottom.

In addition to his analysis of the market, he was swayed by the numerous telephone calls he has received in recent days from professional acquaintances and his sister-in-law, all saying they are getting out of stocks.

“More and more people are doing that and selling out,” Mr. Stovall said.

The opposite of capitulation, of course, is investing at the height of a bubble. One oft-cited sign of the housing market’s top: when dinner parties are dominated by stories about fast profits on flipped condominiums.

During the dot-com boom in the late 1990s, it seemed everybody and their grandmothers were piling into stocks. Now they are bailing out. Tuesday was the fourth consecutive day that the S.& P. 500-stock index registered a decline of 1 percent or more. The last time that happened was October 2002, when the index reached its lowest point during the bear market that started in 2000. The S.& P. is now down 36 percent from its peak a year ago, almost to the day, on Oct. 9, 2007.

Another barometer of panic: volatility, reflected in the so-called Fear Index (or the VIX), which tracks options trades that investors use to protect against future losses. On Tuesday, it climbed to its highest level since the 1987 stock market crash.

Fear is an immensely powerful force, perhaps more so than greed, said Andrew W. Lo, a professor at the Massachusetts Institute of Technology who has studied investor behavior.
Scientists who have studied the brain function have found that the amygdala, the part of the brain that controls fear, responds faster than the parts of the brain that handle cognitive functions, he said.

“Fear is a much stronger motivational force,” Mr. Lo added. “The loss of $1,000 has a much bigger impact than the gain of a $1,000.”

He cites a series of groundbreaking experiments in the 1970s by psychologists Daniel Kahneman and Amos Tversky. In one test, they asked students to choose between a sure bet of $3,000, or an 80 percent chance of winning $4,000 (meaning there was a 20 percent chance of winning nothing). Most students said they would take the $3,000.

The same question, framed differently, asked them if they would rather lose $3,000 or accept an 80 percent chance of losing $4,000 (with a 20 percent chance of losing nothing). In this case, they said they would take the riskier bet.

In other words, they were willing to take a bigger risk to avoid losing money than they were when they stood to make more money.

Those instincts seem to be taking over.

At this point, any spreadsheet analysis of underlying and intrinsic values of stocks becomes meaningless, and concern for preserving wealth overrides the desire to grow it — what some may call greed.

“With negative emotions we tend to have a desire to change the situation,” said Ellen Peters, a senior scientist at Decision Research in Eugene, Ore. But “when things are good there is not much desire to change.”

That perhaps explains why investors are willing to earn virtually no return in Treasury bills just to be assured that they will get their money back, rather than investing in short-term corporate debt that offers a better return but carries some risk. Investors were reminded of that risk after Lehman Brothers sought bankruptcy protection last month.

Even banks, which make money by lending to businesses, consumers and each other, are hoarding cash. That is why the Federal Reserve said on Tuesday that it would buy commercial paper, the short-term loans issued by companies and banks.

If the market is indeed close to the bottom, history suggests any rally in the next few weeks will probably be big. Since World War II, Mr. Stovall estimates stocks have recouped about a third of their bear market losses in the first 40 days after the market hits bottom.

But enough investors have to first be persuaded that the economy and housing market will begin recovering soon. Another major test will be third-quarter corporate earnings announcements that will trickle out in the next three weeks.

Perhaps the most important indicator will be the credit markets: Investors will regain confidence when they believe financial firms are adequately capitalized and money is flowing more freely through the financial system.

Mr. Ackman, the hedge fund manager who has been vocal about his bearish views of some financial companies in recent years, said it is hard to precisely time the market. But, he added, “I do think that stocks are getting extremely cheap.”

David Bertocchi, a portfolio manager for Baring Asset Management in London, echoed that sentiment, saying he was beginning to increase his stake in certain companies.

He is taking advantage, he said, of panicked selling by hedge funds that have to pay back loans to their brokers. “That’s what drives markets to attractive levels,” he said.


http://www.nytimes.com/2008/10/08/business/08fear.html?em

__________

A Day (Gasp) Like Any Other


This panic is taking place in such a compressed time frame that it is just astonishing. Mr. Chernow pointed out that while the stock market crash of 1929 took place over three brutal trading days in October 1929, it took nearly three years to reach bottom. By then, stocks had lost a shocking 89 percent of their value.

This crisis, by contrast, seems to be moving at hyper-speed — one day it is Lehman Brothers, the next A.I.G., the day after that Washington Mutual. This crisis doesn’t wear you down over time. It hits you over the head with a two-by-four. On a daily basis.

A third problem, though, is that confidence keeps eroding. The latest wrinkle is that many hedge fund investors, fearing big losses, no longer have confidence in their hedge fund managers. Thus, hedge fund managers are preparing for huge withdrawals at the end of the year, and so they are selling billions of dollars worth of stock preparing to pay redemptions. That is one reason the stock market is under pressure.

“It becomes a self-fulfilling prophecy,” said one hedge fund manager. Firms fearing redemptions sell off stocks, which hurts their performance. Which undermines their investors’ confidence. Which means there are likely to be even more redemptions. Around and around it goes.

Twelve years ago, Alan Greenspan invented the term “irrational exuberance.” That era seems tame compared with this one. What is going on in the markets is anything but exuberant — at this point, though, it is undeniably irrational.

http://www.nytimes.com/2008/10/07/business/07nocera.html?em

The Gifts that Keep on Giving

Short-Sightedness and the Bad News Phenomenon.

Warren Buffett discovered that everyone from mutual fund managers to Internet day traders are stuck playing the short-term game. It is the nature of the stock market.

The bad news phenomenon is a constant - people sell on bad news.

Companies that have consumer monopolies have the economic power to pull themselves out of most bad news situations.

Warren Buffett made all his big money investing in consumer monopolies.

The Bad News that Creates a Buying Situation

Bad news situations come in four basic flavours:

1. Stock market correction or panic
2. Industry recession
3. Individual business calamity, and,
4. Structural changes.

The perfect buying situation is created when a stock market correction or panic is coupled with an industry recession or individual business calamity.

Where to Look for a Consumer Monopoly

Warren Buffett has discovered that there are basically four types of consumer monopolies:

1. Businesses that make products that wear out fast or are used up quickly, that have brand name appeal, and that merchants have to carry or use to stay in business.

2. Communications businesses that provide a repetitive service that manufacturers must use to persuade the public to buy their products.

3. Businesses that provide repetitive consumer services that people and business are consistently in need of.

4. Retail stores that have acquired a quasi-monopoly position selling such items as jewelry and furniture.

Determining if the Business Has a Consumer Monopoly

A consumer monopoly is usually evidenced by a brand name product or key service.

Warren Buffett looks for the consumer monopoly to produce earnings that are strong and show an upward trend.

A company that benefits from the high profits that a consumer monopoly produces will usually be conservatively financed. Often it carries no debt at all, which means that it has considerable financial punch to solve problems and to take advantage of new business prospects.

Warren Buffett believes that in order for a company to make shareholders rich over the long run it must earn high rates of return on shareholders' equity.

He also believes that the company must be able to retain its earnings and not have to spend it all on maintaining current operations.

The Healthy Business: The Consumer Monopoly (Where Warren Finds all the Money)

A consumer monopoly is a type of toll bridge business. If you want to buy a certain product you have to purchase it from that one company and no one else.

Warren Buffett's test for a consumer monopoly is to ask himself whether it would be possible to create a competing business even if one didn't care about losing money.

A consumer monopoly sells a product where quality and uniqueness are the most important factors in the consumer's decision to buy.

Consumer monopolies, though excellent businesses, are still subject to the ups and downs of the business cycle and the occasional business calamity.

Identifying the Commodity Type Businesses

Commodity type businesses have the following characteristics:

• Low profit margins on sales coupled with low inventory turnover
• Low returns on shareholders' equity
• Absence of any brand loyalty
• Presence of multiple producers
• Existence of substantial excess production capacity in the industry
• Erratic profits
• Profitability that is almost entirely dependent upon management's abilities to efficiently utilise tangible assets.

The Economic Engine Buffett Wants to Own

Warren Buffett has separated the world of business into two different categories:

1. the healthy consumer monopoly type business and
2. the sick commodity type business.

A consumer monopoly is a type of business that sells a brand name product or has a unique position that allows it to act like a monopoly.

A commodity type business is the kind that manufactures a generic product or service that a lot of companies produce and sell.

Warren Buffett believes that if you can't identify these two different types of businesses, you will be unable to exploit the pricing mistakes of a short-sighted stock market.

Stick to it

If you have got a formula that could make money, STICK TO IT.

No one can make all the money, let others make some.

Generally, any tactic that results in profits in terms of shares investment should be followed consistently. Unfortunately, rarely does one stick to sound investment tactics. This is because we are often swayed by others who claim that their tactics are better. However, the truth is that these persons may have only told you about the profitable side of their story and not the losses they have incurred.

Therefore, if you have found a certain strategy which enables you to make money, you should continue to use it. The bottom line is not to be greedy as it can be costly.

As such, the most important thing that you must remember is to follow a strategy that consistently gives you profits. The size of the profit is not as important as the method because with the correct method, you can improve on the amount of profits eventually.