Investors Have Capitulated – Now What?

October 10, 2008 by  
Filed under Investing

It’s pretty clear to Mr. ToughMoneyLove that investors in stock markets around the globe have capitulated.  By this I mean that investors have mentally and emotionally transitioned from not knowing what their investments should be worth to simply not caring.  The result is panic selling.

The problem with investor capitulation is that the panic selling negatively affects everyone and everything. Those of us who at least pretend to be more analytical about buying and selling decisions are dragged down the mountain in the avalanche, as are stocks that even today have good fundamentals. 

The question now is what happens next?  The G7 leaders are meeting on Friday to address the economic crisis but it may be that most of the fast acting fiscal and monetary policy treatments have already been administered.  There is no question that a coordinated international effort is needed.  Without it, the various national treasuries and central banks will simply pass the worst problems from one currency to the next.  

Bernanke and Paulson still have not finalized their plan of how to recapitalize the banks.  That will happen eventually.  But what will signal panicked investors that it is safe once again to be buying instead of relentlessly selling?  Mrs. ToughMoneyLove and I have been accumulating cash over the past year with plans to invest as part of our November asset allocation re-balancing.  However, I am hesitant to pull the trigger in the midst of an all-out investor capitulation. 

Jim Jubak, one of my favorite writers over at MSN Money, has a theory that he discussed today as part of his column on How to Rescue Your Retirement.  This theory is based on the $400 billion in derivatives owned by bankrupt Lehman Brothers that need to be settled out between buyers and sellers.  Some experts believe that these settlements will result in write downs approaching 90% or $360 billion.  That’s bad news for Lehman creditors but it may be good news for the markets.  By this I mean that many major market players are waiting for this big chunk of derivatives to be valued and settled out so that everyone will know exactly what their losses are.  This will allow them to re-strategize, re-position, and begin making moves back into the market. 

According to Jubak’s sources, the settlement of the Lehman derivatives should be completed by October 23.  This closely coincides with the end of the traditional September-October market doldrums.  Thus, Jubak theorizes, the re-emergence of buyers will cause a short term bull market starting on or about October 23.  If history holds, this could be a 20%-30% market rally.  But history also says it probably won’t last long. 

If Jubak is correct, this creates a dilemma of sorts for prudent investors.  One option would be to wait for the rally, sell the winners on the upswing to pull out cash, then go bargain hunting with the cash when the rally ends and the market sinks again.  A second option (for Mr. ToughMoneyLove for instance) would be to go bargain hunting now, in anticipation of the short term rally, then pull out the gains.  A third option is to do nothing. 

I just can’t see using option 3.  The cash we have inside my 401(k) account is in a stable asset value fund and is not doing us much good now.  We really need to re-balance for our long term strategy.  I’m going to think about this for another ten days or so and be looking for the emergence of other metrics that might support or contradict Jubak’s theory. 

I would be interested in your thoughts on this. 

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2 Responses to “Investors Have Capitulated – Now What?”
  1. Joe says:

    Here we are at October 23rd Mr. Jubak’s theorized date. What happend? Was he right?

  2. Joe – Good question. The market did show a net gain last week and surged up earlier this week, followed by a big drop. Up today so I suppose tomorrow will let us know for sure when the mutual fund numbers are finalized. Stay tuned!

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