Investing Truth No. 5: Financial crises happen... everywhere and to everybody

By Mike Jones, posted February 20th, 2014

Most people think of investing as a personal activity that directly impacts their individual future.  However, most of what we are taught is really only applicable to investors en masse, i.e. the market-at-large, and over large periods of time.  Over the next several months I will share 10 points that I believe every investor should know prior to committing funds to any investment program.

Believe it or not, the 2008 market meltdown was not an anomaly. Every industrialized country--yes, every--has experienced a decline of 75 percent or more in its stock market at least once in the last 100 years.

While many global asset classes in the twentieth century produced spectacular gains in wealth for individuals who bought and held those assets for generation-long periods of time, most common asset classes experienced regular and painful draw downs. What's more, all of the G-7 countries-the U.S., Japan, France, Germany, Italy, Canada and the U.K.-experienced at least one period where stocks lost 75% of their value.*

Bottom Line: financial crises happen. Yet in analyzing the origin of financial crises one must distinguish if the root cause is born out of truly deteriorating fundamentals or out of good old fashion PANIC!!!  

During my career I can say that I have seen both.  

Panic driven crises tend to be steep and swift. They create nearly instant winners and losers, inflict sharp pain and are next to impossible to predict.

They are also one of the worst nightmares for investors and portfolio managers alike. Any investor in the securities markets must, and I repeat must, be willing to expose capital to the reality of a sell off due to panic. That reality is probably what I hate the most about the profession I embraced... that the most disciplined, thoughtful approach can be temporarily held hostage by a mob of sell-at-all-cost investors.

When faced with a panic driven type of crisis I believe the best course of action is to stay the course and wait things out.  A recent example of this sort of crisis is the markets sell off relating to congress' inability to raise the debt ceiling for borrowing by the U S Treasury.  In the summer of 2011 the broad market lost about 17% in one month. Six months later all that loss had been regained.

Fundamentally driven crises tend, on the other hand, to build and build until a breaking point is reached. Then, as we have seen in the not too distant past, all ---- breaks loose.

Be it the results of bad policy, loose regulation or far too aggressive and risky decision making in the hands of our corporate leaders, the basic and fundamental interactions of trust erode and confidence is breached.   From this point, financial markets sell off as investors lower their expectations for the future.

Inevitably the fundamentally driven crisis affects the economy and tends to have a negative impact for a while. These types of crises are not fun to deal with. Fortunately, they do not come around very often, and portfolio decisions can be made to attempt to mitigate some of the negative results.

Obvious to most market watchers, the most recent example of this type of crisis was the financial crisis of 2008-09. Initiated by ill conceived loans and excessive leverage by almost EVERY financial institution in the U S, our entire financial system was in jeopardy of unraveling. Fortunately, new restrictions on leverage and time to repair our banking system have greatly minimized the risk of this reoccurring. 

So what lesson is there to glean from this particular investing truth? Very simply, that financial crises are a reality of life and one must invest with this reality in mind.

Don't live in fear. If you do it will control you.

Instead, do what most successful investors have done: have a plan, diversify and don't take on more total risk than you can bear.

^{* Source: MebaneFaber.com}

Mike Jones is Managing Director / Investing Group of Argent Advisors, Inc. Email him at mjones@argentadvisors.com. Write to him at 500 East Reynolds Drive, Ruston, LA 71270 or call him at (318) 251-5844. The opinions of any single advisor do not necessarily reflect the opinions of Argent Advisors, Inc.  No forecasts can be guaranteed.  Argent Advisors, Inc. does not offer tax, insurance or legal advice.  The information contained in this column should not be construed as a substitute for personalized investment, tax, insurance or legal advice.