| There is a fascinating story of the meltdown of | | | | approaches. They basically had thousands of |
| the Long Term Capital Management Company | | | | trades all doing the same thing in many countries |
| (LCTM) in the book "When Genius Failed" by | | | | and markets. They refused to see that what was |
| Roger Lowenstein. | | | | happening to them had happened many times |
| They lost 4.5 billion dollars in 5 weeks. Two | | | | before |
| founders were Nobel Prize winners and owners of | | | | In today's investment market thousands of |
| the company as well as many other Wall Street | | | | financial and fund managers refuse to realize that |
| geniuses. Their trading strategy was perfect (well, | | | | a secular bear market has seized not just the |
| almost). They had leveraged their portfolio to 80 | | | | U.S., but also the entire world. Unfortunately, there |
| to 1. Even the slightest move in the market | | | | is nothing to buy and hold "for the long term". I |
| caused tens of millions to change hands daily. | | | | have written in my weekly financial column that |
| During one day their account dropped over $250 | | | | mutual funds are dead - they just don't know it. |
| million. | | | | They only work in a bull market. For the next 10 |
| For a trader or serious investor this is interesting | | | | years or longer fund owners can look to |
| reading, but it won't make you any money | | | | decreasing fund values. Even the few fund |
| although it might save you a bundle. Having been | | | | managers who realize this will be handcuffed by |
| a floor trader and former exchange member for | | | | their fund's charter and they won't be allowed to |
| 17 years I saw more than numbers and trading | | | | buy bonds to protect their investors or to take |
| strategies. I could not do what they did even if I | | | | short positions. Eighty percent of mutual funds will |
| knew how because it takes a special mindset. | | | | disappear. |
| There is no question those guys were geniuses at | | | | As a market drops lower and lower more and |
| what they did even all the way to end. It was | | | | more sellers will become active. The real horror |
| their thinking that broke them. They were like a | | | | will be when (as they always do) the majority |
| horse with blinders and could not see or be aware | | | | decides to sell all at the same time. Now what |
| of threats that could bury them. That unplanned | | | | does the poor fund manager do when he needs |
| catastrophe did them in. They had been caught in | | | | cash for redemption? The junk and thinly traded |
| a whirlpool of their own making. | | | | stocks in his portfolio cannot be sold because the |
| Here is where it gets scary. Today there are | | | | offers are so far below the market. Twenty and |
| huge pools of money all over the world in mutual | | | | 30% bids under the market will be common. |
| funds, hedge funds, pension plans, state and | | | | Financial managers will have to sell "good" stocks |
| federal retirement accounts run not by geniuses, | | | | like IBM, GE, Microsoft and you-name-it and these |
| but rather by Wall Street-trained thinking that has | | | | will see major declines until the selling is exhausted. |
| made no plan for a bear market. During past | | | | It is not going to happen over night and could |
| years we have seen the NASDAQ fall 75% and | | | | take years before a bottom is reached and a |
| the DOW & S&P drop 40%. This recent | | | | new base is made. |
| rally has gotten back some of the losses but, it | | | | When will this happen? It has been 14 years from |
| could easily drop more from here. | | | | the top in Japan's bear and there still does not |
| So far from what I can tell a very small | | | | seem to be any bottom. Now the real P/E ratio is |
| percentage of tax-sheltered plans (401K, etc) | | | | about 18 for the S&P500. The mean has |
| have sold few of their losing stocks or mutual | | | | been 12-14 and when markets break they always |
| funds. Have any of these people made any plans | | | | go to extremes. How about 6? It has been there |
| as to what to do should this be a secular bear | | | | before more than once. Where does that put the |
| market last for years? The last secular bear we | | | | DOW and S&P? Your guess, not mine, but |
| had saw the DOW lose 89% of its value. That | | | | some analysts (not many are brave enough) |
| was a long time ago in 1929 -31 and can't happen | | | | predict a loss of 62% from here. Unless you learn |
| again - really? When you look back into history | | | | to sell you could be wiped out. |
| you will find that bull markets have a way of | | | | When you know you are absolutely right is when |
| returning to their starting points. This bull started | | | | you experience your greatest losses. The LTCM |
| in 1974 at DOW 770. Don't worry. This time it's | | | | traders had so much invested (and had tunnel |
| different. Where have I heard that before? | | | | vision) they could not get out if they wanted to. |
| Here is the scenario that has not been voiced - | | | | Mr. Average Investor won't rock the market with |
| yet. As the stock market goes lower and lower | | | | a 10% stop-loss order from the high of the move |
| more and more investors will sell until the market | | | | in his mutual fund. (Make it 8% if there is a 2% |
| becomes a waterfall of equities. There will be few | | | | redemption fee.) The first law of the investment |
| buyers and many sellers. The puzzle pieces for | | | | jungle is to protect your money. Brokers will |
| this catastrophe are all there right now. The | | | | argue that you should not sell, but with the |
| timetable for its occurrence has not been written. | | | | experience of 2000 recently behind us it is clear |
| Almost none of the financial managers today | | | | to see that is wrong. |
| have any experience with bear markets and have | | | | As the market drops into the next crater of |
| no idea how to protect client money. | | | | losses (like now) you will be fat, smart and happy |
| Forget the SEC (Securities and Exchange | | | | in cash. One thing Wall Street will never tell you is |
| Commission). If they are aware of the possibility | | | | that cash is a position. If the market breaks 50% |
| of mass exodus from the securities market they | | | | you will be able to buy back twice as many |
| are not doing anything about it. Mutual fund | | | | shares. Don't believe another one of the lies that |
| managers are required by their charter to keep a | | | | you can't afford to be out of the market. Being |
| large portion of their portfolio invested even if it | | | | out during a bear phase is what I call a reverse |
| means buying stocks they know have no value. | | | | profit. |
| They give the excuse that the long-tern horizon is | | | | The most important thing about investing is you |
| excellent for this-or-that company. That will not | | | | must be able to change your mind. Every |
| help the hapless investor when he comes to | | | | successful professional investor knows this. He |
| retirement and his money has shrunk to cans of | | | | does not fall in love with his positions and is |
| dog food. No more filet mignon. Many funds will | | | | constantly reviewing whether he should hold or |
| not allow their managers to buy T-Bills when | | | | sell. The LTCM principals could not believe they |
| there is nothing worthwhile. This is something the | | | | were wrong and refused to face the reality of |
| SEC should do, but probably will not until after the | | | | what the market was telling them and almost |
| fact. | | | | caused a world banking crash. Never mind the |
| Lowenstein's book points out that the LCTM | | | | world; think about you own account. |
| partners refused to believe their thinking could be | | | | Now is the time to take a close look at your |
| wrong. They believed in diversification and thought | | | | investment portfolio. |
| that meant many positions rather than different | | | | |