Category Archives: Finance

Market volatility feeds fear and greed

Domestic and international financial markets are are in uproar, causing selloffs and deep concern among investors. The US lost its top-level credit rating, equating its creditworthiness with Belgium and New Zealand, but below 13 other countries: the Netherlands, Switzerland, Finland, Norway, Sweden, Hong Kong, Germany, France, Canada, Britain, Denmark, Austria, and Australia.

Many Americans are wondering, “What should I do?”

Two reactions are common:

  • Fear
  • Greed

These two reactions can be powerfully motivating and are prompting some very irrational behavior. First, let’s look at an extreme example of fear: In 2008 when the market dropped significantly after the real estate crisis, many fearful Americans called their broker, liquidated everything, then went to the bank and withdrew all their money. Those strongly held beliefs about the end of America & fear of losing everything caused many others to stop investing and simply hang on to cash. It seems silly now, in retrospect, given the continuity of our American way of life that anyone would have acted so irrationally. Still, from a behavioral perspective, people are terrified of losing their security. One this is clear: when facing economic uncertainty, acting from a basis of fear is risky.

Greed is the other common reaction to the fiscal calamity. Some investors are using the volatility to profit from the downturn. Short-sell strategies and derivitives can enrich a portfolio as the market goes down. Without insider information, betting on the downturn is risky.

A conservative approach

Speaking with local financial advisor, Greg Melia, I learned about the “rule of 100.” The rule of 100 is simple:

100 – Your Age = Maximum % of Your Portfolio in Stocks

The basic idea behind the rule of 100 is that the closer you are to retirement, the less risk your portfolio assumes. What are other investment alternatives to stocks? Consider more conservative alternatives like bonds, annuities, CDs, even Gold.

Betting on the rising dollar

The Federal Reserve is arguably the most powerful entity in the world. Chiefly, it has the power to control interest rates, as well as discount rates, margin requirements, and more. When the Fed moves, the ripple effect is like an earthquake, shifting markets – often violently. The global market raises and falls on the US economy. That’s just the way it is.

Today the Federal reserve started selling TIPS with a negative yield.

Wait now, what does that mean? Treasury Inflation Protected Securities are bonds that have a principal adjustment feature that matches the inflation rate. Simply put, it is a tool designed to keep investments from losing value in the case of high inflation.

Hyperinflation has devastated economies. I have travelled to the “breadbasket” of Southern Africa in 2006, to the nation of Zimbabwe. Among other features (like Victoria Falls – one of the seven wonders of the world), Zimbabwe has all the components of a rich agricultural climate. Sunny skies. Dark soil. Raging rivers.

But Zimbabwe isn’t the breadbasket any longer. It’s more like a financial wastebasket. The economy was doomed by inflation. Currency gone amuck. The value of a Zim dollar is almost nothing, a derivative of the exponentially increased rate of inflation. Along the walls of the national parks you will find portraits of President Mugabe – long time dictator responsible for the financial ruin of the nation. You will find his bust in the once bustling city centers, now brimming with secret police – police making sure no back room deals of other currencies for stacks of Zim dollars take place.

During my trip I went to the back room of a sewing shop. I traded two one hundred US dollar bills for rubber banded stacks of Zim bills – far too many bills to count. Not just bills- bills marked in denominations like $100,000,000.

Fast forward to the present. The Federal Reserve is battling deflation. Oil and other prices are at depressed levels. What financial analysts assert is that deflation can have a powerfully negative effect on the economy. Consequently the Fed continues the entertain tactics to slowly raise the inflation rate and fight deflation.

When the Fed starts selling TIPS with a negative yield it’s a statement to investors. The statement goes something like this: “Inflation is coming.”

Tread lightly, Mr. Bernanke. Consider the effect of hyperinflation in Zimbabwe.