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Confessions of a Money Manager: Don't get caught in panic seller's trap

Ray Unger  —  10/03/2008 5:01 pm

Given the roller coaster ride the market's been on these past few days, I pondered what to write about this week.

I thought about the Jane Fonda, Jeff Bridges classic movie, "The Morning After," to illustrate how some traders, after a tumultuous and near drunken orgy of selling, find themselves the next morning holding nothing but cash when the market is skyrocketing upward. Or leading off with that familiar investment chestnut of looking for companies with "bags full of money."

I finally settled on the above headline because it seems that so many investment commentators tell us that we must "do something" when panic afflicts the traders and they sell everything in sight.

Believe me, doing nothing is an important investment decision.

Tuesday's Wall Street Journal listed the 10 steepest one-day declines for the Dow Jones Industrial Average, and Monday's 777.68 point loss was the worst. But it wasn't the worst in terms of percentage loss. That prize goes to the panic sell-off of Oct. 19, 1987. On the previous Friday, the Dow closed at 2,246.73. On Monday morning, the roof fell in. From the moment the bell rang on floor of the New York Stock Exchange, sell orders from all over the world deluged the trading posts and pandemonium broke out.

Keep in mind that back then we didn't have the sophisticated information systems we have today, but we were equipped with computers and some of the savvier institutional money managers developed what we now call programmed trading orders.

In other words, if you were a mutual fund manager and you feared that someday you would need to raise a huge amount of cash in your fund for whatever reason, you simply set up a pre-programmed set of instructions to sell $10 million, $20 million or $50 million of stocks and bonds. Then, when the time came to raise this emergency cash, you just whisked this sell order to your favorite broker on the floor of the exchange and waited to hear that it was executed. How simple life can be.

Unfortunately, quite a few money managers hit that sell button at the same time and caused a cascade of selling that turned into panic. The bids (floor brokers routinely have bids to buy stocks regardless of the market's direction) were pulled and because the programmed trades are, in essence, market orders, the prices of the most respected blue-chip companies in the world fell 10, 20 even 30 percent in one day.

Needless to say, my colleagues and I were in shock and disbelief at what was happening. The phones started ringing off the hooks and our clients were caught in the grips of an apoplectic shock that I'd never seen before. Meetings with clients were instantly set up as we managers held skull sessions and devised strategies to work out of this horrific event.

We saw what other money managers were doing -- some actually liquidated their client's portfolios instantly -- but we where hesitant to do anything so rash. Some of the clients we met were convinced that this stock market shock was the precursor to a prolonged and deep downturn in the economy and directed us to sell.

But as the trading days became weeks and finally months and the end of the year came, we discovered that Black Monday was, indeed, a false harbinger of disaster. You see, the Dow Jones started the year at 1,895.95 and hit its high of 2,722.42 on Aug. 25. After the horrendous sell-off in October, it recovered and by year-end it closed at 1,938.83 for a modest gain of 2.3 percent (without dividends) for the full year.

How does this fit with 2008? Easy. The financial crisis is real and quite a number of banks and brokerage firms crumbled. If you owned shares in those companies you lost most of your investment; they won't recover.

But is the financial crisis going to take down the rest of the economy? I doubt it. If there's one thing our government is good at, it's spending money, so there wasn't much doubt that the House would eventually pass the bailout bill, as it did Friday. That means the rest of the market will also recover, just as it has after every major financial upheaval.

Just a few footnotes about how things were in 1987:

• 10-year U.S. Treasury securities were yielding 8.4 percent, while today they're at 3.8 percent.
• Conventional mortgages were being originated at 10.2 percent, and today's rate is roughly 6 percent.
• The prime rate was 9 percent and today it's at 5 percent.
• The Dow was up 18.5 percent for first 10 months of 1987 leading up to Black Monday. So far in 2008, the Dow is down 18.2 percent, so it's not as if the market has not discounted troubling times.

So if you've avoided the financial disasters like Lehman Brothers, Bear Stearns, AIG, or Wachovia, stay put. Don't get suckered into the panicked traders trap that leaves you out of the market just when it starts recovering.

Ray Unger is chairman of Forward Investment Advisors in Madison. He can be reached at 833-9400; e-mail: runger@forwardinvestmentadvisors.com

Ray Unger  —  10/03/2008 5:01 pm