Have You Prepared For A Market Crash? Be Ready, Not Worried


Unfortunately, we’ve finally come to a point where given the pace of things, the conditions have deteriorated to a point where a major global economic crisis may no longer be containable and a severe stock market downturn like what was experienced in 2007 is highly likely to occur.   If you’ve been following my tweets, I’ve been hinting at the increasing probability of another 2007-2008 type large scale financial crisis for a long time now.  Those who have had conversations with me on the global economy, also know that we’ve been expecting this since Greece was bailed out the first time.  Its quite disappointing to see that nothing has really been done to resolve what can be summed up as debt problems around the world years after the last financial crisis.

It is important to realize that it is impossible to know exactly when they will occur (time events).  There is also never a guarantee they will happen at all.  However, at a certain point, you can look at all the conditions and determine that such events are very likely to occur anytime after that point. For example, conditions were observable in 2006-2007 that foreshadowed the financial crisis that unfolded in the U.S.  Even though the crisis and market crash occurred a few years ago, it did so in the latter part of 2007, and not in 2006 or early 2007.

The present conditions have been building steadily since Greece required the first bailout, but the problems of the last financial crisis triggered by the U.S. economy have never been truly resolved.  Based on a various conditions it seems more certain, that going forward the same type of widespread financial crisis & market downturn is very likely to be unavoidable.  The probability of such risks occurring and being realized going forward (at anytime), rank very high in my books.


Abundance of Red Flag Warning Signs

– Several European bond yields have gone above 7%, and are at near unsustainable levels. Europe does not have the political willpower to fix the situation in a timely manner.  Even the citizens in the countries like Greece (which have been protesting since the first bailout in 2010) have trouble acknowledging the dire circumstance, and show very little indication of changing their attitude towards the problem.
– The IMF did not expect to actually bailout Italy and other periphery nations such as Spain and Portugal.  They do not have the funds required for financial assistance to Italy, let alone aid the other two countries as well.  Italy’s debt load is larger than all the other PIIGS nations combined.
– US investment banks have been very reluctant to divulge their holdings of European bonds (in particular Italian, Spanish, etc.), which likely mean they own larger amounts than people will like to see. Although, U.S. regional banks will not be affected directly, they will be indirectly impacted by a global economic downturn.
– Canadian banks that hold international investments will be affected in same manner as in 2008. Royal Bank (RBC) has already been impacted due to their JV in distressed Belgium lender Dexia.  That story has yet to be concluded.
– Although, given the present situation, China is less likely to be the trigger than Europe, it is very likely to have its own debt crisis.  Conditions in China have been brewing for a very long time.  Chinese regional state banks have been reluctant to fully report their bad loans to local Chinese municipalities & state projects. This will definitely add fuel to the fire when the crisis in Europe eventually impacts the rest of the global economy.  Lets not forget that Europe is China’s largest export market, and they will be directly impacted by their crisis.  Chinese excess also continues to add to the debt problem there.
– Investors have been relying too heavily on growth in emerging markets, China in particular. China and other emerging markets will eventually be unable to live up to growth expectations.
– U.S. debt problems have not been resolved, and this week issues surrounding the deficit have again resurfaced.
– Corporate earnings for Q3 have been a mixed bag of results, with a good number of large businesses reporting earnings misses.
– Many global corporations are still implementing major planned layoffs. This will eventually impact job numbers.
– Although the “green” bubble has not yet had an impact, it too has been growing.  Governments and banks have been lending a lot of money to economically unsustainable “green” energy projects and technology.

Keep in mind these are just a few issues, and the list is nowhere near exhaustive. Although, I won’t be covering the fine details of all these issues in this post, it is meant as a starting point for investors to do further investigation. It’s always much better for investors to piece together the picture on their own, in order to fully appreciate the circumstance.


What Are We Likely To See?

Going forward (and in the coming year), it is not unlikely to see a European liquidity crisis. Global banks will likely hoard cash and may be unwilling to lend to European banks in particular.  We are likely to see a run on several European banks. Continued political instability, will not be unexpected.  U.S. investment banks will likely show large amounts of bad European debt.  A potential Chinese liquidity crisis is not out of the question, although how it will be handled will be very interesting to see, given the political and financial system in China.  And of course, the equity markets are not likely to take such events well.


Increase Capital For Opportunities & Reduce Risks

Forgo further short term profits, prevent and limit losses from unnecessary risk, and increase cash for buying opportunities.  If you haven’t already, it is a good idea to increase capital, in order to increase financial flexibility and allow you to be more opportunistic.  It may be a good idea to hold off on new acquisitions for better pricing. Investors should go through various buy / sell / hold considerations, similar to those which have been mentioned in my previous post during the brief decline in August.    We will also revisit these conditions in the next section below.  Investors should take a look at their investments and reduce any unnecessary risks that may be remaining. This should NOT be misinterpreted as a recommendation to sell all investments!  Risk should NOT be confused with potential short term decline in market prices.  Real investment risk would be the probability of being impacted in such a manner that would result in actual (non-temporary) losses.  For example, financially weak companies that are likely to file for Chapter 11 if access to capital was to be reduced or the global economy stalls, exposure to European debt that would cripple or severely reduce the value of the company, European bonds from countries likely to default, etc.


Considerations For Investors To Buy, Sell, or Hold?  (Revisited)

Should an investor buy, sell, or hold their investments?  Do not let emotion influence your decisions. Investors should first consider what their investment plan was and what they were trying to do with their portfolio.  What was the investment thesis for each investment that was made.  Has the reason for purchasing the investment changed or will it likely just be the price that will change?  How will the competitiveness, long term growth, or financial position be impacted? Please keep in mind there is no blanket solution or recommendation that would be the best for all investors, as investing is highly personalized to each investor’s situation and holdings. Below are just a few points to start the process of weighing the costs and benefits to find the best fit for you personal situation.

BUY Considerations:

Prices are off 52 week highs, but such opportunities existed even before the decline in August.  If you didn’t buy then, prices are not likely cheaper now.  However, if you had your eye on a few companies, one might consider adding them (if they meet your cheapness criteria).  But you may find it still might not be cheap enough at current levels. In addition, given the high probability of much lower prices going forward, better opportunities may likely arise.  At a time when investors are fearful, it is time to be greedy!  But that does not mean being hasty!  Investors will be much more fearful if a full blown global economic crisis and market meltdown occurs.

SELL and HOLD Considerations:

Investors will need to assess what the likely impact will be on each individual investment. Risk reduction should be at the top of the list.  As mentioned above, it would make sense to sell off or reduce the holding of investments that would have a high probability of being impacted in such a manner that would result in actual (permanent & non-temporary) losses. This would also raise another question of why they were holdings in the first place, if they were carrying so much risk (as high risk does not necessarily mean high return).

Assess your investments to see if they or the issuing company are still making profits.  If businesses are still making profits and are likely to continue to do so (even in an economic crisis), it may make sense to hold them.  Many quality businesses that operate globally (such as Coca-Cola, for example), may remain highly profitable even in large downturns.  This is not to say that their market prices will not experience a decline. If a company is highly likely to be impacted in such a manner that operations will become crippled (financial reasons, competitiveness, etc) for an extended period with little chance of recovering, then it may be prudent to consider the costs & benefits of selling it, before that actually occurs.  As we learned from both the tech bust and the last financial crisis, some companies will be so severely impacted that they never return to the same level of profitability, while others will cease to exist completely.

Should you sell off investments for the sake of increasing capital or to repurchase at better pricing?  This is always a tricky question as it depends on a number of factors (value, amount of capital, goals, etc), as well as the potential costs & benefits of doing so. Focus on weighing the probability of such events occurring (and the opportunities that may arise) or not occurring (everything gets better and market moves upwards), and how things will look under each scenario and decision made.  Determine if the current market price of a particular stock or investment is below (undervalued), currently at (fair), or has surpassed its intrinsic value (overvalued).  It may not make sense to sell at mediocre or depressed prices, as there is no guarantee that you will be able to repurchase at a better price than your original cost base. Consider what the probability may be, of better prices occurring (for the holding in question).  Selling may be an option, if you have no free capital on hand, and do not expect to be able to increase it without selling off current holdings.  In this case, weigh future opportunities (from freeing up capital) versus potential additional profits that you may have to forgo (from holding) if markets rise instead. Will you have to sell at a loss?  If you cannot acquire additional capital without selling current investments at a loss, it is a more difficult choice. Weigh the cost of the loss versus the probability of opportunities arising (or not arising), and factor in your ability to capitalize on them.


What To Do With Capital?

Cash in high interest savings accounts and term deposits with short durations (less than a year) is a good place to park cash despite yielding lower percentages than longer term holdings. Given that the current rates are so low, it is unlikely they will drop much further than this level.  Savings accounts and terms less than 1 yr are very close to rates for 1 year terms, so there is no advantage to locking it in for a full year.  They also ensure your capital can be ready at a moments notice and give you financial flexibility to maneuver.  It also allows an investor to benefit if rates increase.  Its often difficult for investors to not put large sums of capital to work or immediate use in higher yielding investments.  However, the benefits outweigh the costs.  See the older Holding Cash article for the benefits.


Future Opportunities

Make a list of quality names and investments.  For stocks, determine their intrinsic values and set price points that give you a large enough margin of safety.  When and if they reach that price, you’ll be ready to purchase them.  Investors should also consider the classic shopper problem, that better prices may follow, but also an equal likelihood that prices will increase (less discount).  Therefore investors should decide ahead of time how to best capitalize or pass on opportunities that arise, while weighing the cost of waiting for or forgoing possible future ones.


No Guarantees, Make The Best Possible Decisions Based On What You Know Today

Remember, there are no guarantees as it is just my perspective and I could be completely off the ball.  But the main goal is to make the best set of decisions given what you know today, after having considered the likelihood of events occurring or not occurring. At the end of the day, you should be satisfied with your decisions and actions, regardless of what scenario comes to pass.


Market Crashes & Financial Crisis Should Be Part of Investment Planning

Periodic market crashes & financial crisis should always be a part of your investment plan, as they occur over & over again. They are unavoidable, but you need to know how you will handle them (capitalize on them, reduce risks and their negative impact, etc). Knowing how you will handle them in advance is what planning is all about.  No one can know when they will occur exactly, but uncertainty needs to be factored into your plan and should be based on observable conditions (both quantitative & qualitative).

Be ready, and not worried!!


Full Disclosure:

I am long Coca-Cola and do not plan on acquiring or selling shares within the next 3 trading days.


Thanks & Happy Investing! — The Investment Blogger © 2011

[Some of you will recognize this as a more refined version of the memo I sent out earlier, but it does not contain any new info.  My view on the subject and recommendations remains unchanged].


10 thoughts on “Have You Prepared For A Market Crash? Be Ready, Not Worried

  1. I do not think we will be seeing the same downturn as in 2007 nor 2008. Although the market looked very similar recently as in 2008 (big downturn, choppiness, recovery to 200 day SMA and then again even larger downturn in 2008 we now had similar pattern except recently the recovery was better than in 2008).

    Also the European crisis seems to be priced in the market since it no longer reacts hysterically on bad news (and there still is so many bad news! and the crisis hasn’t been solved at all!)

    So now it looks like we are bottoming and maybe starting a new bullish trend, but it is too early to say at this point. Maybe a total crash of Euro zone may spark a huge market crash.

    1. Thanks for adding a technical/pattern perspective! The market downturn may very well be less severe than the one in 2007/2008 as you suggest, if it occurs at all. I wouldn’t be surprised with any outcome given present economic & financial conditions. Although recent central bank developments lower the likelihood of a liquidity crisis (but not completely), the solution to the problems is likely to take years, and probably not without economic pain. It will be interesting to see how the market is impacted.

      However, investors should include a range of scenarios (including a large market crash) into the realm of very real possibilities. =)

  2. I don’t think we will experience a bear market like the last one. As an investor bear market is a good opportunity to buy more share and a great price. In my opinion try to sell some share that is over valued in your portfolio to stack some cash and be prepare to use those fund to buy more share in a downturn. Another alternative is use option to hedge the market, doing so will cost you some return but they provide a safety net for you portfolio!!
    Best regard,

  3. we all hope that the European crisis can be handled well, but the economy there is always a cycle and I am sure we can still get the odds on when the market in a downtrend

  4. I would argue that crashes happen when nobody is looking for them. Right now (and especially in November 2011 when this post was made) all anybody talks about is the rigged markets and the coming crash. Everyone is investing with the rear-view mirror of 2008. That ship has sailed. There will be plenty of booms and busts ahead but the causes of the 2008 crashes are largely behind us. The “safety” plays of gold and treasuries are already priced for Armageddon or close to it. Equities, especially developed world, is the only fundamentally reasonable investment right now. They are not as cheap as November 2011 (or March 2009 — ha!), but still reasonable. At some point investors have to snap out of irrational fear just like they had to snap out of irrational exuberance of 1990s.

    1. I should add that if I were a Canadian investor and/or home-owner I would be more pessimistic as well. Both Canadian equities and real-estate markets seem to me to have run up further than they should have. While the US and Europe have already had / are having their crises, Canada is yet to face its. Then again, if the demand for commodities holds strong Canada may yet escape unscathed.

      1. Thanks for adding your perspective! Cdn housing mkt & debt loads is a still concern in my view as well, esp in Gta & Gvr. Lots of foreign investment in RE here, esp from Asia (debateable). When China property bubble blows I expect shocks to hit Cdn RE mkt as well as Austrailia’s.

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