Adopt a cautious stance

Talk about a one-day – or, more accurately a one-afternoon – wonder! The U.S. Federal Reserve Board unexpectedly lowered rates on Jan. 3 and the markets went crazy, with Nasdaq scoring a record one-day gain in percentage terms. By the next morning the gloom had set in again. At the close of trading at week’s end the markets had given back all of the gains and more.

What it all means is that investors are genuinely frightened. Even a dramatic attempt by the Federal Reserve Board to restore calm to the markets is not enough to ease the growing trepidation.

Make no mistake about it. The move by the Federal Reserve Board is an indication that the complex stream of data that pours through Alan Greenspan’s computer every day is telling him that there are very serious problems emerging in the U.S. economy, many of which we are probably not even aware of yet. Greenspan is not a man who takes impulsive action. Every move is carefully thought out. So when he got on the blower right after New Year’s Day to persuade the other Federal Reserve Board governors that an immediate half-point cut was required, you can bet that he had a very strong case.

When investors recoverefrom their initial elation at the news of the cut, they began to realize the same thing. If the Federal Reserve Board is so concerned, surely the economy must be in more trouble than we know. Translation: sell!

In my initial comments on the outlook for 2001, I sounded a cautionary note, with a warning that at least the early months of the year would likely be a difficult time for the stock markets. As a result of the latest developments, I am even more wary and urge you to adopt the same stance. Just as bad news was almost ignored a year ago at this time, now it has a disproportionate impact on the entire market. Look at what happened to the financial sector of the U.S. market on Jan. 5 after rumours (denied) swirled about big losses at Bank of America. Investors are so skittish right now that it would only take one major negative event, such as a large bank seeking bankruptcy protection, to trigger a large-scale sell-off unlike anything we have seen so far.  The situation is that precarious.

It’s important to understand that this market brinkmanship is largely psychological. The North American economy is still in pretty good shape. Yes, growth is slowing but it hasn’t stalled by any means. The latest unemployment numbers show that job creation is still strong, both in Canada and the U.S., although the American gain was the lowest since August. We had a meltdown in tech stocks in 2000, but the broader markets held up reasonably well. Oil prices are easing, which will not only be good news to consumers but will reduce costs for manufacturers, transportation companies, utilities, and a range of other industries.

Franklin D. Roosevelt is famous for telling the American people at the height of the Depression: “The only thing we have to fear is fear itself.” We need to be reminded of those words again today. The only thing that will drive the stock markets into a broad crash at this point is fear. Unfortunately, the market has gained the ascendancy in the eternal greed/fear struggle that drives investor psychology and the markets. It will require more determined action by the Federal Reserve Board to assuage that fear – some good profit news, and perhaps some luck.

In the meantime, do a close review of your portfolio if you haven’t already and take appropriate action if needed. At this point, I recommend that at least half your assets be held in cash and fixed-income securities. Risk on the equities side should be minimized. The next few months are likely to be turbulent.

This article is adapted from the Internet Wealth Builder, a weekly e-mail newsletter edited and published by Gordon Pape. For information on how to become a member, go to