As if we did not have enough negative news regarding the current housing debacle and the accompanying mortgage crisis, Goldman Sachs (GS) analysts came out with a report stating that 2 trillion dollars of loan reductions could be possible and could initiate an ensuing credit crunch. The implications are obvious: obtaining a loan would become more arduous which would put us closer to a Recession. Being dependent on almost $100 a barrel oil and foreign investment is only adding fuel to the fire. It is very interesting how just several short months ago the U.S. mortgage system was the envy of the world. Now unfortunately it seems the U.S. mortgage system is imploding.
In the early 1980's we were going through another financial crisis. Then, as now, times were becoming very difficult. However one major difference was the fact the government did not come in and bail out the financial institutions. They were allowed to fail. There was a proverbial wringing of excess. Possibly due to this wringing of excess we enjoyed one of the longest running bull markets. Mr. Bernanke and his colleagues have taken a different approach. They have lowered interest rates.
In life, as different as things seem to be, many times they are similar. What I am referring to is the case in the late 1980's when Japan's stock market was at a parabolic high. Japanese investors were buying up U.S. real estate assets as well as companies. Easy credit and cheap money were flowing like water [sounds familiar? see the situation in the U.S. up until recently].
In 1989 the Japanese stock market, which hit a high of approx 39,000, started to implode. The financial strength of Japan started to unravel. The Japanese government thought it was prudent to lower interest rates to bail out the lenders. In retrospect it is very clear that this did not work. For the last 15 years Japan has been experiencing virtually an economic disaster. The Japanese stock market has been down for now almost 18 years and sits at less than half of its former value at 15,154.61.
Zero rates did not lead to economic growth!
What I have learned from all my years of investing is that anything can happen and PRUDENCE is Paramount to Return. I have had this discussion regarding Japan with clients and not one thinks this can happen in America. After 1929 it took 25 years for the Dow to get back to its 1929 levels. Regardless of your beliefs and bias on the markets, have a plan. It is obvious when your investments and trades work, but more importantly when they do not work out, know when to exit according to your plan.