Market Wrap Week Ending Fri 12th Dec 2008

By Jason Fittler

Storm What Happened?
 
Let me start by saying that this memo is going beyond the bounds I normally set. But this week I thought it was relevant as a way to help my readers understand what is going on and how to avoid this happening to them.

If this offends anyone I apologise, nor is this an attempt to have a go at a competitor, this is merely a lesson we should all learn. One of my favorite quotes is “A Smart man learns from his mistakes, a wise man learns from the mistakes of others.”

So what happened?  And what might happen from here?

1.    Clients borrowed against their house and then double geared with a margin loan. I.e.: 100% geared.
2.    Borrowing was within security limits before the market fell.
3.    Market fell 53% and client went into margin call, at which time Storm cashed up the clients. The cash was only sufficient to cover the margin loans, some clients were left with a home loan to pay off.
4.    Those who do not have jobs or other income may have to sell their house and pay down the debts as they have no other means of paying off the loan.
5.    On Friday Colonial First State announced that they will close the index funds that the Storm clients were invested in and use the proceeds to pay down their outstanding loans. This will have the effect of crystallizing the losses.
6.    As all the equity is now gone for these clients portfolio they will now have to put in more cash or leave the market. In short they will never recover their losses.

The Storm strategy is an aggressive strategy, what this means is that in tough times you could lose all of your initial investment and still be left with some debt to pay off. The flip side is that in good times you should outperform the market.

The lessons to learn from this are simple.

1.    When you’re looking to boost your performance, gearing (borrowing) is a great way to do this. But you need to be careful, normally keep the overall gearing below 40% never at 100%. Long term you will always loose when geared 100%.
2.    If you have big gains use this to reduce your gearing, under no circumstances should you use your gains to increase your loan balance.
3.    Investing is a long term activity, the market will fluctuate over this time and there will be long Bear markets as well. Always make sure that you can service your loans from other income separate to the income from your investments.
4.    If you are highly geared and the market turns down, act quickly, sell assets, and avoid a margin call at all costs. Margin calls are always the worst possible result.
5.    Greed – it is easy to be greedy and then blame others when things do not work out. Remember you are in charge of your future, talk with your adviser constantly to make sure they are aware of your concerns and goals. If you are chasing big returns, expect big losses.
6.    Invest to achieve your goals; if you do this your investments will be different to others. Do not compare your performance to that of others. Work only on securing the result you want.

Always keep in mind, if something looks too good to be true... it probably is. (too good to be true)

So what will happen from here?

My guess is that there will be many threats of class actions, maybe they will get up maybe they won’t. Either way the investors who have been hurt by this will most likely never see their money again. Some will be young enough to start over, others will not. Many will now have to look forward to living off the pension.

Many of these investors will leave the market forever and never regain their losses and most likely talk the next generation in their family into never investing in the share market. This is the real tragedy. If you have the chance to speak with someone who went through the Great Depression, listen to there view on the markets.

What should happen?

Get back on the horse, the best way to recover your losses is to keep investing, buy quality and have a long term view. Find another adviser who can help. I tell my son that quitting is never an option, every successful person understands this.

Until next week.