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Whew! What a wild wide today on Wall Street — apparently driven by concerns that a debt-driven contagion could take hold in Europe and spread around the world. The Dow Jones Industrial Average was down almost 1,000 points (9.2%) before recovering to a 348-point loss (3.2%).
 Here's a gut-wrenching summary from the Wall Street Journal:
Stocks plummeted in a flashback to the panicked trading of 2008 as investors registered deep fears about the European debt crisis. Selling accelerated late in the day due to a wave of automated sell orders that turned an ugly drop into full-blown market washout.... The velocity of the plunge in stocks was breath-taking.
Fears of contagion from Greece's debt crisis grew during the day and stocks were lower for most of the session. But many were at a loss to explain why stocks suddenly made such a staggering move.
A near 1,000-point drop is "people jumping out of windows" territory, said Gerard Cassidy, an analyst with RBC Capital Markets.
As losses piled up, the Dow went into freefall, tumbling through 10000, before dropping as much as 998 points, or 9.2%. The biggest closing point drop in the Dow's history occured on Sept. 29, 2008, at the height of the financial crisis, when the Dow ended the day down 777.68 points, or 6.98 percent.
One observer suggested to the WSJ that photos and video of street protests in Greece played a significant role in today's market turmoil.
"To tell you the truth, people are seeing what's going on in Athens on CNBC and it's not helping the market at all," [said Joe Benanti, managing director at Rosenblatt Securities]. "You're just watching things sort of melt away."
As much as anything, this could simply be an overreaction on the part of extremely jumpy investors, following a year of huge market gains without any significant corrections. The Greece situation and potential it seems to have to spread and roil the debt markets just looks too familiar to what happened 18 months ago. Sometimes when the market has run up too far, too fast, just about anything will do as an excuse for a fall (though they aren't usually as dramatic as today).
There's another key ingredient here: fear. The old saying is that the stock market "climbs a wall of worry." Worry is out there all the time, as investor fret about this and that. But some days that worry, given the right spark, explodes into full-blown fear. The WSJ's MarketBeat blog reports the market's "fear index" (also known as the VIX) is "currently hovering around 40, a level we haven’t seen since April last year."
It's difficult to know precisely what to make of this. Most fears are unfounded — as noted in our our February 2008 cover story, The High Cost of Fear (subscriber link). Or at least things we're fearful of don't turn out nearly as bad as first assumed.
But, on the other hand, sometimes fear can help protect us from genuine threats. And, make no mistake, genuine threats are out there, as we have noted many times here on the blog and in our monthly newsletter.
The best approach is to review your long-term plan, reflect as calmly as possible on current events, and keep away from emotional decision making.
As noted in our January 2009 cover story, How to Avoid Panic and Reduce Fear (subscriber link), "[i]nvestors are biologically induced into short-term thinking by the stress hormones released during episodes of acute fear. Fear has the effect of inducing concrete short-term thinking with poor flexibility in judgment."
Remember our SMI bedrock verse: "For God has not given us the spirit of fear, but of...a sound mind" (2 Timothy 1:7).
The New York Times' "Wealth Matters" column — targeted to wealthier readers — has served up a profile of Princeton economics professor, Burton G. Malkiel, author of the long-time bestseller, A Random Walk Down Wall Street, and now (with Charles Ellis), The Elements of Investing (Wiley, 2009).
Dr. Malkiel is a strong proponent of investing via no-frills, low-cost index funds. He argues that even the wealthy are more apt to come out ahead by using simple indexes, rather than hiring advisers to help them try to find outperforming stocks, hedge funds, and/or alternative investments.
From the Times:
For the wealthy, index funds have an image problem. They are considered the economy cars of the investing world: they'll get you there but not in style and you're always worried they may break down. Anyone at a serious level of wealth, the thinking goes, needs the equivalent of a luxury sedan, with strategic stock choices, hedge funds, private equity, real estate.
Burton G. Malkiel says this is all hogwash....
[He argues that the wealthy] would have fine returns without the volatility and high fees if they simply used indexes to diversify their money across asset classes. "This is still a strategy that is good for people of all income levels," he said.
Malkiel says many wealthy people waste money by paying for advice that doesn't improve their investment performance beyond what they would experience with index funds.
While the old adage says you get what you pay for, Mr. Malkiel argues the opposite. "The one thing I'm absolutely sure about is the less I pay to the purveyor of the service, the more that will be left for me," he said....
This makes sense for the modest investor with a straightforward portfolio. But the counterargument is that the wealthy need more advice because of the complexity of their assets, and that the advice is worth the fees. (Mr. Malkiel would say the rich just need more tax-planning advice.)...
"You don't need a commodities fund if you're really well diversified and into emerging markets," he said. "You’re going to have some investments in Brazil, which is natural resource rich. It's simple."
We agree with Dr. Malkiel that many investors — including many wealthy investors — overcomplicate matters, thereby increasing expenses without any significant increase in performance. That's why we developed our simple Just-the-Basics strategy.
Although SMI's Upgrading strategy clearly offers superior performance to indexing over the long haul, if the simplicity of indexing strikes your fancy, you won't get any argument from us. Indexing is a solid approach that (as Dr. Malkiel says) "is good for people of all income levels."
Not an SMI member yet? Today's a great day to join and gain access to all of our investing strategies and online tools!
Here is an interesting tidbit from former Treasury Secretary Hank Paulson's new book, On the Brink: Inside the Race to Stop the Collapse of the Global Financial System.
 Back in my temporary office on the 13th floor, a jolt of fear suddenly overcame me as I thought of what lay ahead of us. Lehman was as good as dead, and AIG's problems were spiraling out of control. With the U.S. sinking deeper into recession, the failure of a large financial institution would reverberate throughout the country — and far beyond our shores. It would take years for us to dig ourselves out from under such a disaster.
All weekend I'd been wearing my crisis armor, but now I felt my guard slipping. I knew I had to call my wife, but I didn't want to do it from the landline in my office because other people were there. So I walked around the corner to a spot near some windows. Wendy had just returned from church. I told her about Lehman's unavoidable bankruptcy and the looming problems with AIG.
"What if the system collapses?" I asked her. "Everybody is looking to me, and I don't have the answer. I am really scared."
I asked her to pray for me, and for the country, and to help me cope with this sudden onslaught of fear. She immediately quoted from the Second Book of Timothy, verse 1:7—"For God hath not given us the spirit of fear, but of power, and of love, and of a sound mind."
The Wall Street Journal has a longer version of this excerpt, courtesy of the Hachette Book Group, Inc.
Just weeks after Charles Schwab shook things up in the ETF world by introducing its own brand of commission-free exchange-traded funds, Fidelity has unveiled a commission-free model for 25 ETFs from iShares (managed by BlackRock). Schwab currently has only eight commission-free ETFs.
The no-fee ETFs from Fidelity include some of the most popular ETFs on the market, including the iShares S&P 500 Index, iShares Russell 2000 Index, iShares MSCI Emerging Markets Index, and the iShares Barclays Aggregate Bond fund.
A Reuters report characterized Fidelity's move into commission-free ETFs as a belated recognition that exchange-traded funds have gained a significant presence in the mutual-fund marketplace.
[Fidelity's] new alliance with BlackRock of New York marks a final acknowledgment of the growth of ETFs and their importance to retail investors, said Paul Justice, an analyst who follows the industry for Morningstar in Chicago.
Although the industry has more than doubled since 2005, to $1 trillion globally by BlackRock's count, ETFs will continue picking up market share, Justice said. Following Fidelity and BlackRock's move "you will see a great deal of competitive response," he added.
The rapid growth of ETFs offered by iShares, State Street Corp and others is in stark contrast with the skepticism investors have shown traditional stock mutual funds, which saw high outflows as stock markets sank.
Fidelity introduced a single ETF of its own in 2003, but never followed up with additional products....
Tom Lydon, editor of the ETF Trends newsletter, said he expects ETFs to continue to grow as investors realize their fee benefits. ETFs also have room to gobble more assets in 401(k) retirement-savings plans, where they have been little used to date, Lydon said.
Fidelity also announced it is replacing its current tiered-pricing model for stock trades with a flat $7.95 fee for online trades — $1 less than the stock-trading fee recently implemented by Schwab.
Neither Schwab nor Fidelity has announced any changes in their pricing structure for traditional mutual funds.
In an article on passive vs. active approaches to mutual-fund investing, the Wall Street Journal quotes Vanguard founder (and passive indexing guru) John Bogle on what is perhaps the biggest challenge facing active investors: "Yesterday's winners," said Bogle, "are far more likely to be tomorrow's losers."
In other words, many actively managed funds are loaded up with stocks that did well in the past (that's why managers bought them) but that are in the process of becoming underperformers. Active managers are constantly playing a game of "move ahead, then fall behind" — which generates expenses, but not much to show in terms of actual profits in comparison with low-cost indexing.
Two observations: 1) Bogle is right — this is the general case with active management; 2) Nonetheless, many actively managed funds have runs of outperformance that can stretch for many months (even years in rare cases).
Identifying these outperforming funds and investing in them until their success begins to falter is the essence of our Upgrading strategy. Upgrading isn't perfect, but that's okay. There is no perfect strategy. What Upgrading has been able to do is generate annual returns that have strongly outperformed indexing in recent years (although not every year; as noted in our just-released February issue, indexing eclipsed Upgrading ever-so-slightly in 2009).
We're all for indexing for those investors who want to follow that approach — and we're thankful that Mr. Bogle's Vanguard firm offers a terrific mix of index funds that we use for our Just-the-Basics indexing strategy. But we're also glad that Upgrading offers a way to meet the "yesterday's winners, tomorrow's losers" challenge and (usually) come out ahead.
Citing stats from the Investment Company Institute, USA Today reports that investors withdrew a net $490 billion from money market funds during the first 10 months of 2009. Most of went — where?
If you guessed "into stock funds," you're wrong. Nearly two-thirds of the money went into bond funds.
Normally, investors chase after stocks during periods of red-hot returns, and this year has produced rip-snorting returns for many stock funds. The average stock fund has soared 27.4% this year, according to Lipper, which tracks the funds. And 36 funds have soared 100% or more in 2009.... But investors aren't chasing hot returns.
Instead, they're "chasing" the perceived safety of bonds. Plus a significant number of investors apparently are cashing out and using the money for "non-investing" purposes.
"More money is flowing out of money funds than is going into bond funds — something that's only happened twice in 26 years," says Vincent Deluard, strategist at TrimTabs.com, which tracks fund flows. "It shows how deep the recession is: They may be taking money out to pay the bills or the mortgage."
Unfortunately, the story doesn't break down — for the dollars going into bonds — just how that money is being spread among funds of different average durations. Given current low rates, short- and intermediate-term funds would seem to be the safest bond funds to be holding now. People buying into funds with long durations may be setting themselves up for a major disappointment.
Bond prices typically rally when interest rates fall and tumble when interest rates rise. The yield on the bellwether 10-year Treasury note is just 3.54%. "If rates rise, that would be bad," Deluard says.
Indeed, as we warned in the January issue of SMI, the "potential for rising inflation to hurt bond values by pushing interest rates higher is one of the more important big-picture ideas for investors to be mindful of going into the next decade."
For more on this, read Mark's recent article, Re-Evaluating the "Safe" Part of Your Portfolio.
The Wall Street Journal has also taken note of the heavy inflow into bond funds, speculating that the shift from stocks to bonds is influenced by the fact that "[b]aby boomers...are bulking up on bond funds as they approach retirement."
In November, only three of the 20 best-selling funds were diversified U.S.-stock funds (one index mutual fund, two index ETFs).
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