Stock Markets Crash, Banks Crunch

For the past few weeks I've been watching the stock market - not in fear, but in amazement. Before you continue reading you should know that I'm based in Germany, so lots of what I'm saying here is directly related to what I perceive to be the current economic situation in Europe, especially in Germany. I think, however, that some of it relates to the USA and other countries, too.

I've been watching the stock market and I've been reading the news. But this I do not understand: Why is it that everybody is selling off their stocks? By "everybody" I really do mean everybody. It is as if there was nobody left willing to invest in the stock market anymore. That doesn't seem logical to me. Although most of the publicly traded companies will be affected by the coming recession, I don't see how the extreme losses in the stock markets of 50% or more can be justified.

Let's take Daimler as an example. Daimler's stock price fell below €20 earlier this week, it was at €80 about one year ago. That would mean the company lost 75% of its value in the stock market, but that does obviously not represent its real market value. Daimler is still expecting to make a nice profit in 2008 (although it's a lot smaller than what was predicted at the beginning of the year), and the company has cash available. In addition, it is an established brand well-known for its high-quality products, which it successfully sells to customers everywhere in the world. The company didn't shrink to 25% of its value overnight.

I believe panic is a profound factor. Investors have been panicking and selling off their stocks as quickly as possible. I blame the media for playing a significant role in this, too. Whether you turn on the TV, read a newspaper or listen to the radio, it is nothing but gloom and doom these days. It is as if there was no tomorrow, as if the major global players wouldn't be existing next week anymore. That might have been true for some banks and financial institutions, but it won't happen to the businesses in the real economy. I'm talking about companies with a sustainable business model. The banks and funds that got caught up in the crisis mostly had eyes for quick profits. They didn't seem to be thinking about the future of their businesses as long as profits were on the rise and managerial salaries and bonuses were gushing. The products they were selling were so complicated that even some of the bankers themselves didn't fully understand them.

I am not saying there won't be a recession. We have to face the truth. The global economy is headed for a recession, and the USA might be the first to arrive at that point. European and Asian companies will be hit, too. Revenues will decline, but they will get back up. I don't believe the panic. I've been investing in companies with solid business models and "real" products to sell. Many of those companies are undervalued in today's market, in my opinion. Make no mistake; investing now is risky given the uncertainty of most market participants and investors. You never know what they'll be selling or buying tomorrow. (Nobody saw Volkswagen getting from €200 to €1,000 within two days, for instance. Hedge funds lost billions because of this unpredictable development.) So little makes sense in the stock markets today. But if you have money that you can afford to lose in the worst-case scenario and if you can wait patiently, this could be an opportunity for you to buy stocks at low prices. It will probably take some time, but stocks will eventually get back up.

The economy will get back on track. There is also a difference between some economic crises of the past and today, because this time governments and central banks have been faster to react. They're pumping money into the markets to keep the banks liquid, which is risky, but it has been the right thing to do. One thing, however, has not been done very well, I think:

In Germany, the government decided to put up €500 billion for banks in need of money. That's been the right thing to do, but the way it was done hasn't been good. German banks do not have to take the money. Why would anybody refuse to accept billions of Euros in cash, you might think. Here is why:

Firstly, if banks take money from the hefty rescue package in Germany they must agree to cap the annual salaries of their managers at €500,000. That means the bankers are not very inclined to take money from the German government because it means they will earn a lot less annually. I would think the managers are intelligent enough to understand that the overall economy is more important than their personal net worth, but you never know. There sure is a conflict of interest that should have been anticipated earlier.

Secondly, most Germans have a hard time understanding why the government is putting up €500 billion to save banks that got into the situation they now find themselves to be in by their own fault. The taxpayers understandably don't like the fact that it is ultimately them who will be financing the €500B package. Therefore, if a bank accepted money its image would be damaged.

A third reason why German banks have been so careful about taking money from the package, is that it could be perceived as a new sign of the bank's weak financial situation, which in turn would lead to a further decline in the bank's stock price.

Taking these reasons into account, I can only come to the conclusion that the situation has been handled a lot better in the United Kingdom. There, banks must take the money. That means they cannot be blamed for taking it and they don't have much to lose. Yesterday, news came in that the German banks are going to claim money from the rescue money collectively to avoid bad press for individual banks. That’s a smart move the German politicians should have thought of from the beginning.

Summing things up, I wouldn’t panic in today’s situation. We’re headed for a recession, but the situation could be much worse. If you’re an investor, if you’re not risk-averse and if you have disposable cash, it could be a good opportunity to buy stocks from undervalued companies. Many companies are undervalued in today’s troubled market. Central banks and governments are doing their part to help get the banks and the overall economy back on track. I trust that it has been the right decision to pump massive amounts of cash into the markets, although it’s me and you who finance that package, because in the long run we will benefit from that decision. Without the various financial rescue packages, the recession would probably turn out much worse.

I’d be interested in hearing your opinions on the current economic situation, especially from an investor’s point of view. Do you plan to invest in the stock market now that many stocks can be bought for cheap or are you going to wait longer before taking that rather risky step?