This is the story of Ernest and Serenity J. Ernest is a project manager at Dubblebubble Space Corporation. His wife is a teacher. They have 2 children, Cordelia 14 and Brent 11. Since the family came back from vacation in Halifax, Ernest has been working a few late nights and weekends as his company is expanding their information systems. As a result he and his wife have had to postpone their usual Saturday night dinner date. However, this gave Mrs. J and the children the opportunity to go to West Edmonton Mall for some back to school shopping. She is planning to surprise Mr. J with a 60 inch plasma TV for his upcoming birthday.
With her babysitting money Cordelia buys the latest trends from TuTutemon. Brent has already put in a request for a Playstation 3 for Christmas. He is too young to work but makes a few dollars from walking the neighborâ€s dog when they are away.
The Johnsons make sure they invest regularly for their long term financial plans and also contribute to Third World causes.
Mrs. J has a cousin Tonya, in the US. In Tonyaâ€s last email she said she was worried about how long her house had been for sale. Although she has a good paying job the interest rate on her adjustable rate mortgage has risen twice in the last 18 months. She has had to cut back on her other expenses to be able to afford the higher mortgage payments. She is still in a better position that some of her neighbors who have had to foreclose on their houses. She is asking Mrs. J if she should lower the asking price on her house.
What is so amazing about this narrative? Nothing! However, if you were to believe the thick black headlines in the media a few weeks ago you might think that this Canadian family and their normal earning and spending habits have been abducted by aliens never to return.
Unless you and I and the Johnson family decide to tell the boss what to do with our jobs, stuff our money into the couch cushions, and head for a remote island in the Arctic, economic markets will continue to advance.
So what happened in the last few weeks? It can be called the return of common sense.
In the past few years financial institutions have employed activities such as extreme leveraging (borrowing to invest) and packaging of various debts and selling that package as an investment. But what happens if the investor has borrowed a million dollars and the underlying investment is only worth $400,000 when the lender wants their money back? In the second case, fewer and fewer â€˜investorsâ€ have wanted to buy those packages of debt, in part because some of those debts included very risky mortgages from the US.
Companies whose main business included the above practices found themselves walking on very thin ice. The result was that the alarm was sounded and the stock market suffered a correction, which was a positive event. It removed a lot of speculation in the market. My definition of speculation is: When people base their investing decisions NOT on sound financial evaluation but take advantage of what everyone else is doing in the market.
It bears repeating: If so and so financial product is the only topic of conversation around the water cooler at work RUN donâ€t walk the other way. This lesson is very hard to learn as investors large and small repeatedly make the same mistakes again and again. Want two examples? The tech dot bomb and more recently the income trust upset.
It may be counterintuitive but peoplesâ€ predictable behavior is also what keeps the stock market advancing.
The Bottom Line
So bottom line: This most recent stock market selloff is no reason to be worried. The majority of businesses in the market are financially sound. Now is a good time to buy. Central banks and world governments are also being proactive in their intervention which is helpful. But again it was good to see the return of common sense. It was missed.