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Investing in Today's Unsettled Equity Environment

Jun 2, 2008
There's no way around it: investors (big and small) are experiencing real pain in the US stock market. To successfully navigate today's uncertain stock markets, it's important to approach investing cautiously. Here's why.

It's really important to understand that much of the 2002 to 2007 bull market was built on excessively high levels of borrowing by banks, private equity firms, corporations and hedge funds. These companies then went on a buying spree, grabbing natural resources, stock, even entire corporations. Unfortunately, the borrowed money came from countries with weak currencies and low interest rates, and was leveraged up even more with complicated credit derivatives.

Which brings us to today's investing environment. The situation has not only completely disappeared, it has gone in a completely opposite direction. Rather than borrowing money, these groups now find themselves struggling to pay their debts. The result: no more leveraged buyouts or major share buy-backs. Suddenly, a vital leg (liquid capital) has vanished from the market.

The bubble has burst. Some might say "again", but we'll leave that for another day. Leverage is a powerful tool when it's working in your favor, but when the deck suddenly goes against you, leverage can be absolutely lethal.

The problem is, as soon as a credit bubble bursts, there's no going back, no magic way for it to be re-inflated. And while the average investor might not see that as particularly important, the implications stretch far beyond the banks and brokerages. After all, most companies depend on credit to expand.

An absence of credit remove all the potential life out of real businesses and investments.

Essentially, the collapse of the credit market has impacts far beyond the banks and hedge funds. In fact, it doesn't stop at the credit market, or at the stock market. The absense of available of credit is an unqualified catastrophe. And what's worse, the situation cannot easily be remedied by central banks' efforts to dump cash into the monetary system. A robust credit system doesn't just rely on liquidity after all, it's also about confidence. Central bankers can "create" money, but that doesn't mean the banks have to lend that money out.

Ultimately, this affect every single investor. As equity investors, we are looking for companies to grow, to expand, to improve. Without access to credit, that process becomes a whole lot more difficult. Which makes it even harder for us to really excel in the stock market.
About the Author
Michael Lee-Smith writes about real world investing strategies, and enjoys stock market investing/.
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