Monday, March 17, 2008

Surviving a downturn (1)

Since the US sub-prime initiated credit crisis began making its effects felt in the third quarter of 2007, I have been generally optimistic that (i) the effects would be limited and (ii) the effects in markets outside the US would be even more limited. I have also allowed my optimism to combine with my fear of rising inflation and the low returns on cash to dictate my investment strategy. In particular, I have minimised my exposure to cash and deposits as an asset class. So far that has proven to be an awful decision - only the currency effect (benefiting from a weak US dollar), positive cash flow from properties and a small exposure to commodities have held portfolio losses to very modest levels. However, this is false comfort. Some of my mark to market investments have fallen by 30% in local currency terms.

A combination of the reduction in value of my mark to market investments, rising uncertainty regarding my income and my employment generally and a some leading indicators have lead me to belatedly consider the implications should the markets and the economy in general experience a prolonged downturn.

During the last 20 years I have been through three downturns (i) the 1987 share market crash (ii) the Asian crisis and (iii) the SARS epidemic (the tech crash was sandwiched between the last two but had relatively little effect in Asia). In spite of each of them being both financially and emotionally stressful events, experience has given me a degree of confidence in terms of our ability to get through the downturn and emerge in good financial shape on the other side. That said, it must be acknowledged that each down turn has presented its own unique challenges and issues. While the phrase "this time it is different" may be a generally dangerous belief to hold when asset values are rising, if my (limited) experience and reading of history is anything to go by, the phrase may have some validity during a downturn.

Downturns need to be addressed at three levels:

1. financial survival;

2. financial opportunity; and

3. mental health and personal opportunity.

I will review my position on each of these in successive posts.

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