Is the world going to end …. ? Of course not.

I have been in discussion with a lot of people today about the potential fall out from the Lehman Brothers spectacular bankruptcy filing in New York. The Dow Jones fell 504 points overnight and the ASX is now down substantially for the day – approximately 120 points when I last checked. With all the other underlying financials in the United States pointing towards a massive market downturn – many people have asked me – should I be scared that the financial markets around the world are going to collapse?

My standard and immediate answer is No.

The reason I say this is because no matter which way you spin it and no matter how bad things are at the moment – history has shown us that financial markets will always recover. I find it personally fascinating when things have been so good for so long, how people are all of a sudden “shocked” when there is a downturn. Don’t get me wrong, this downturn is much more serious than most others in history (but not all … are we so short sighted to have forgotten the great depression?) and is just a reflection of one person cutting corners and allowing 1000 other people to do the same thing. It’s most interesting to note that Regulators will now “all of sudden” become very active because times are tough, instead of being more proactive when times are rocking along. The Securities regulators in the US should have been much more stringent in their management of US financial system during the last seven years than perhaps taking the “times are good, we don’t need to do anything” strategy. This is, sadly, always the way it works when it should be “times are good, we should be freaking out why they are”. It’s the management of risk that was critical in the United States, and clearly most firms capital adequacy requirements went out the window and they were able to lend to anyone.

So what exactly is going to happen now ?

People will move to safer investments. You will see a large move into secure and risk adverse opportunities such as bonds, treasury notes and term deposits. I think there will also be a larger shift towards underlying commodities as people shed the risk on futures markets and invest in the underlying fundamentals which make up our markets. Whenever there is huge write downs - most people fall back to investments which are safer and allow them to more easily manage their risk. This just makes sense.

Equivalently, this means that there will be some very good buying opportunities. Spin the clock back on your charting programs 7 years and what will you see ? Most stocks (which still exist) are hugely higher than when they were 7 years ago. So what, you ask? Well this is just to point out that even after the Tech Bubble Burst and the tragedy that was September 11 occurred, the market has managed to recover hugely.

So don’t fret too much – the financial world is NOT going to end. The only way forward in anything in life is to get rid of the bad odors, and I think that we have still not seen the complete end of the bad smells yet. The standard business cycle is around 3 years and we have had 7 years of “up” – something had to falter and it had to falter in a huge way. You cannot expect the US economy to loose in excess of $1 Trillion dollars and think that things are “going to go back to the way they were”. It’s not economically possible for this to happen.

But as we more forward now and more and more people shed risk and invest in secure investments – asset bases will build back up which allows banks to borrow more and more – which consequently “frees up” their now risk adverse lending practices and the cycle begins again. People always want money and they always want it as cheaply as they can get it – this means that although we are going to see a severe “tightening of the belt” – sooner or later banks need something to eat.

Times will be tough for the next year or so and maybe even longer as risk policies are dusted off and shaken down – but the the funding squeeze will ease up, and interest rates will start to fall (because consumer sentiment will have taken a battering) which will make the liquidity markets start flowing again and the good times will return. The key for you, as a small investor – is to the rid the waves of highs and lows

Such is the game of the Financial Markets.