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The Buy Side

In times of crisis, approximation beats perfection Add to ...

As we ride the market volatility caused by Europe's economic turmoil, I can't help but think back to Oct. 19, 1987, a date that will forever be imprinted in my memory.

Black Monday saw the Dow drop 23 per cent, while the TSX was down 11 per cent. As an aspiring analyst at Richardson Greenshields, I had just published two 'Buy' reports - Laidlaw and Investors Group if I remember correctly - in which I wrote glowingly about the companies' long-term fundamentals, competitive position and attractive valuations.

All of that good stuff went out the window, however, when the market went into free fall. Everything was going down including my shiny new recommendations.

Fortunately, I was smart enough, or devastated enough, to abandon my desk and go hang around the traders for the rest of the day. I just sat there stunned and watched the insanity.

Black Monday was my first experience with a serious market decline - a crisis that garnered coverage in the front page of the newspaper. Looking back, it didn't matter that I froze up. I wasn't managing money at the time and the sales team and clients had more important things to do than listen to me.

But the day didn't go to waste because I learned some lessons that have served me well in subsequent crises.

More information, less knowledge

When a crisis hits the front page and information is flowing fast and furiously, you have to know two things. First, the markets have already absorbed most, all, or more than all of the bad news. When people are talking about it at the water cooler, the markets have already moved on.

And second, the quality of information is poor. Very poor. It's heavily tilted toward the negative. And because it's often something we've not gone through before (crises tend to be that way), it doesn't fit into anybody's model. We look to the experts to make sense of it, but without the necessary time and data, they are winging it just like the rest of us.

Under-react When the experts are guessing and emotions are running high, it's not a time to take a strong view. Big shifts in strategy at times of crisis lead to bad decisions. The potential for blowing up a portfolio, or asset management firm, is very high. Investors who sold all their stocks at or near the bottom last year have devastated their retirement savings, just as many did 10 years earlier when they got carried away with technology.

When things are coming apart, we all desperately want to take action. But trust me, under reacting is good.

Back to fundamentals That's not to suggest that there aren't things to do. Even if no radical shifts are planned, it's important to know where you stand with regard to your long-term asset mix and what your next steps might be.

While everyone else is looking at the big picture, it's important to get back to what matters - fundamentals and valuation. Even if earnings and multiples don't seem to matter at the moment, they ultimately will. So, watching for securities that have been unduly penalized by the crisis is time well spent.

Baby steps When there are large dislocations in the market, it is likely some portfolio rebalancing will be required. Last month's asset mix will no longer be in place. I'm a big proponent of taking incremental steps to get where you need to be. Market extremes are not a time for perfection, but rather approximation. Investors who aim to make a bold move at just the right time, usually end up doing nothing because the stakes are too high. They can't afford to be wrong. It's better for investors to take small steps that in aggregate are approximately right, as opposed to not doing what they think might be brilliant.

I'm so excited

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The Pointer Sisters had it right. Certainly for investors in the accumulation phase, market crises are a time to get excited. It's a gift. New investment dollars buy more in depressed markets and the value of existing holdings are never impaired to the degree that short-term prices imply. When securities are being dumped for uneconomic reasons - automatic sell programs, fund redemptions, and good old panic - you want to be buying.

Europe has serious economic and political issues. The crisis will have an impact on economic growth and capital markets. Indeed, the world's debt overhang is a major reason why I've been cautious in recent months. But as the support programs, spending cuts and tax increases play out, I'm prepared to do some rebalancing. I have my buy list ready if markets experience a sustained decline (which they haven't so far). And while I'm not planning on freezing up like I did in 1987, I'm also not expecting to do much. I'm afraid my under-reactivitis condition is chronic.

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