Lessons from the 2008 Markets Selloff: Searching for Alpha, October 2009

It's been a year since the fall of Lehman Brothers, the storied investment bank that was forced to declare bankruptcy following an unsuccessful bid for a government bailout. Its failure caused a massive selloff on Wall Street that eventually pushed the S&P 500 index to the 666 level in early March 2009. Stocks have since rallied about 60%.

Though these types of market events are rare, they do occur, and it's both surprising and awe-inspiring to witness global wealth destruction on such a grand scale. What can savvy advisors and investors learn from such scenarios?

First, market swoons and the explosive rallies that often follow are excellent examples of how difficult it is to buy bottoms and sell tops. Adding to a losing portfolio seems insane when everyone around you is panicking. Hedge fund managers were slow to re-enter the markets until just a few months ago. What looks easy on a price chart is often much more difficult in the real world.

The importance of diversification was certainly well illustrated last year. As all risky assets crumbled in price, 30-year Treasuries (TLT) gained over 30%. Having all of one's eggs in one basket can be devastating when that basket eventually succumbs to the laws of financial gravity.

A final important lesson is to properly gauge investor risk tolerance. All suffered in 2008, but that merely set the stage for this year's recovery. Over-allocated investors who bailed out of the markets in the fourth quarter aren't likely to get their principal back for a long time.

The Monthly Index Report for September 2009

Index

Sep-09

QTD

YTD

Description
S&P 500 Index*

3.6%

15.0%

17.0%

Large-cap stocks
DJIA*

2.3%

14.9%

10.7%

Large-cap stocks
Nasdaq Comp.*

5.6%

15.6%

34.6%

Large-cap tech stocks
Russell 1000 Growth

4.3%

14.0%

27.1%

Large-cap growth stocks
Russell 1000 Value

3.9%

18.2%

14.9%

Large-cap value stocks
Russell 2000 Growth

6.6%

16.0%

29.1%

Small-cap growth stocks
Russell 2000 Value

5.0%

22.7%

16.4%

Small-cap value stocks
EAFE

3.9%

19.5%

29.6%

Europe, Australasia & Far East Index
Lehman Aggregate

1.1%

3.7%

5.7%

U.S. Government Bonds
Lehman High Yield

5.7%

14.2%

49.0%

High Yield Corporate Bonds
Calyon Financial Barclay Index**

2.0%

1.4%

-2.2%

Managed Futures
3-mo. Treasury Bill***

0.0%

0.0%

0.3%

All returns are estimates as of September 30, 2009. *Return numbers do not include dividends.

** Returns are estimates as of September 29, 2009.

Ben Warwick is CIO of Memphis-based Sovereign Wealth Management. He can be reached at ben@searchingforalpha.com.

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