An Uncertain Panic

Story Highlights:

• Leaders of European countries and the US Fed are taking steps to strengthen financial systems and public confidence.
• Investors may have seen these actions as proof of the financial crisis's extension, leading to large losses across global markets early in trading sessions.
• Markets saw partial recoveries towards the end of the sessions, suggesting investor outlooks are still mixed.
• Uncertainties weigh heavily on investors' minds. But when faced with uncertainty, investors should act based on objective rationale and not on panic or fear.

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The financial crisis, having done away with Wall Street's major players, is now at the heels of major banks. But these banks, with explicit and implicit government guarantees in the US and elsewhere, will likely see a different fate than the old Masters of the Universe.

Over the weekend, leaders of European countries adopted emergency measures to strengthen domestic financial systems and public confidence. In the US, the Fed also took steps to ease liquidity pressures by increasing its Term Auction Facility operations to $900 billion and announcing it will begin to pay interest on cash reserves banks hold at the central bank (as part of the $700 billion bailout plan).

From Monday's market reaction, it's uncertain if these global government measures helped to increase stability or instead just served as further proof of the financial crisis's extension. Monday saw no reprieve from the recent trend of extreme single-day market volatility and warnings of investor panic crowded headlines. But markets retrenched much of their earlier losses towards the end of the sessions, suggesting investor outlooks are still mixed and highlighting the short-sighted faults of panic-selling.

There is currently much for investors to be uncertain about. Government intervention—and especially of current scope and escalation—is worrisome for the unintended, negative consequences it may produce. Perhaps an early danger (and reason behind the panic-selling) is the ambiguity of the Treasury's bailout plan, but it's still too soon to clearly evaluate any true potential benefit or damage. The tightening of inter-bank lending is also worrisome with its clear negative implications for the greater economy, and it remains to be seen how effective government promises and liquidity injections prove to be.

Uncertainties weigh heavily on investors' minds. It's no surprise recent psychology studies show investors' outlooks are increasingly being shaped by just a few days' worth of negative, fearful events. Our inherently risk-averse brains were made for physical survival not financial survival, and we tend to remember the immediate past when contemplating the future—especially when uncertainty is involved. But investing for most investors is a long-term engagement and negative sentiment can last long past market bottoms. When faced with uncertainty, investors should act based on objective rationale and not on panic or fear. Still, it's easier said than done—even for the savviest investor.