Stocks pulled a U-turn on the road to oblivion on Tuesday, as the major indexes apparently decided it was not the right day for a total meltdown. Yet breadth was terrible, volume was poor and selling pressure was strong.
I’m afraid there was something very fishy about the last minute turnaround, and I would not be surprised to see the entire gain given up early in the Friday session and more. I’ve been recommending a lot of short-selling positions to Trader’s Advantage members in cyclical stocks like Research in Motion (RIMM) and Cameco (CCJ), and unless there is some miracle cure that I am not aware of, shares are likely to resolve the recent indecision pattern by moving lower and possibly by a material amount.
I’ve been hesitant to recommend that long-term, conservative investors short the market this month, however, because governments in Europe, the U.S. and Asia have been intervening heavily by pouring liquidity, bank capital, bank guarantees and the like into the system—up to $2 trillion worth. It seemed impossible that this would not serve to boost prices. I had been waiting for a bounce to at least the 1,000 level of the S&P 500, but it never came.
There is more than technical analysis and government-sponsored money flows at stake. Stats that I look at include a rolling 13-week S&P 500 return that is as oversold as it was at the bottom of the 1987 crash. And the median U.S. stock is down a record 55% from its two-year highs, even though the S&P 500 is only down 43%.
Here’s why there hasn’t been a typical oversold rally:
Deleveraging, both forced and pre-emptive, has been so powerful it will take years to resolve. Negative developments are everywhere you look, from corporate bankruptcies to near-bankruptcies of countries, states and cities. Huge bets in commodities have not yet fully unwound. Basically, it’s dawning on folks there isn’t enough money in the world to bail everyone out.
Fear and volatility have made normal, fundamental-based value investing very difficult, partly because the effects of toxic credit are little understood. Also there just aren’t as many long-term investors any more, as volatility has shortened time horizons.
The range of expectations on the economy is unusually wide, ranging from a mild recession that ends in the middle of 2009 to a serious global recession that lasts til 2010, or worse, a Depression. Most are now figuring that it does not make sense to start buying heavily now if the recession lasts another year.
Earnings multiples are cheap now, no doubt, but in the 75-year scheme of things, they are still relatively high. Investors figure they’ll get cheaper in six months than they are Thursday.
How Do We Survive This Mess?
I’ve been recommending very high cash levels, ranging from a minimum of 70% to as much as 100%. But there are other options.
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You can just put a stake in the ground on certain companies you consider to be rock-solid franchises with strong balance sheets and decent growth prospects, such as Coca-Cola (KO), and just keep buying them regularly until there’s a turn.
You can swing-trade stocks within the volatility if you are so inclined, as we do in Trader’s Advantage.
Or you can just sit tight in cash and be patient, waiting until the recession is believed to be half over, because the market will start rising then. In this case, only start adding to stocks once the S&P 500 surpasses its 12-month average, now 1,300, at the close of a month.
Out of Circulation
One bit of data that caught my eye Thursday was the increase in the amount of funds that are being swept into Treasury-only money-market funds. People continue to flee the sort of ordinary money market funds that provide short-term financing to companies via commercial paper, and are instead parking their dollars in funds that offer the greatest safety. This is understandable on some level, but it harms the economy by making less money available for lending.
The flight to Treasurys shows that investors are abandoning the credit markets just as much, or more, than they’re abandoning the stock market. And really, who could blame them? The Wall Street Journal reported on Thursday that funds managed by the veteran credit managers at Bain Capital have been savaged, sinking 50% this year. They are reportedly receiving margin calls, and their assets are being seized by brokers and sold forcibly into a market with little demand.
And their low bids are in turn forcing other holders of similar debt to lower their own marks, or the prices at which they are carried on books. In that way, one fund’s problems becomes the problems of the whole credit market, allowing a contagion to develop.
One item worth mentioning is that it’s not just bond issuers who suffer in these contagions. Insurance companies that buy debt for the yield that helps them meet longterm obligations also find themselves having to mark down the value of their assets even if they have no intention of selling them –creating more unnecessary losses.
Although companies that have issued a lot of debt have been the worst hit, low-debt companies have also suffered. Just look at Hewlett Packard (HPQ) and International Business Machines (IBM), which sell very little debt to fund their operations, or Dell (DELL) which also has little debt. How could these companies be affected? It sounds crazy but it’s due to a subtle but important issue.
Companies with high cash levels usually decide to invest it in the highest-yielding paper possible. To the extent that they have invested in structured investment vehicles at banks that have blown up, or in commercial paper that has suffered low marks to market lately, they may have to report losses. In other words, having high cash levels might be just as dangerous as having high debt levels!
To learn more about trading in this environment, check out Trader’s Advantage.
This article was written by Jon Markman, contributor to InvestorPlace Media. For more actionable insights likes this, visit www.InvestorPlace.com.