It Is What We Don’t know That Could Hurt Us?

Stocks have had a wild ride the last few weeks, to say the least. It appears equities used every last bit of energy to get to 14,000 on the Dow on July 19^th. In the next eleven trading sessions we have given back over 8% in one of the more volatile periods I have witnessed.

Last Wednesday was the most roller coaster day we can remember. The Dow Jones futures were down over 150 points in pre-market trading as the world indices were roiling. By the time the market had opened, the futures had cut their losses and the Dow opened up over 65 points. Fifteen minutes later we were down over 50 points. Ninety minutes later we were up nearly 100 points for the day. In the next forty minutes the Dow gave up 133 points and we have to admit we were actually a little queasy. With thirty five minutes left in the session the Dow was down over 65 points and threatening to break the lows of the last week. The index rallied 215 points in the last thirty five minutes in what was a perfect finish to the most E-ticket day (we do believe you have to be over forty to know what E-ticket means?) we have ever witnessed. Stomach acid remedy stocks were big winners on the day.

The gyrations in the market appear to be tied to the issues in the credit markets. We all know that the sub-prime mortgage market has had its woes. What we don’t know at this point is the extent of the problem as it relates to the consumer, the hedge funds and their levered positions, the lenders to the mortgage market, and the other related lending players (corporate, municipal, and consumer) outside the mortgage arena.

The Goldilocks economy of not-too-hot-not-too-cold economic growth may be over shadowed by these unknowns, as we believe they will be, and start revealing themselves in the coming weeks. If these revelations turn out to be more serious than many of the talking heads on the tube lead us to believe, and the global economy hiccups simultaneously we could have more E-tickets ahead.

Remember in February when we first learned the term sub-prime? Many said it was just a small piece of an economy that was in good shape. Well it turns out to be a bigger problem than first believed. A Southern California independent broker dealer, Brookstreet Capital, had to close its doors and layoff 650 financial advisors. This because their mortgage desk had too much exposure to the sub-prime mortgage market and the firms equity went negative within a few days. Bear Stearns had its credit downgraded after two of its hedge funds were deemed worthless and that the firm’s profits may be impacted. It will be interesting to see what holders of hedge funds do over the next few months massive redemptions could create margin calls and an inordinate amount of selling, maybe even the good stuff, to meet those calls. In 1998 the market dropped 20% in six weeks when the hedge fund Long Term Capital created a dislocation in the bond market. That slide was stopped when then Fed head Alan Greenspan stepped in and maestroed a bail out of the fund’s upside down positions.

We have been espousing caution in this space for the last couple of years and every time it appears the market may be starting a serious correction, it climbs up off the precipice headed toward new heights. Our technical analysis work gave us two buy signals in the last couple of weeks and they have both failed. We have not seen that happen since 2002, as mostly it has been the sell signals which have not worked the last four years. The buy-the-dip-crowd has been right since 2003, but remember we eventually always run into a dip-not-to-buy. Could this be it? Let’s ask Ben Bernanke.