Is The Worst Over … Or Is There More to Come?

You’ve no doubt noticed the bloody red ticker symbols streaming across the TV screen and your web pages recently. The bad news is relentless, even good stocks and other securities are getting murdered, and nobody seems to really know what to do.

The Federal Open Market Committee, Treasury and government in general has been putting on a fine show of incompetence these past two weeks.

For example, the U.S. Federal Reserve is considering making unsecured loans with the intention of directly purchasing commercial paper. This would be a historical first, but the Fed claims this is necessary for it to participate in the frozen inter-bank money market and the shrinking commercial paper market. Apparently those naughty ‘lesser’ banks aren’t actually lending any money and are instead hoarding cash. It would seem that only the Fed is wise enough to perceive when money should be loaned out. The free market dummies just don’t ‘get it’.

But there’s a catch. Since the Fed doesn’t have the legal right to make unsecured loans, the Treasury must therefore guarantee any losses. Wow, that would certainly encourage the Fed — or pretty much anyone! — to make unsecured loans. No-risk profits certainly sound like an exciting investment to us! Where do we sign up?

Sadly, we’d probably be turned down for these kinds of guarantees despite our best efforts to boost the economy by throwing around money like confetti while not worrying about any losses as they would now be illegal. After all, we’re not an institution that’s ‘too big to fail’.

And not so incidentally, there isn’t any such thing as a truly riskless investment. By ‘guaranteeing’ to return any losses, the Treasury would be transferring the risk from the Fed into your pocket book. You’ll be paying for any screw-ups, just like you’ll also be paying for that $800+ billion bailout package from last week. Come to think of it, so will your children and grandchildren.

No accountability, no losses, no risk, no sanity … Perhaps these no-risk, unsecured loans are the ‘logical’ next step in FedWorld. After all, wasn’t last week’s massive bailout one giant sub-prime loan already?

An Emergency Interest Rate Cut Aimed At Your Future

And in other news, the Fed decided to lower its target for the federal funds rate 50 basis points to 1.5%. Apparently, a "weakening of economic activity and a reduction in inflationary pressures" was the excuse they needed.

Reduction in inflationary pressures? Perhaps they’ve forgotten that an increase in the money supply is inflation by definition? And perhaps the extra hundreds of billions they’ve pumped into the market recently have just magically disappeared?

Granted, a stock market meltdown is deflationary, but with the Fed working the money pumps like a crazed oil prospector on his first well, deflation won’t be lasting very long.

What you can be sure of is that this interest rate cut is going to cut your future purchasing power as prices rise. Even if you’re scared of banks right now, keeping dollars in a mattress isn’t a great idea when those dollars are actively being devalued at breakneck speed by the institution that’s supposedly safeguarding them.

You’re no doubt filled with confidence by the following graph, right?

Real, tangible assets – not paper assets backed by the ‘trustworthiness’ of an institution – will be the way forward.

Market, Market Burning Bright, In the Forest of the Blight

Now that we’ve made you cringe with a terrible sub-headline that’s successfully mangled the famous William Blake poem — and you’re hopefully more pain-resistant than you were a moment ago — let’s look at the Dow. Oh dear …

You have to go all the way back to 2003 to find prices like today’s ‘bargain’ value. Not only are both monthly moving averages history, but that all-important support level at 10,000 is gone too. Where’s the next stop for this descending elevator car? It seems to have snapped its cable.

The emergency brakes will kick in before long (but perhaps only temporarily). There should be some support at 9000 but 8000 is more likely to hold. Certainly there’s nothing in any indicator to give us confidence that the bottom has been found just yet. And even though the slow stochastics indicator is recording the lowest value in a decade, any oscillator can be ‘overbought’ or ‘oversold’ for long periods of time when a strong trend asserts itself.

There’s also no volume peak that would indicate a bottom. Look at the 2002 period by way of example. There were two distinct volume spikes that stood out from the crowd. Of course, this month is far from over but if you know your history you would be well aware that October is the traditional month for major market declines. This not the time to buy anything unless you know the fundamentals of a given stock very, very well and an irresistible price presents itself to you. 

Nothing to Fear But Fear Itself?

You made have heard of the VIX (the ticker symbol for the Chicago Board Options Exchange Volatility Index). VIX is quoted in percentage points and approximates the expected movement in the S&P 500 index over the next 30-day period, on an annualized basis.  It’s popularly known as the Fear Index, and as you can see there’s an unprecedented bull market in fear at the moment.

What exactly does this mean? With the VIX at 54%, this represents an expected annual change of as much as 54% (15.59% in 30 days when you divide 54 by the square root of 12). You’re allowed one guess as to which direction this expected move would take.

Of course, VIX doesn’t guarantee that the Dow will lose half its value in a year. But you can see for yourself that fear has never been higher in the four years this index has existed in its most modern and robust form.

The panic is real, and it will last until the market can find a stable bottom and show convincing resilience in the face of bad news. Our guess is that it will take a trip to 8000 before this happens. Keep your powder dry!

Good investing,

Nick Thomas
Analyst, Oxbury Research