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In the aftermath of this massive stock
market decline, there were pundits galore that expressed their opinions on
why the market saw such a move down. Some blamed it on a system failure (ala CNBC's Jim Cramer)
others bemoaned the Chinese stock market that supposedly triggered this
decline, and another still blamed this sell-off on Alan Greenspan's use of
the "r" word...recession. Perhaps the most mind-boggling blame was
placed on Matt Drudge of the Drudge Report. I
guess Drudge was responsible for simply reporting the news.
As always, I want to give you my spin on
things. First, I do want to point out that in my opinion this decline was not
an aberration or simply a technical glitch in the system. It is the beginning
of a major correction in the U.S.
stock market. The panic that occurred on Wall Street tells me that most
investors are not as optimistic as they come across. If they truly believed
that the US
economy was robust and that the stock market was headed for a strong year,
there would be buying. Instead, there was selling. And lots of it.
Now I want to make one thing abundantly
clear. I do not think that we will see a precipitous sell-off in the markets where
we see a 20% decline in a single day. The bounce back in the market was to be
expected. However, I do think the sell-off will be more staggered where it
will eventually reach a 20% + decline. There will be rallies where investors
will jump in thinking that this correction is over. I would caution against
this. The fundamentals, market environment, and investor sentiment warrant a
much larger correction in the near future.
I also wanted to touch upon several more
interesting aspects of this recent sell-off and thoughts that came to my mind
as I saw the stock market decline unfold. I will break these thoughts into
several points.
1) "The Blame Game Mentality" -
What we saw in the last couple of days is "the blame game"
mentality that has become en vogue on Wall Street. Gone are the days where
market declines were blamed on fundamentals or simply characteristics of how
markets move. To be fair, there have been some that have correctly argued
that the U.S.
market was due for a correction and that the current economic environment
does not bode well for the economy. By in large, however, many have blamed
factors that are simply ancillary to the larger problems that face this
economy. Indeed, instead of viewing this sell-off as a "wake-up"
call, they simply viewed this as another opportunity to play the blame game.
2) "Denial" -
Tied into this "blame game mentality" is the simple fact that most
are in denial of what is currently transpiring around them. Consider, for
instance, the dismal economic news that has occurred over the last couple of
weeks. Inflation numbers
jumped at a higher than expected rate, orders placed with US factories for durable goods
fell by more than expected, and the January's ISM numbers signaled
a contraction in manufacturing. To top it all off, housing is far from
bottoming and sub-prime mortgages are in a dizzying spiral. Take a look at
two of the many statistics surrounding the housing market. New home sales had
the biggest drop from a previous month (16.6%) in 13 years. There are over a
TRILLION dollars of sub-prime mortgages. Since sub-prime mortgages are given
to individuals who have below average credit, I would imagine that there will
be a substantial default rate. The default will not only affect the borrower,
the lender, but also the butcher, the baker, and the candlestick maker that
have benefited from this real estate rise. In other words, mortgage defaults
and a real estate slowdown will play havoc on a variety of businesses.
Interestingly enough, most investors are
in denial of the current financial makeup. While corporate profits and cash
flows have undoubtedly been strong over the previous several years, using
this reason to rationalize what will likely happen in the future is getting
old. Corporate profits will dry up as quickly as the consumer says, "I
can't afford to make my mortgage payments" or "I have to cut back
on my spending because my adjustable rate mortgage just went fixed".
3) "What we have here is a failure
to focus on the fundamentals." -
Most of what is transpiring falls back to what I have been saying the last
couple of years. Last January, I wrote a commentary titled "Real Estate Burst, Upcoming
Recession, and Soaring Commodity Prices" Now, I am not bringing this up because I want to say,
"I told you so." I am the first to admit that the real estate
market has lasted longer than I anticipated and the stock market has
appreciated much further that I would have imagined. However, as many people
know... The market can stay irrational longer than you can stay solvent. What
I do want to bring up is that it is key and important to focus on the
fundamentals. You cannot just sweep all of the bad economic factors (whether
it is housing, inflation, or the fact that the consumer has over-extended
himself) under the rug. Focus on the fundamentals...it is what ultimately
moves the markets.
4) Understanding The Fundamentals Will
Also Provide You With Buying Opportunities. - One
of the more interesting moves that occurred in the last couple of days
happened in the gold market. In the previous week, gold rallied to new highs
as geopolitical tensions, higher than anticipated inflation numbers, a
declining dollar, and rising energy prices brought in buyers for a number of
different reasons. Around the $690 level, gold looked strong for a quick
break to test the $720 highs. Instead, gold prices decelerated quickly in
after hours and plummeted by more than $25/ounce to hover around the $660
level.
Interestingly enough, the sell-off in
gold could not be attributed to any of the above mentioned factors. The U.S
dollar did not have a strong rally on the upside, oil prices did not plummet,
the inflation numbers from last week were not revised downwards, and there
was no resolution in the Middle East. Instead,
the market ignored positive signals for gold (declining dollar, the attempted
attack on Vice President Cheney [increased geopolitical tensions], stable oil
prices, and market instability which typically results in buying of a
historical safe haven). It seems to me that investors panicked by selling
everything in sight, funds liquidated profits in gold, and the downward
decline in gold was not fundamentally warranted. If anything, it provides a
buying opportunity. I firmly believe that gold is heading higher within the
next 60 days and we will be re-testing the $720 highs.
5) Understand The True Meaning Of Diversification. -
Another lesson to learn from the market sell-off is that investors who think
they are diversified because they have stocks across various sectors and
various international markets should realize that their diversification is
limited. Domestic and International Markets, large and small cap stocks, and
a variety of sectors all experience declines in this stock market sell-off.
The idea behind diversification is that
you want to construct a portfolio that has investments that either have a low
or negative correlation to each other. Consider allocating an alternate asset
class in your portfolio that is not correlated to stocks and bonds. One of
these asset classes is managed futures. I was on CNBC on Tuesday talking
about the benefits of managed futures as a non-correlated and diversifying
asset class. If you are interested in viewing the interview and receiving a
free complimentary brochure on Managed Futures you can request one here:
In short, here are several benefits of
managed futures:
- The Opportunity for Reduced
Portfolio Risk
- Potential For Enhanced
Portfolio Returns
- Ability To Profit In Any Economic Environment
- Ease of Global Diversification
You can also see the benefits in the
following chart which shows the performance of managed futures during several
periods of worst declines for various stock sectors.
Source: CBOT
Futures and options trading involves substantial risk and is not suitable for
everyone.
If you are interested in learning more about the
commodity bull market, I urge to pre-order my forthcoming book, "Commodities for Every
Portfolio: How To Profit from the Long-Term Commodity Boom".
Emanuel Balarie
Senior Market Strategist
Wisdom Financial, Inc.
Direct toll free: 866-465-0017
International: 949-548-2021
Emanuel Balarie is the Senior Market Strategist at Wisdom Financial.
As an expert on foreign markets, foreign currencies, and the precious metals
industry, Mr. Balarie often speaks at public
engagements and his research is regularly published in investment
newsletters. You can find out more about Mr. Balarie
and his services at www.wisdomfinancilinc.com
The risk
of loss in trading commodity futures contracts can be substantial. You should
therefore carefully consider whether such trading is suitable for you in light
of your financial condition.
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