10.24.08

10.24.08

.          

             A grim outlook from electronics maker Sony on Friday triggered selling right out of the gate, and another bleak forecast from the automaker Daimler Chrysler added momentum to the drop. The first half hour saw the Dow down over 500 points. By the close however it had recovered close to 200 of those points. Still the indices closed out the week at levels not seen in over 5 years.

            Many investors are convinced the world economy is headed for a severe downturn even as governments have raced to revive credit markets on the hope that a return of more normal lending levels by banks and other financial houses will fan economic activity. But some say the recent pullbacks have been set off by forced selling, keeping some bargain-hunting traders from entering the market.

             We believe that the market will continue to be weak until traders become convinced that this will not continue once the hedge funds have been forced to unwind the huge amount of leverage they had build up over the years. They are working on it, but it still has a ways to go. As the markets go down, the leverage works against them, forcing them to sell assets to raise cash to meet margin calls. This in turn forces the market down some more, creating a viscous cycle.

            Some advisors are saying that now is a good time to start buying because stocks are cheap. We disagree, cheaper maybe, but 17+ times earnings are not cheap. And earnings are coming in lower which in turn raises the P/E. That in turn makes the market more expensive and the price has to goes down because it can’t support a higher P/E on lower earnings.

            For another good example of how margin works all you need to do is look at Oil Futures. On the way up it seemed as though the price would never stop, but it did at around $147 a barrel. These futures contracts are leveraged 20 to 1. For only $1 down you could control $20 worth of oil. The speculators loved it. When the tide changed and the price started going down it worked in reverse and they have been slammed. Oil is now around $62 a barrel, having given up over 50% in just a few weeks time. A drop of $65 dollars at 20 to 1 leverage equals a loss of unbearable proportions. Some of those traders went from the Penthouse to the Outhouse in just a few weeks time.

            We are still on the sidelines and happy to be there. 100% in Cash and sleeping like a baby.

Till next time

The MTA Staff