This Is Only the First Round of Selling

The Dow has been all over the place in last two days. Yesterday it finally ended up higher after a jig-jag motion throughout the day. However, warning signals are emanating from everywhere. Just because stocks have seen sharp selloffs in the past, analysts are trying to call it a bottom. All those undecided investors choose one side or the other in last one hour. Wednesday we saw a move down and Thursday a move on the upside. However, stocks haven't bottomed as yet. This momentary relief in selling should not be considered the bottom. The first round of sellers might have been exhausted by this time. But economic conditions are really bad.

San Fransisco Fed governor Jenet Yellen said yesterday that there are still significant headwinds facing the economy and we are nowhere close to the end. The mistake some investors are making is that they think stocks are cheap at these levels and since the first round of sellers is exhausted, we are seeing some buyers in the market. But yesterday Hartford Financial (HIG) warned about the significant problems being faced by the insurance companies. And to my surprise Prudential (PRU) and MetLife (MET) were up in the morning session.

These are the symptoms of turning a deaf ear to the problem. Such mistakes and blind belief that everything will always go up in price caused major burns for investors initially. Had they awakened to the severity of problems at investment banks after Bear Sterns closed its two hedge funds back in mid 2007, they could have avoided significant pain. But unfortunately they always get lured back into equities as soon as there is an uptick.

Now I am not a pessimist but I am a realist. And stocks still do not reflect the underlying fundamentals for most of the companies including Apple (AAPL) and some commercial banks (JPM, BAC). These stocks should trade at significantly lower levels if we value them properly. Bank stocks in particular are relying solely on the faith that the US government will solve all their woes. I don't think that the US government will be in position to do so. For example, take the case of AIG, it has already withdrawn almost $123 billion dollars from the Fed and Treasury and still think they will need more. So if you think that a $700 billion dollar package will bail out every single bank, investment bank (their names have changed), insurers and then some hedge funds too, you must be living in a truly unrealistic and impractical world.

The Fed and Treasury never attacked the real problem of commercial paper until too late. They could have saved a lot more money had they taken the right steps. But now that the wrong path has been chosen, it's just a matter of time until Paulson goes back to Congress asking for money. But even if that worst case scenario does not happen, investors can value the companies for their realistic worth. Because when that process triggers we'll have the second round of sellers: people who are buying at these levels considering the stocks a good buy because they seem so cheap. And that will be worse than the first round since stocks will go much lower from already existing levels.

A better options would be to invest in some corporate bonds and municipal bonds which are currently priced at very attractive levels.

Stock position: None.

Comments

[Steven Hansen:]

oh yes, but the big boys are trying to pump the market. notice the funds and investment managers all out in force talking about stellar gdp growth next year?

be careful out there because i would be amazed if anybody really knew what they were talking about.

2008 Oct 31 06:22 AM

[investor88:]

Gold Digger's article is insightful ie this is [probably] the first round of selling.

The Hand comments are timely, be careful inspite of all the bull calls. The way forward is fraught with uncertainty and pitfalls, no time to bet the farm.

2008 Oct 31 08:39 AM

[peterthepai...:]

this is not a sprint...you should have mostly cash...and be buying the dips in small percentages of that cash...the bottom may be a long way down yet...if goldy is right we will be able to average out and still be able to buy...however low we go...remember japan, 1973-5, 1929-32,33...if goldy is wrong...we will still have our money...oh ...an this is not advice...just a personal view etc...

2008 Oct 31 09:17 AM

[ksmithdc:]

Patience and prudence will prevail in this time of insanity.

2008 Oct 31 11:15 AM

[henarl:]

Agree, except on Munis. States and municipalities are just as under water as banks and other corporations. The fed doesnt have enough to bail out all of the munis either and neither do the insurers. Look for muni defaults in the future.

2008 Oct 31 04:45 PM

[MNSL:]

I think we should no rely on these giants now.

Can we believe their forecasts?

They said oil will go to $200 a barrel during this period. Now oil is trading around $60 a barrel

We should be very careful in selecting fund mangers, insurance companies, banks in the future.

They have overleveraged in almost all the areas:

Such as property
Commodity
Currency

In addition dealing in some of the highly risk instruments can bring down entire financial systems.

2008 Oct 31 10:31 PM