After U.S Index Futures trading on global markets had priced in a 5% plunge when the markets open today, the Fed decided to try to salvage the situation by cutting rates by 75 basis points.
Immediately, futures gained lots of lost ground, as Nasdaq 100 ETF (QQQQ) is only pricing in a mere 2% decline. (QQQQ quote taken 8:30 AM).
But was this the right thing to do?
I'm not so sure.
First, let me establish that I don't want stocks to fall. I own an Ultrashort Oil & Gas Fund (NYSEARCA:DIG), which can be seen as a hedge against oil (and the entire economy), but I am very, very long, which is clearly not the place to be right now. I'd like nothing better than to see the market go up 20% tomorrow, but for logical, meaningful, substantial reasons.
The Fed's early cut is purely symbolic, not something that will actually have an effect on the financial situation in America. Since the policy (rate cuts) take many months for their effects to be felt in the economy, realistically, waiting until the meeting to cut 75 points would have provided the same stimulus in the second half of this year. If anything, I think it may have been better to cut then - if things got even worse, then they could cut a full point without making it seem like the sky is falling.
I can't say that a decline of "only" 5% isn't bad (especially since some stocks I own, like Countrywide (CFC) (an arbitrage, at this point) were set to open down 10% or more. But global markets have faired even worse over the past two days - Indian and Chinese markets are down 10-20% since last week.
It's hard and unreasonable to tell people to do this, but if people could just act rationally, and avoid clicking "close" next to all of their positions, we'd be a lot better off. For example, I follow Activision (NASDAQ:ATVI) and Electronic Arts (ERTS), two stocks who should have shot up after news of an absolute blowout of video game sales numbers during the holiday season. However, both were flat (or down) last week after the announcement was made, and both were/are pricing in a 5% dip today. Clearly, if we're in a recession, people are still buying Guitar Hero and Call of Duty; if anything, investors should be buying up shares of a seemingly-stable niche.
Now that the day's news (BofA's (NYSE:BAC) awful earnings and the Fed cut) are on the table, it looks like markets will open down about 3%. What they do during the day is anyone's guess - We could finish positive, or we could lose 10%. According to WSJ articles over the weekend, markets have priced in 80% of the impact of a recession - this potential decline today should increase that figure further. I truly believe that a recession is fully priced in; there's clearly some stocks that are still overvalued (I think that tech like Apple, RIM and Amazon are still grossly overvalued), financials seem to be fully discounted.
Barron's wrote an article about the bond issuer MBIA (NYSE:MBI) this weekend; they stated that the company's liquidation value is at least $30, while the stock currently trades around 8. Countrywide is being merged into BofA; the terms of the deal, which can be broken but are generally unconditional, priced CFC around $7; now, when CFC converts into BAC at .1822 shares, you're essentially buying BAC stock for $25 (instead of the market's $33) if you buy Countrywide today.
If you can stomach a short term loss, in five years, they should identify early 2008 as the best buying opportunity in years. Yes, the economy may not be great. Yes, the subprime problems are not over yet. But companies (and the entire market) are heavily, irrationally discounted, and an investor with a strong stomach will thank his nerves a year or two from now.