Al Capital

Planned, Cautious Buying Amidst This Panicked Selling

That was a thoughtful post. The element that was missing however is the plan under worst case scenarios, or what I would call "survive to fight another day" scenario. Although I have suggested all cash positions since February, I recognize that "traders" are looking for "deals".

Look, it might be unbelievable, but the market reaction to the current crisis is painfully obvious. First it will discount all growth since the housing bubble, basically assigning 5-10 cents on the dollar to mortgage backed securities of that vintage and bringing the Dow and S&P down to 2002 levels. From that point it could get even worse, much worse, so in making choices in this market, realize that the risks are enormous. The VIX alone documents an extraordinary risk level.

That brings me back to your point about "a plan". That plan should also account for the risk and costs of being wrong, meaning that if you are just hoping for a stabilization, or hoping for a bounce, then the plan should be to avoid risk.

Regarding the comment about "buy low and sell high", that works great in retrospect, but today's price might seem low now, but in fact turn out to be very high in a month from now. Don't invest using aphorisms, as you know "a fool and his money are quickly parted".

Asset Securitization Crisis: The Butterfly Effect

Strictly speaking, the "Butterfly Effect" describes predictable non-linear systems, albeit ones that can be catastrophically affected by very small changes in some factor (the effect was discovered by noting results from roundoff errors in computer modeling of weather, and explains why weather cannot be forecast more than a few days in advance).

What is happing in the economy is quite the opposite, it is the result of a catastrophically large change in credit markets and resulting capital deflation (deflation creates further positive feedback causing credit to shrink further). That being said, an optimistic projection for the general market bottom would be 7500 for the Dow, or roughly 2002 levels. However, if things go badly, we could see a bottom at 4000-4500. There is a small chance that the national banks can avert this disaster, however, the risks remain extraordinarily high.

Remember this, if you are using the word "hope" in your description of investments (e.g. "I hope the market improves"), then you are not investing, you are gambling. An investor factors in the risk.

The Cramer Crash?

I guess you geniuses all figured out that Cramer's comments TODAY caused the global market free fall LAST WEEK.... what is wrong with you people, can't you do simple arithmetic. The financial sector is potentially $6 trillion dollars in the hole, a hole that can't be filled with hope, so let these investors protect themselves and if they think it is in their best interest, to exit the market. And if you know something that Cramer doesn't, by all means share that INFORMATION , but don't fault the man for his market-experience based advice just because it makes you feel bad. Too, I am really surprised by this Bespoke Investment Group Cramer voodoo story... you don't really believe in that do you? Or were you among the ones who thought Meredith Whitney caused the financial crisis by exposing Citigroup's weakness? Hey, y'all should use that energy to help investors figure a way out of this crisis without cutting off a limb. But looking at Cramer as a scapegoat, well that is just pathetic: don't you recall that Paulson, Bernanke, Immelt, Congress etc, have been saying we are in difficult times for weeks, if not months.

Why Is This Market Holding Up?

You might take a look at my recent statistical decomposition of the S&P for some ideas regarding the current market strength.


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Understand True “Excessive Bearishness”

You make a valid argument regarding the true turn, or inflection point, between a bull and bear market, which is a useful reminder for investors in index tracking stocks or funds, such as SPY.

I consider "bearishness" and "bullishness" to be forward looking sentiments, reflected in market volatility. Based on increased volatility (e.g. VIX) there IS more "bearishness": see also
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Why Markets Fell Post Fed Cut

There is little doubt that whatever action the Fed took, the "market" was going to sell, simply because the action was driven by uncertainty and no one likes uncertainty. But the recession risks, at least those presented as probabilities as in Eli's post, are not accurate. The range of recession sentiment varies from about 5% (and I am in that camp) to 100%. Now although the Wall Street Journal presents that data to indicate the average = 36% chance of recession, the data actually indicate that there is no consensus, and that is all. In terms of monetary indicators the chance of recession is very low, and in terms of productivity, the chance of recession is very low.

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Inflation, Deflation and Your Investment Decisions

Thanks for the analysis David. Perhaps an analogy would be helpful.

Consider the economy to be a fleet of large ships. They float on a sea of capital, and if credit conditions are poor (eg. inverted yield curve) they can run aground. If the yield spread is high, credit is available and they can easily float and move forward.

Productivity drives their engines more efficiently. The opposite is inflation, which makes their engines run less efficiently.

Growth is never the result of monetary policy, it is the result of productivity gains (that is the core of capitalism). However it is certainly true that without credit, growth is restricted to cash rich sectors.

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How Powerful or Wise is the Federal Reserve?

To rephrase some of your comments using my own analysis, the Fed does not have a large "toolset" to modulate the economy, and that is by design. IF the Fed had such broad powers, it would be vulnerable to strong political subversion. The Fed should not be able to "control the economy", but should only be able to set monetary policy. The need for the Fed arises from "combined and unequal" realizations in that is a characteristic of our economy. In other words, inherent "lags" in the economy cause transient dislocations in the money supply, which the Fed is supposed to compensate. However, the reverse is also true, ie. the changes in Fed policies initiate monetary "ripples" of different wavelengths, causing effects to happen at different timescales. Normally, the chance or probability of the Fed's policy to exactly superimpose and magnify the economy's "ripples" is exceeding small, so the "tsunami" size events do not occur.

For my comments on the recent turmoil see:

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or for general commentary see:

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The Triumphant Return of Volatility

Herb, thanks for the thoughtful and well written post. I believe that most of us will agree that you have touched upon some of the key issues facing us.

Note that the traditional methods of looking at wage inflation may no longer work. For example, despite the demographic reality of the working population, which strongly suggests an inflationary tendency, outsourcing and the presence of a large foreign population have kept inflationary force at a minimum. Basically, modeling wage pressures is more complex than it was in the 1950s and 1960s.

However, healthcare costs of our population is a huge economic and social burden, and effects all segments of the population. That is where some new and large efficiencies are needed, and we are all scanning, back and forth, on the IPO frontier for some signs of a solution, hopefully before politicians are tempted to fabricate one.

The "cheapness" of equities in comparison to risk free returns is however a very uneven condition, and thus while your statement is certainly true for groups of equities, it is not a general rule.

Interest Rates & Markets: Pondering The Consequences Of Uncertainty

The uncertainty in interest rates is being used as a "cause célèbre" to mask the underlying certainties regarding economic growth. The only real uncertainty is how this growth is valued and where that value goes as indicated by the US Trade Balance. The volatility in stocks is much simpler to accommodate for the long term investor.

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