Dow Jones 11951.09 -194.65 5:40 pm PDT, March 15, 2008 NASDAQ 2212.49 -51.12 For info, visit access.smallcapnetwork.com S & P 500 1288.14 -27.34 Change your subscription status here Russell 2000 662.90 -16.81 VOLUME 08 : ISSUE 25 Economy, Market Playing Pinball (& You're the Ball) I don't recall the last time everything hit the fan like it did this week - for the economy or the stock market (the two should never be confused with one another). By Thursday I was getting a little dizzy. Having been able to sleep on all of it for a night though, today I've hopefully got some meaningful perspective on the mess. Hint - it's not all bad. In the same vein, I've got a comment about something all of you could/should be doing to make the most of a recession and/or as a bear market. Another hint for you ...I wasn't kidding a couple of weeks ago when I said being in the right sector is half the battle (at least).    Recap OK, let's see if I can get my bearings.... Monday: The market gets pounded. In some cases the indices saw new lows for the year, and we were all still feeling the pain from terrible results the week before (and a disappointing week before that). Most of the weakness was rooted in rumors that Bear Stearns might become insolvent, though Blackstone's $170 million write-down (thanks to FGIC's demise) didn't offer any inspiration. Tuesday: Bernanke steps in before the market opens and says he's going to loan $200 billion worth of high-quality debt to the lending industry while the Fed holds their low-quality paper for a few weeks. The idea is to give banks and mortgage companies the ability to make more loans. The market loved it....for a few hours. (I blogged my thoughts later that day..."The Fed's Throwing Away Good Money After Bad")  Wednesday: Bernanke's purchase of a rally goes bust when the market figures out that the Fed's measure won't actually solve the problem; stocks sank moderately. Thursday: Treasury Secretary Henry Paulson (& company) release 20 pages worth of recommendations to the lending industry for (1) getting out of the mess they're in, and (2) not getting back into the mess again. Once again the market liked it....sort of. We saw a huge intra-day rebound, which got the indices back to a break-even for the day. Gold reached $1000 per ounce. (I blogged my thoughts again that day too..."Paulson: 'Time to toughen rules on mortgage brokers.' (Me: 'Ya think?')")  Also on Thursday, the Wall Street Journal ran an in-depth story about the economy's woes. According to their surveys, most economists now think we're in a recession; they had an encyclopedia of facts and figures to support the opinion. See this blog entry for the whole scoop. Friday: Bear Stearns (NYSE: BSC), on the verge of collapse, is bailed out by the Fed and J.P. Morgan (NYSE: JPM). Bear Stearns was in trouble because of the possibility they may be the new, un-proud owners of some worthless mortgage-backed securities that Carlyle Group was sitting on. Knowing this was a possibility, Stearn's customers and lenders just wanted to cash out rather than get stuck with the downside of insolvency. The market sank again. I think that covers all the big stuff, but what does it all really mean?    The Message I'm not going to repackage the obvious. Instead I want to tell you some of the things I heard in the back of my head over the past six days. First of all, the subprime mess is clearly not just a perceived problem. No news there. However, the subprime mess is far from over. There are an estimated $400 billion worth of ARM loans to be reset (to higher rates) in 2008 in addition to the approximately $300 billion worth of reset loans for 2007. There's something close to that figure slated for resets in 2009. The exact dollar amounts are all over the map, but it doesn't matter - the scope is enormous. You could argue the government has a bailout plan, but they don't. The ARM rate freeze is voluntary, not government funded, and only applies to a very small portion of ARM borrowers. Anybody more than 60 days behind, or any borrower who made a 3% (or more) down payment, are ineligible for the any help. So what?  If subprime mortgage-backed securities are essentially worthless now, how will they recover any value this year or next year? If other financial organizations are in the same boat Bear Stearns is/was in, are they going to face insolvency too? I think the answer is 'yes'. That certainly won't affect all financial stocks, but it may be a problem for more than you think. Mortgage companies, banks, bond insurers...all these struggling companies may not get any relief for a while. The other idea I can't shake off...the Fed is coming across as desperate. The White House is too.  The odds of a full point rate cut on Tuesday are now at 46%, while the odds of a 3/4 point cut now stand at just a hair under 100%. That would put the Fed funds rate at 2.25% or 2.0%, depending on how deep Bernanke goes. Either is wildly low though. My point of view when it comes to interest rates is admittedly the minority one, but here's how I see it - when the Fed gets in a 'rate cut mode', I get scared. The Fed (Greenspan at the time) was slashing rates like crazy between early 2001 and early 2004, but it didn't help the market until early 2003. So, if anybody thinks a rate cut always has an immediate benefit, the historical evidence doesn't conclude it.  There is an upside though - the economy doesn't run in sync with the market. In general, the market leads the economy by a few months....when there's a correlation (there's not always a measurable relationship). If we are in a multi-month recession, stocks may rebound in anticipation of the economic trough being made.  That ultimate market bottom may still be a few months out, which leaves room for more downside. However, I know I'm going to be most interested in buying when nobody else wants anything to do with the market. Why? Because most everyone else is making their investment forecasts based on historical economic data. Big mistake - you can't tell where you're going by looking behind you.   Bottom Line I'm actually bullish in the very near-term (days). We have the Fed meeting on Tuesday, and Ben Bernanke is going to essentially be required to do something inspirational for the market. Plus, stocks are oversold, and the short-term mood is maximum pessimism...the right ingredients for a decent bounce. Beyond that (in terms of weeks), I think too many people are convinced we're entering a bear market. These same investors will be subject to their own self-fulfilling prophecy. Besides, we really need a good cyclical bear trend to clean up some of the problem areas. Throw in the fact that the government is really starting to sweat. I'll have more on all of this in upcoming editions.    A Little Homework  I know I've been focusing on the same topic the last couple of weeks, but hey - it's what means the most to all of us right now. However, I want to look at something else I mentioned earlier about being in the right sector at the right time...even during a bear market.  Here's a little homework for you - take a look at the nearby performance chart, and try to figure out what each of those lines represents. I don't want to give too many hints, but think style, sector, market cap, region, etc. By the way, the timeframe for this chart is exactly one year. I'll have the answers for you in the next edition. I'll also make my point at that time, though I hardly think I'll need to...the answers will make my point for me. 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