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When will the selling stop? Ask the big boys: the hedge funds, the trading desks at Wall Street banks and the chief financial officers at the world's biggest companies.
They've panicked. For weeks, they've been selling just about everything that had some value in order to cover margin calls or investor redemptions. That wave of selling looked to me like it was about to end after stocks hit new lows Oct. 10. In the following days, on Oct. 15 and Oct. 20, stocks even managed big gains.
But now the selling has resumed. What happened to derail the recovery? The big boys, in their panic at the size of the losses they were being forced to realize when they sold, doubled down, making even riskier bets in attempts to make up for losses. And now that those new bets have generated huge losses, too, the big boys are selling again.
My worry is that this selling will be enough to force the stock market below the Oct. 10 intraday lows of 7,883 for the Dow Jones Industrial Average ($INDU) and 840 for the Standard & Poor's 500 Index ($INX). A break below those lows would likely cause the panic to spread from the big boys to other players in the market, and that would set up another leg down in this very depressing and severe bear market.
Bad tips from the pros
There are two lessons here for individual investors like you and me:- First, in a risky market -- and this one counts as risky in spades -- never try to recoup your losses by taking on even more risk.
- Second, just because the big boys have panicked, done some really stupid things and been forced into selling, doesn't mean you have to sell in a panic, too. The big boys aren't paying any attention to the value of what they're selling. In fact, they're most likely to sell those stocks that have held up best up to this point, because they're the best source of cash right now.
I think it's way too early to buy much of anything in today's market, unless it comes with a high and safe dividend yield or unless you're a steel-willed practitioner of dollar-cost averaging at the beginning of a long investing career. (See my column for these investors, "When to start investing? Now.")
But I think it's way too late to sell the good stocks you still own. They've undoubtedly plunged along with all the junky stuff -- and could drop some more -- but they're now probably trading at prices that in a year I suspect will look like real bargains, even if the economy has slipped into a recession.
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By now I hope you've got a decent cash position in your portfolio so you're ready to take advantage of the turn in the market when it finally comes. If that's the case, I think the only selling you ought to be doing during this panic is when what you thought was a good company turns out to have serious long-term problems (dump the sucker; the turkeys aren't going to fly very high when the panic is over) or when you can sell to trade sideways to replace a good stock with a great stock in the same sector.
Because everything is selling off now, trading up to the shares of a better company isn't likely to cost you much, if anything, in the way of a premium. So, for example, if you've always wanted to own Monsanto (MON, news, msgs) for its dominant position in the seed industry but bought DuPont (DD, news, msgs) instead because Monsanto was too expensive, well, now might be a good time to trade up by moving sideways in the sector, since Monsanto shares were down 37.2% from May 1 to Oct. 24 and DuPont shares were down 38.5%. That's just about a wash.
Even if you still want to raise cash, I think this is the wrong time to sell. The S&P 500 is very close to dropping to the 2002 low set in the last bear market, and a bear market rally from that base is extremely likely. All bear markets include protracted rallies, and we're way overdue for one because of this extended wave of selling by the big boys. Panics don't go on forever. Bear market rallies typically show gains of 15% to 25%. And after a panic this deep, I think any bear market rally is likely to be near the top of that range.
To understand what the big boys have done, it helps to think of them as gamblers. These gamblers lost all their cash, and the titles to their cars, when a full house beat their hand of two pairs -- aces and 8s, of course. And then these gamblers, rather than walking or running away, decided to try to win back what they'd lost, and more, by betting the deed to the family house on the slim odds that they could draw the last card they needed -- a 6 -- to fill an inside straight. If they didn't draw the 6, the hand of a 4, 5, 7 and 8 would be virtually worthless. Anybody with a single pair -- heck, even with a 9 -- might've beaten it.
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Is market near a bottom?Fundamentals say stocks are getting closer to leveling off. Unfortunately, with fear driving the market, you can throw fundamentals out the window. Only the economy will decide whether there’s 20% or 50% more to go, Jim Jubak says.
And, of course, this is exactly what has happened. First, the big boys made big bets on risky mortgages that had been sliced and diced into packages of mortgages, on credit-default derivatives based on the chances of companies defaulting on their debt and on derivatives based on buyout loans. When those bets didn't pay off -- because homebuyers defaulted at higher rates than expected by Wall Street's computer models -- the big boys saw the value of those investments plunge.
And that sent the whole debt, equity and derivatives pyramid tumbling, taking down not just the risky derivatives themselves but the global debt and equity markets. That set off what amounted to a global margin call. Banks that had lent money on the value of these portfolios suddenly started calling up hedge fund managers and other managers and asking for more collateral. Managers started selling whatever they could so they'd have cash on hand when their investors demanded their money back. The big boys sold and sold and sold, and with each sell, the demands by banks and investors just grew.
Continued: Doubling down, dimly
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