In a Crisis Correlations Converge to One
To some investors Monday presented a great opportunity to pick up stocks following a steep sell-off last week. That is why we saw a decent rally yesterday. Early today more bargain hunters started to pick up stocks. Late in the day, we had another sell-off. Both groups were burnt badly this afternoon. For investors still looking to pick up more stocks at bargain prices, Financial Watch has one recommendation for you – wait. Fundamentals do not matter at this moment. Everything is going lower.
The bears are firmly in control right now. American Home Mortgage is latest lender to blow up. It will not be the last. There are too many mortgage lenders that will not be trading in a year from now to name here. Avoid everything in the mortgage sector. Financial Watch believes that in time we’ll see enough fraud in the mortgage business to make Ken Lay and Enron look like choirboys. Income statements and balance sheets cannot be believed. A few weeks ago we saw what happened when illiquid investments are marked to market as happened to the two hedge funds that blew up at Bear Stearns. In time, we’ll learn significant assets held by banks, mortgage lenders, pension funds, and homebuilders are not worth more than a fraction of what is currently marked on the balance sheet.
A key feature Financial Watch looks for in determining when we’ve reached a bottom is called a double-bottom. In this situation a sharp pullback is followed by a small rally, and then a subsequent move downward that stops higher than the previous pullback. This afternoon the bottom broke just prior to the close. Our next level of support is at 1390 or 2% below where we started the year and 10% below the peak on the S&P 500. Financial Watch expects we’ll move that far down. Only the Fed can step in to stop the panic. The Fed will meet next week to discuss interest rates. Unanimous opinion is that the Fed will keep rates at 5.25% next week; we’re not entirely convinced they will do nothing. Friday’s employment report will be key to determining what the Fed will do next week.
In a crisis correlations converge to one. Otherwise, it does not matter how good your investments are performing right now. Everything is going lower in the coming days. Our only safe-haven is treasuries. With yields at 4.7%, most of the rally has already occurred in the treasury market. Financial Watch believes it is best to stay in cash until the storm passes. And then it will be time to pick up stocks trading at bargain prices.