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October 8th, 2008 - The Big Lie

Keeping up with recent events has been an exhausting task. The days of holding stocks in short or long term trades, with your only worry being Google’s earnings report, or worrying about the impact of a surprise “earnings miss” on your favorite stock, are gone. Those types of concerns have been replaced with companies becoming insolvent overnight, bankruptcies, credit market implosions, housing market declines, and bank failures. We even added one more worry to the list: entire nations becoming insolvent. This morning we learned that Iceland essentially went into default, as their currency lost most of its value in 24 hours and was no longer being accepted as a valid form of payment in some places.

Yep, the good old days of just worrying about a bad earnings report are gone, for now.

The rapid growth witnessed in almost all sectors of our economy are gone. Most of the growth was an illusion based all on credit. Everything grew quickly,from home prices to iPods and big screen television sales, all because of the free flow of credit.

The big lie being put to the American people, is that the heart of the credit implosion is due to individuals getting in over their heads and no longer being able to pay their mortgages. The truth is that it was Wall Street investment firms that sought to capitalize on the free flow of credit and rising housing prices, by securitizing mortgages. They created numerous forms of investment securities (based on mortgages) that were so highly leveraged, that when the underlying asset (mortgages) began to weaken just a bit, the leverage ratios came crashing down hard. And, it did not stop there. The very same firms that created these exotic investment securities, sold them to everyone from pension fund managers to foreign governments, with very little (if any), warning of real risk potential.

Do you want to know an even bigger lie? Our government telling the American people that they will get their money back. That’s right, it is a lie. The US government will use our tax dollars to buy the toxic assets from anyone who was duped into buying them.  Then, they promise to sell them later, at a profit. Remember, these toxic assets are all tied to the housing market in one fashion or another.  So, in order for their plan to work, there must be a demand for these assets at later date.  Demand will ONLY exist if the rapid rise in housing prices returns. This will not happen, because it was the credit bubble that created the housing bubble, and credit is evaporating rapidly and will never return to the likes of what it once was. These toxic assets will end up being nuclear waste on the US balance sheet and will eventually have to be buried, along with the $700 Billion that we paid for them.

The events of the past year have created a generational shift in the way our markets will behave for a very long time. It could be as many as 10 years before we ever see new highs again in the Dow or the S&P 500 indices. One only has to look at the Nasdaq to see what happens when a bubble explodes. Following the bursting of the “dot com” bubble in the late 90’s, the Nasdaq traded in a subdued fashion, never coming close it’s previous highs. This is what we have to be prepared for once this current crisis has passed.

A buy and hold strategy for making money in the markets will likely be a futile exercise for many years to come. The real money to be made will come from getting in and out of the right stocks and at the right time. That, we will help you do.

We are at the precipice of a bear market rally or a hard crash. Even the global rate cut announcement this morning was not enough to get the market going. Those who bet heavily in the morning, thinking the market would go skyward, ended up in the loss column by the end of the day. These remain very dangerous and treacherous times in the markets. The Financial Times reported tonight that the stress in the credit markets is even higher now than in recent months, and that was after the global rate cuts were enacted. When the time comes for the next bear market rally, know that we will play accordingly. We still expect the bear market to last well into 2009. Long term outlook for the economy and the markets remains bearish.