Devastation

October 10, 2008

Just when you thought it was safe to enter the market.  Also, “what a difference a year makes.”  Exactly one year ago, the S&P 500 and Dow Jones made all-time highs… one year later, we’re making fresh and significant five year lows.  Let’s look at the S&P and the XLF Financial Sector on weekly charts.

S&P 500 Weekly Chart (compressed):

To say the ferociousness of the recent price swing down was unexpected (in its magnitude) is perhaps an understatement.  Many of us - myself included - did have price targets beneath S&P Index value 1,000 (some even down to the 2002 lows near 750) but I don’t know of anyone who had the targets being achieved this quickly - it was stunning and remarkable.

Notice how the market was making lower swing lows and lower swing highs in an orderly fashion - that is the ‘rules of the game’ and normal conditions.  The trajectory (trend) is clearly down but it is peppered with stable, salient retracements (usually to key Fibonacci levels such as 50% of the prior decline).  In this current swing (which - as of this writing - is not over yet), there wasn’t a pause or breath - it fell like a rock, blinding many fundamental, technical, and quantitative analysts.  “This isn’t normal.”

But it is what it is - Mark Douglas said it best:  “Anything can happen [in the market]” and “Every moment in the market is unique.”  I thought of his quotes immediately when the government banned short-selling on Financial stocks - did anyone see that coming… or even as a conceivable possibility?  Even if you did, could you have foreseen the ramifications of that decision?

So we’re in a new world with perhaps new rules - what worked in the past doesn’t seem to be working (in terms of long-term investing or short-term/position trading when it comes to ‘buying what’s overextended’ for a ‘reversion to the mean’ style trade).  It is what it is.

Anyway, let’s look at today’s 7% index decline as distributed across the AMEX select Sector SPDRs.

The intraday Sector Performance:

The Energy and Financial sector were hit hardest, with - surprisingly - the Technology sector holding its own (Apple - AAPL - though it closed slightly lower, did well for the day and could be starting a counter-retracement up along with RIMM - but that’s another story).

Let’s zero-in on the Financial Sector.

XLF Financial Sector:

The major culprit behind the recent ‘crisis’ stems from past practices with Financial related companies.  The financial sector - and investors in it unfortunately - have suffered dearly for those mistakes.  Banks are in serious trouble and are seizing up - credit is no longer lubricating the US Economy as freely as it had in the past - banks are afraid to lend and no one’s exactly sure when the next shoe will drop or how much ‘toxic debt’ is still on the books.

So what is the expected play now?

You’ve heard it 100 times now - the market is so overextended that a rally is due.  But the next day brings more selling, so the sentiment grows more urgent:  “Well, we’re certainly due for one now.”

My response?  Absolutely, and it’s probably going to be a quick rally - but it seems like the government is doing everything it can to start that rally (cutting rates, giving speeches, passing the Bail-out bill, etc).

But it hasn’t happened.

Let the professionals play in this market.  Let them catch the falling knives - somewhere (perhaps here), price will hit valuations that fundamental (and even technical) traders will find unbelievably attractive and they will begin buying - perhaps aggressively.  But as long as fear and panic rules the day, it’s uncertain when that time will come.

Whatever you choose to do, your #1 goal should be capital preservation - be it taking smaller positions, trading more selectively (not just jumping at anything that moves), going away from stocks temporarily and only trading ETFs (perhaps even Index ETFs), or even just sitting in cash while avoiding the market altogether - it’s your choice.

But don’t think you’re going to make a killing when everyone is getting killed.

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