Tuesday, February 27, 2007

From Shanghai to Frankfurt to NYC: One Helluva Ride!

Okay, let's call this what it is. Today's 508-point slide on the NYSE was not a Black Tuesday. It might have been something like a Grey Tuesday. And to be sure, the bloodshed might not be over, but for the moment, we are not experiencing a really big correction, percentage-wise. In fact, as markets closed down over 400 points, this correction is turning out to be a roughly 3% move.

By now everyone knows what happened. A very bloated and very opaque stock market in Shanghai got a bloody nose when investors bailed, out of fears that their Communist bosses were going to reign in the good times. Couple that with a botched attack on the U.S. Vice-President, and with words from former Fed Chairman Alan Greenspan--and you have got the makings of a global, financial calamity, right? Not necessarily.

There are some hidden dynamics that have made this small correction even possible, and the average investor typically has no idea that this stuff has been building. So lets try to put some of this into perspective.

(1) There is no such thing as a unique trading strategy anymore. Institutional investors have been moving with a herd mentality for some time now. They piled into commodities in the spring of last year, and then they turned around and bailed out at the same time as the fall began. For example, it took one large investor, Goldman Sachs, to rattle high crude oil and natural gas prices, and they inspired a sell off that brought energy prices back down. (After all, it was only speculation based on fear that kept them high, anyway.) Consequently, guess where all of the money that left commodities ended up? Answer: in the equities markets. And guess who did the most selling today? Those same institutional investors.

(2) Let's talk about where this began---China. Oh, come on; it's China! You have to understand that not all markets are created equal. Some do not require that listed companies utilize transparent accounting methods, or even require that those companies have routine financial reporting protocols. Think of that, along with a perceived desire by the Communists (who are still, yeh, just that) to control capital outflows---and investment in China's market was a risky game to begin with.

(3) This correction was not based on a lack of good fundamentals. There are still strong companies in our domestic market, and for the individual investor, this is as good a time as any to sift them out. Don't be afraid to look for them now. Their stocks might be a little more of a bargain today.

(4) The drop in the dollar is a double-edged sword. Certainly, this means that your summer trip to London, or the price on that BMW, might be a little more expensive. But a weak dollar is a hopeful tool for our U.S. exports. (BTW, do not worry about China. They had pegged their yuan to our dollar a long, long time ago. So, if we fall, relative to the Euro or yen, they do so, accordingly, keeping relatively cheap the goods manufactured there and then imported here. So the flatscreen at Best Buy will be okay, for now.) My concern here, however, is how the Fed will read a weaker dollar, as its counterparts in Europe and Japan ratchet up their own interest rates, if only slightly. Why be comcerned? Well, the Fed has to consider if inflation could pop up and, additionally, if our own treasury vehicles (which finance our debt) could still be attractive buys for foreign investors who'll now have alternatives in Europe or elsewhere. The Fed needs to make a decision for real balance--growth, but smart growth. Anything less--and a wrong move, like our own ratcheting up of rates too soon, could really put harmful brakes on growth.

(5) When the dust settles, look for some reports about electronic trade triggers. Some of this selling was provoked by computerized trading set to unload stocks, et al., when markets hit a certain points. There are supposed to be governors to curtail such electronic trades. The question is, did they work? Hm, probably not.

(6) There are some very real reasons for concern that investors do not need to ignore. A weaker housing market and a horde of sub-prime mortgages are specters for the financial-services industry. If people start to default on their mortgages, then you could see a lot of liquidity drying up, and that would be no good, because we have been financing our way through the last few years. What's more, though there is a LOT of oil out there , there is limited capacity to refine enough for it for our summer demand, and we could be looking at another year of supply-side fears. (Heck, I paid $2.30 per gallon of gasoline today, and that is above the price this time last year.)

Taken together, how do you digest this? Well, you do not...Believe it or not, as Larry Kudlow of CNBC said, the event today is a blip; all of the fundamentals are still strong and forwardly encouraging. This is good. And if today's wild ride rolls on for the remainder of the week, this should not be gauged as the beginning of the end for the financial markets. In fact, it might be the beginning of some good opportunities to find really good values in the market.

And so---while the world gets really nervous about the sleeping dragon's indigestion, or bearish about the today's stock market activity, then just read this as nothing more than an occurrence. And remember that markets are not secure from risk, and from time to time, we will see volatility, like we did today. Only the day-trader would go nuts now. The rest of us should hug our mom and our kids. Enjoy a game of golf in this nice weather, or maybe take in a good movie. And relax. After all, it's just one day.

Matt 5:16

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