Dealing With A Historic Day In The Markets

MULTI-YEAR LOWS FOR MARKET

NEWS: The S&P 500 (^GSPC) closed at the lowest level in nearly three years after one a history-making weekend for the financial sector. The index lost 59 points or 4.7% to close at 1197. The Dow (^DJI) plummeted 504 points or 4.4%. The NASDAQ (^IXIC) fell 81 points or 3.6%. Oil also fell after the hurricane did not do the damage to the oil installments that many expected and closed below $100 for the first time in months. Gold was the lone bright spot, gaining over $20 on the session.

THE BOTTOMLINE: The Dow closed at the lowest level in two years, but did hold above the July low of 10,827. At this time the index is on the verge of a major breakdown and the next few days will be telling for the Dow. The S&P 500 has already broken support and has another 2% until it finds any support on the charts; the long-term support is at the 1136-1139 zone. The NASDAQ held up better than its peers, but still got crushed. But what I find interesting about the tech-heavy index is that it is sitting at a triple-bottom. The low of March was 2155, low of July was 2167, and today’s low was 2179. This can go either way; if it holds it could be a buying opportunity off a triple-bottom or if it breaks below 2155 it would be a very damaging breakdown for the index.

Since 2003 the CBOE Volatility Index (VIX) has only traded as high as 31.87, a level it hit today, only three times. The first was in August 2007 when the S&P 500 bottomed at 1370 before rallying to a new all-time high in mid-October. The second time was in January when the S&P 500 bottomed at 1270 before rallying to 1400 in the next two weeks. The third was in March when the S&P 500 rallied from 1256 to 1426 over a two-month timeframe. Typically when the VIX gets to this level is suggests fear is running rampant (which it is) and a short-term bottom is very close. Unfortunately I am not sure that is the situation today and would like to see other indicators in my favor before giving any type of buy recommendation.

HISTORY IN THE MAKING

NEWS: This weekend was one for the history books as the 4th largest investment firm (Lehman (LEH)) files for bankruptcy. Then Merrill Lynch (MER) gets bought for $50 billion by Bank of America. Finally, the largest insurer in the US is also on the verge of collapsing.

THE BOTTOMLINE: Even though thousands of Lehman employees are out of jobs and shareholders are left out in the cold, I believe what took place was the best for the individual investor and America. By letting Lehman go the route of bankruptcy versus a government bailout it is a large step forward in getting to the bottom of this mess. It was time for the government to let the free markets take care of the situation on their own and Lehman just so happened to be that victim.

In the case of Lehman, they were one of the largest underwriters of mortgage-backed securities and profited greatly from it. The fact they held on too long and overleveraged themselves should not become the tax payers’ burden. The key here is that Lehman did not implement any risk management and therefore is no longer in existence after over 150 years in business.

The free markets were also at work today with Merrill Lynch taken over by Bank of America in a $50 billion deal. The purchase price is a 70% premium to Friday’s close, but about 50% below the 2008 high for the stock. This was the one silver lining in a disastrous day on Wall Street. I believe Bank of America will be one of the financial leaders to come out of this mess in the months ahead. The purchase of Countrywide Financial and now Merrill at very low prices indicates they are willing to take advantage of a buying opportunity when they see one. The same type of mentality works for individual investors in times like this. However, I would wait for more moderation in the financials before running out letting the buying spree begin.

I just have a few parting shots on the situation today and how investors should be dealing with it. First and foremost, do not panic. I know it is not as easy as it sounds, but it is what you must do to make it through this market. If you feel more comfortable with more money in cash, I am not against that, but do not sell in panic - instead, put together a plan to sell. Second, keep in mind that once the panic is removed from the Street, there will be numerous opportunities for educated and willing investors. When a market is in this state of mind, all stocks are sold regardless of whether they are affected by Lehman or any of the financial crises. Therefore two strategies are suggested.

One, diversify into a number of sectors to avoid anything like we have seen in the financials. Two, raise some cash; we sold some positions over the last month to limit our exposure to the market and have even gone as far as hedging with short ETFs.

Examples of stocks that have been able to hold up well in this market, but were down today with the overall market include: Johnson & Johnson (JNJ), Activision Blizzard (ATVI), and True Religion (TRLG). Think about the stocks above and what they do. JNJ is in consumer health, medical devices, etc. Their customers are not going to debate whether to buy a new medical device used for surgery or shampoo based on Lehman. ATVI and TRLG are tied to the consumer, but have held up very well in this market and continue to grow earnings at a high pace again this year. As long as earnings continue to increase, any drop in the stock price makes it that much more attractive.

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