Michael

Right now it is very difficult to tell what is going to happen to the market. A highly watched measure of volatility is the ^vix and many call it the fear index. When this index is above about 30, that usually indicates high volatility. The index has been running above 30 for about three weeks and hit a high of 48 (ultra high) last Monday and has not dropped below 39 since then. Normally when the index returns back to below 20 after a big spike, that indicates the market had a very big drop and may be ready for a turn around to the up side. However, since shorts are currently banned for financial stocks, I suspect the index may currently not be predicting the bottom of the market but if it dropped below 20, I would still take a chance on the market.

Select max for the chart and you will see spikes that match up very well with large drops and then turn arounds on the dow, s&p 500, and nasdaq markets. Specifically you will notice that in 2003, the index spiked and then dropped below 20 starting the last bull market.

The index is not very complicated in that it only tracks put and call options and when interest is high, the index is high and when interest is low, the index is low.

http://finance.yahoo.com/q/bc?s=%5EV...=on&z=m&q=l&c=

http://www.wisegeek.com/what-is-vix-...lity-index.htm

Michael

Although most of the financial news over the past few months have centered around the US financial system, banks in Europe seem to be in worse shape. Unlike some major US banks (Wells Fargo, JP Morgan/Chase, and US Bankcorp), Europe does not have any major banks that appear to be as healthy as those US banks.

Last week Irish banks had a run on deposits and Ireland insured all deposits (no limit) in their banks but not other banks operating in the country. Although on the surface this would seem to be a good thing, UK banks in Ireland are not covered by that guarantee and the British government is concerned that that there could possibly be a run on deposits on UK banks in Ireland as well in the UK since Irish banks are also located in the UK.

Also other members of the EU are concerned that Irish Banks have an unfair advantage over other EU banks and will attract depositors from those EU banks.

http://www.cnbc.com/id/26993482

http://www.ft.com/cms/s/0/79e8fe8a-9...00e2511c8.html

RoadWarriorFromLP

Well, it's a bit late for me to make predictions, being that this has now happened, but as we can see, there has been a lot of volatility this week. Today, the market ran up in anticipation of the vote, but then fell as the votes were being tallied and it was clear that the deal was going to get done.

With the bailout approval just about behind us, we now have time to focus on the next pending crises: overseas bank failures, soaring overnight lending rates, tight credit, increasing US unemployment on the horizon, the likelihood of declining corporate earnings, investors running scared, etc., etc.. In my opinion, all of that doom-and-gloom adds up to the bear market continuing, but with a lot of volatility and possibly erratic upward spikes on the path downward. I think that it could take several months or more before the markets become bullish again.

Right now, it's what the pundits call a "trader's market." That basically means that issues are trading largely on volatility (price movements), rather than on pure fundamentals (the underlying value of the companies.) If you're a casual investor, I'm of the opinion that putting your money into stocks without active management is a good way to erode your principal.

I normally would not recommend market timing to the average person, but times like this may be an exception. You might be better off staying on the sidelines for the next several months, rather than getting in, so that you don't lose money. I'd stay in cash, government securities, etc. until things become less crazy and you can see some light at the end of the tunnel. Just don't avoid the markets forever -- there will come a time again when investing in stocks based upon the fundamentals makes a lot more sense.

Steerpike

What if you are already pretty heavily in the market? I have quite a bit of stocks and mutual funds, and am off about $200k already since their high of 1-2 years ago; off about $40k this week. To sell now would lock these losses in, but - better to cut losses than keep losing. However, my big mistake years ago (2001) was pulling out and then not getting back in when the market went back up!

RoadWarriorFromLP

No one can predict the future with complete certainty, but if you are invested in reasonably sound stuff that is just moving around with the market as a whole, then I'd probably hang on to what you have and wait for it to come back. The GE's of the world should be with us for awhile.

Don't hang on to the complete losers that are doomed to fail, but there's isn't much point in selling generally sound investments unless you have a substantially better use for the money. I'd be reluctant to simply liquidate everything just in the hopes of getting the reenttry timing precisely right (which you probably won't.)

Market economies go in waves. Things go down on their way up, but the general trend is for successful companies to climb over the long run. The rides downward may be gut wrenching, but you should get it back later.

Michael

I'll have to agree with RoadWarriorFromLP. Although I don't think the stock market has bottomed yet and still expect another drop of 1,000 points or more for the dow, the market is now in a trend that is very difficult to time. There is currently so much gloom and doom that the market could possibly turn upward on a dime after a major drop. However, if a person didn't currently have large loses in the market, I'd again recommend getting out and if they missed a re-entry point, that is just life. For someone that currenly has large loses in the market, getting out now could possibly cause major damage since they may not be able to get back in so they may never recover their loses. For someone who did not experience loses due to not being in the market, they don't have to get in at the bottom so their timming is not that critical and if they miss re-entry, nothing is lost (just not the advantage of gain).

I was lucky that I jumped out of the market about 18 months ago when there were hints of sub-prime market problems. At first I thought I had overacted since volatility was still low and the market kept rising for another 6 months. However, since I was approaching retirement, I didn't want to take a chance with the market since I had previously lost my arse during the tech bubble (even though I am usually a fairly conservative investor but against my better judgement got caught up in the frenzy and speculated heavily in highly speculative tech stocks when I exercised in my stock options which I considered as extra cash).

I think I mentioned several months ago on this site that I thought it would be time for people to get out of the market at the time the dow was around 12,000 (not that far down from the top of the market so for most people losses shouldn't have been too great). Normally I don't make predictions but this time it seemed like the right thing to do. However, during that time, I was also looking for an entry point into the market again and even questioned my judgement to stay out as the market went up and down but things did not look right. I'm still looking to get back into the market when I feel conditions are right.

If I had the guts, I'd currently probably short the market but that is real gut wrenching. I could also play the put options (not very expensive but have a large spread in a downward market and can be very difficult to sell) but those have to be correctly placed on individual stocks since even a large market drop doesn't necessarily produce a profit. Since I normally don't do short sells or put options and my knowledge is limited, I'm staying away from that.

Michael

Today I was watching CBS 60 minutes and a guest stated that the crisis is not primarily caused by the sub-prime mortgages but instead by Credit Default Swaps that the banks, hedge funds, and insurance companies sold to insure the sub-prime mortgage backed securities. Apparently wall street called them Credit Default Swaps instead of insurance since they didn't want to be regulated by the insurance regulators which would require the banks to have money set aside to cover the insurance. Apparently banks offered Credit Default Swaps to customers to entice them to purchase mortgage backed securities (CDOs). Amazing that the bank managers could be so dumb.

Apparently much of the loses are due to the Credit Default Swaps.

Maybe the Fed should just let those banks (already Bear Sterns, AIG, and Lehman Brothers) that have large amount of Credit Default Swaps loses or outstanding swaps go under. You would have thought that Hank Paulson would have known what was going on since he was a previous CEO of Goldman Sachs and could have stopped the practice when he became treasury secretary.

I thought that almost $600 billion (mostly US and European banks) in loses worldwide due to sub-prime mortgages was too high but now I suspect the banks are including loses due to the credit default swaps in the figure. That would have been about $200,000 loss per home for 3 million homes if the total loses were attributed to the sub-prime mortgages and the average American home was valued only about $300,000 at the height of the market. I wonder how much of the loses are still not being reported by the banks.

Apparently WaMu, Wachovia, Countrywide, and Merrill Lynch must have had few credit default swap loses since those were able to be sold pretty well in tact without any cost to the government. However, I suspect the Bear Sterns, Lehman Brothers, and AIG had to many loses due to the credit default swaps and couldn't be sold without either government backing or bankruptsy. I don't think Freddy and Fannie should be in too bad of shape since their application requirements should have eliminated speculators as well as people that could not prove ability to pay.

For the past few months, CNBC has been talking about problems about credit default swaps and it took me until last week to understand what they were. Yesterdays program cleared up how they were used.

Things appear to look worse than I thought but still unsure how bad since there are so many unknowns.

RoadWarriorFromLP

I have been contending from the start that the "subprime" story was a lie, meant to hide the real problems of excessive leverage and bogus theories of risk allocation. Unfortunately, the media bought into the rhetoric and disseminated it widely, so the increasing defaults of prime borrowers and the weakness of the financial institutions could be shoved under the rug.

More greed than stupidity. That, and publicly traded financial institutions in particular are burdened by the need to earn short-term profits on a par with their competitors. It would be tough for a bank to explain why it is avoiding the aggressive lending market when its competitors are playing in it and reaping profits from it. It's easier just to go along with it than to be bold and avoid it.

The bailout and other intervention by the US and other treasuries should help to get this moving. But the turnaround isn't going to happen overnight, these liquidity measures will take weeks to put into play.

In the meantime, don't panic. This isn't great, but it isn't 1929. Hopefully, we learn from this experience and never allow this runaway train of excessive leverage to happen again.

Michael

On CNBC today, they were discussing the problems that credit default swaps caused Lehman Brothers and one of the talking heads said that he thought that the problem was that since the swaps weren't regulated, Lehman Brothers did not put aside reserves to cover the swaps.

One of the guests was an ex-Leman Brothers employee and he said he didn't think that was the problem but just that Lehman Brothers probably didn't charge enough for the swaps. I wonder what he would say the next time a company goes under even though they charged double the current price. These wall street people just don't seem to learn that you shouldn't sell insurance when you don't completely understand the risk of the underlying security and if you do understand the risk, then you should set aside reserves to cover the probable risk.

Tarkak9

Also, in "business school", they should also put emphasis on teaching business history as well as their so called business ethics.... patterns and indications have been existing over and over again t/out the years.

They are also saying that next year will bring about 100 more bank failures.. Bauer Financial suggest to say the largest numbers of troubled banks are in California, Florida, Georgia, Illinois and Minnesota.

RoadWarriorFromLP

They're just denying it in order to avoid culpability.

We won't learn from this. The usual pattern is to blame the third-party reports (ratings agencies, appraisers, accountants) and "corruption" (certain CEO's), while ignoring the systemic issues that actually caused the problems. Attacking symptoms instead of causes is just the norm.

anotherlimey

There was a big piece on NPR over the weekend covering Credit Default Swaps, very interesting and an accident waiting to happen.

I hope no one invested too much cash last week. I've been hammered this morning.

Michael

More problems is Europe.

HUNDREDS of thousands of UK savers were yesterday blocked from withdrawing their cash from Icesave, the troubled Icelandic internet bank, amid warnings the parent group was likely to go into liquidation.

http://news.scotsman.com/uk/British-...-as.4567943.jp

Iceland has been having a run on its currency over the past year so the government had previously raised short term interest rates (overnight and 7 day CDs) to more than 15% to try to stablize the currency without much luck.

http://www.sedlabanki.is/?PageID=224

Chancellor Alistair Darling has announced a £50 billion emergency rescue plan for stricken UK banks. The scheme will see taxpayers' money used to buy stakes in major banks in an attempt to halt the meltdown in the financial sector.

http://ukpress.google.com/article/AL...N6vJ-DaZV-CpUw

Spain will spend as much as 50 billion euros ($68 billion) to buy assets from its troubled banks, the first effort by a European country to follow the U.S. rescue plan.

http://www.bloomberg.com/apps/news?p...4&refer=europe

Michael

Steerpike,

I previously gave you advice that wasn't very good. No one has seen such a market like this. Even though the markets rose over 10% today, I suspect it is a bear trap.

I don't think the crisis is over and do not think that it will be v-shaped recovery like previous market declines. I suspect that the market will retest or exceed the recent lows several times over the next few months.

The following are the reasons that I think the market problems are not over.

• With all the government intervention, the banks around the world are probably in much worse shape than we realize.
• The market decline and credit crunch has caused major damage to economies around the world. Earnings should continue to decrease forcing stocks down.
• Credit is still very tight and the markets are still frozen.
• Market volatility is still very high.
• Bank toxic debt is probably very high and is still held by the banks. It is going to be difficult for the economy to recover with the bad debt on the books.

Since I believe that the market will rise and fallback several times over the next few months, this is what I would do if I was in your shoes. If the market is stable tomorrow, I would stay put but if the market rallies, I would sell 20-25% of your securities into the rally. I suspect that there will be a pullback after that rally and then I would purchase stocks on the pullback with the money that you got when you sold the securities. Over the next several months, I'd continue to sell 20-25% of the shares into rallies and repurchase stocks on the pullback. Personally I would purchase Diamonds (DIA) instead of trying to figure out which stocks to choose. Its a little difficult and you have to be disciplined (try not let emotion get in your way) but I suspect this is a perfect market for that technique but you have to watch the market closely.

The only risk to using this technique is that if the rally is real, you may not get the gain of the 20-25% that you sold and may have problems with a wash sale (this can be eliminated by either selling off your complete portfolio 20-25% at a time and then repurchasing Diamonds. When you end up with all Diamonds in your portfolio, you can then purchase Spiders (SPY) to eliminate any possibility of wash sales). Another issue is that you could get hit with short term capital gains when you sell the Diamonds but that is OK since you should be able to write off the loses in your current portfolio making no tax owed.

This is just a suggestion and I'm sure there are other possibilities including just holding tight.

Michael

It looks like the US banks are in worse shape than most people expected. According to Bloomberg and CNBC the government will acquire a stake in the following major banks tomorrow.

Citigroup Inc.
Wells Fargo & Co.
JPMorgan Chase & Co.
Bank of America Corp.
Goldman Sachs Group Inc.
Morgan Stanley
State Street Corp.
Bank of New York Mellon Corp.
Merrill Lynch & Co.

Apparently the banks were required to take the government money. This would seem to indicate that the Fed considered that they needed the money. The most unexpected would seem to be JP Morgan and Wells Fargo since they were considered the most solvent banks.

http://www.bloomberg.com/apps/news?p...714&refer=home

Since the states and municipalities are also having a very difficult time borrowing money and remaining solvent, the federal government will probably also get involved in that issue.