Good Calls: Jim Welsh on the Russell 2000

By Jim Slagle | October 08, 2008 | 3:06 PM | 0 Comments

The following is an excerpt from a post by Jim Welsh on August 17th of this year. His insight as always was spot on. The Russell dipped below 550 today.

Any concerns you may have about the banking system are justified. The Fed's second quarter loan survey released last week showed lending standards on most consumer and business loans at the highest level in history. The Fed can cut rates and push money into the banking system, but if banks are unwilling, or unable to lend, the Fed's efforts are for naught. Mortgage rates are higher now than when the Fed funds rate was 5.25%, and Fannie and Fred have said they are going to have to reduce their mortgage lending. With an 11 month supply of homes for sale, lending constricted and mortgage loans more expensive, housing prices haven't stopped going down. This means there are more losses from mortgages of all types are coming. Global securitization of all types of asset backed securities is down more than 80% in the last year. Working backwards, if Wall Street can't sell securitized paper to investors, the banks can't sell their mortgage, credit card, auto loans, etc. to Wall Street, which means they sit on bank balance sheets, and banks can't increase loan volume.

If banks won't/can't lend and credit markets remain dysfunctional, the US economy is not going to rebound until well into 2009. In the meantime, investors will not be comforted with more job losses, loan losses from credit card and auto loans, rising corporate debt default rates, falling commercial real estate values, and the nationalization of Fannie Mae and Freddie Mac. Despite this gloomy outlook, Wall Street is forwarding the economic concept of FIFO - first in, first out. Since the US was the first major economy to weaken, it automatically follows it will be the first to recover. Although the simplicity of the idea has appeal, I doubt investors will have the patience to wait another year for the US to come out of this funk. And if the economy performs as I expect, domestic earnings will be under pressure and the lift from international earnings will weaken too. 

Wall Street is also trying to put a happy face on the fact that the global economy is slowing, by recommending small cap stocks, since they are not reliant on international sales. That may be true, but if small companies can't borrow money from the banks to help finance their growth, that's going to inhibit their growth. Of course, these are the same 'experts' who last year were touting stocks that did have exposure to global growth, which was going to insulate them from the slowdown in the US. Since then, most foreign markets have lost more than the US market. OOPS! In addition, the National Federation of Independent Business said last week that planned capital investment by small business in the next six months is at the lowest level since 1975. Not to worry. When Wall Street latches onto a theme, common sense and the facts take a back seat. Unfortunately, for investors who are now buying small cap stocks, the upside is limited to 3%-5% (around 770-790 on the Russell 2000), but the downside? Back down to the recent lows near 650, and possibly, as low as 550.