Another historic day to cap off another historic week. The last time we declined 8 days in a row were the days following Sept. 11, 2001. The DJIA (INDEX: $DJIA) lost 18.2% this week. The DJIA had a 1,018.77 point range and the S&P 500 had a 96.56 point range. Today marked the 1-year anniversary of the DJIA’s all-time high of 14,164.53. We are now down over 40% since that peak. Today is one of my favorite days, not because it’s the end of the worst week in market history, but because the end-of-day rally created so many trading opportunities for next week (yes, can you believe it?). I’m talking about trading power spikes, one of my favorite patterns. A stock exhibiting a power spike is one that displays an immediate and forceful change in sentiment from the previous day. Whatever the reason, traders instantly changed their minds on the direction of the stock…a very powerful signal indeed.

The challenge as an investor living through the last four weeks is to look forward. It is even harder if you have followed the tune of, don't worry you are in this for the long term. That has been my favorite saying from advisors and money managers like John Boggle. Yes, asset allocation models work over the long term. Yes, the S&P 500 ($SPX) did recover its losses from 2000-02, only to give them back over the last 12 months. In fact the 10 year average rate of return on the S&P 500 index now stands just under 2% per annum. Maybe long term is longer than 10 years. I will have to do some research on that and get back to you.

Sorry for the tangent. My point was to look forward not backwards. See how hard that is. The bounce today off the intraday lows of 840 on the S&P 500 shows some interest in buying stocks. I am not talking about a bottom just interest in picking up stocks at these levels. Will this lead to a rally next week? Good question. The answer lies in the G7 meeting this weekend. If the guarantee comes for banks and depositors. In addition the need to free up the commercial paper market. Plenty of talk around both of these issues. They will be key points heading into next week.

How do we build a portfolio looking forward. Well my assumption first of all is you are primarily in cash at this point giving you plenty of room to ladder into longer term positions. Energy is one of the first sector I would look into with the conditions here extremely oversold. The value will be realized as prices on crude return to normal. Normal being taking out the big swings up and down and some sanity to trading in the sector.

Financials are the second area to dig. The outcome of all this money flying around will lead to finding the winners. The trashing of the regional banks is the first place to dig. The insurance companies are another piece of the financials that have been trashed as well. Balance sheet looking here as well as the credit rating are important along with some patience. This will take some time, but I am looking through the remains.

Basic materials is a sector I have been short for a several weeks, but it is starting to look attractive at this point. There are some very attractive valuations on a forward looking basis. As the negative tone subsides there is value.

Last, but not least is the small cap stocks. The bounce off the lows today and closing higher by 4% gives plenty of reason to think this sector is oversold. I will be watching early next week for some follow through on this move.

VIX ($VIX) could have climaxed today at 75. That will give some indication next week how this plays out short term. From a longer term perspective there is value. Building positions versus trying to time the bottom is the best approach looking forward.

I am not sounding the all clear sign, just saying there are opportunity. Remain patient, focused and most of all disciplined.  Relax and enjoy your weekend, you deserve it.

By now you have all come to realize that we just had the biggest stock market crash of our lifetime!  The market's behavior is unprecedented.  From the high three weeks ago (Sept. 19th) to this mornings low, the S&P 500 is off 33.7%.  This is worse than the depths of the crash of 1987. ...and he took logic and reason with him. The market action is completely devoid of any and all logic. Prices have been taken down in a manner not justified by the fundamentals for more than 95% of the stocks out there. Fear and panic are ruling the roost. While I believe the above paragraph is correct (even if worded a bit sensationally) markets act with no logic or reason occasionally, nothing new about that. Crazy selling does not have to end today even though the open does show some classic signs of a capitulation.

"This notion that great misadventures are the work of great and devious adventurers, and the latter can and must be found if we are to be saved, is a popular one of our time. Since the search for the architect of the Wall Street debacle, we have had a hue and cry for the man who let the Russians into Western Europe, the man who lost China, and the man who thwarted MacArthur in Korea. While this may be a harmless avocation, it does not suggest an especially good view of historical processes. No one was responsible for the great Wall Street Crash. No one engineered the speculation that preceded it. Both were the product of the free choice and decisions of thousands of individuals. The latter were not led to the slaughter. They were impelled to it by the seminal lunacy which has always seized people who are seized in turn with the notion that they can become very rich. There were many Wall Streeters who helped foster this insanity, and some of them will appear among the heroes of these pages. There was none who caused it."

-       From ‘The Great Crash: 1929' by John Kenneth Galbraith.

 

"Senator Couzens: "Did Goldman Sachs organize the Goldman Sachs Trading Corp. ?"

 Mr. Sachs: "Yes, sir."

 Senator Couzens: "And sold its stock to the public ?"

 Mr. Sachs: "Yes, sir."

 Senator Couzens: "At what price ?"

 Mr. Sachs: "At $104. The stock was split 2-for-1."

 Senator Couzens: "And what is the price of the stock now ?"

 Mr. Sachs: "Approximately $1 ¾.""

 

-       From Senate hearings in 1932, and cited in ‘The Great Crash'.

Perhaps the biggest mistake Goldman Sachs ever made - other than launching its eponymous investment trust in 1929 - was its decision to go public in 1999. That enabled the former partnership to retain employees otherwise then being enticed by the prospect of dotcom riches, by means of share options and restricted stock. But it also turned a tightly focused private partnership into a public company. That involves a loss of independence. And as Chris Dillow recently suggested in a Times article ("Why aren't hedge funds failing as fast as banks ?"), the current crisis is as much one of ownership as of finance:

"It is not markets that have failed, but a peculiar form of ownership that we have taken for granted for decades - stock market-listed companies with dispersed shareholders."

As Chris points out, the succession of hammer blows to the market this year have come from stock market-quoted companies, not from hedge funds - which, despite the misplaced mudslinging from the more wilfully ignorant members of the financial press, are largely blameless bystanders in this colossal drive-by shooting. That is not to say that hedge funds will be immune to the ferocious deleveraging gale blowing wildly round the world, not least as the implosion of investment banks and reining in of credit provision may prove terminal to more highly leveraged strategies and funds. But in Chris' opinion (which I very much share), the principal-agent problem is at the heart of the crisis:

"Big, quoted companies have been unable to solve this problem. Shareholders - often, ordinary people with pensions - have little control over fund managers. Fund managers have little control over chief executives. And chief executives have had little control over trading desks, partly because they just didn't understand the complexities of mortgage derivatives.. In hedge funds [for example] things have been very different. Very often hedge fund managers invest their own money and take key decisions themselves, or at least closely watch those who do. Their incentives to take huge risks have been smaller. So these have at least survived [in general].. What we're seeing, then, is the cost of separating ownership and control. In private firms, or partnerships - even limited liability ones - the two are closely aligned. In stock market-quoted firms, they are not."

Maybe Goldman Sachs (which by now seems to have become a placement agency for the US administration) and Morgan Stanley survive as the last remaining former investment banks. Maybe they don't. But if they don't make it through this crisis, expect an orchestra of the world's smallest violins to play to their demise. The taxpayers of the world are in no mood to indulge the whims of (what's left of) Wall Street any further.

But the search for scapegoats has to be relegated behind the urgency of shoring up confidence in the financial system. By all accounts the UK's bailout plan, revealed this week, takes the right tack. It seems increasingly likely that other countries will follow a similar interventionist model. But what is needed is coordinated action as opposed to piecemeal band-aid flinging. This weekend's G7 meeting is an opportunity to prepare such action.

As Redburn Partners point out, the Dow Jones has now racked up the worst 12 month performance since 1932. The MSCI World Index has recorded its worst weekly fall since records began. When does it end ? There have been plenty of false dawns throughout the crisis but the UK rescue plan has ignited a glimmering of light at the end of the tunnel. But it needs bold and international follow-through. We will know that the low is in when the market stops going down after being hit by new bad news. For investors with some semblance of a balanced portfolio, it seems late in the day to be capitulating now and fleeing the stock market. Die-hard contrarians would be selectively buying (pharmaceuticals; consumer staples; the more solvent banks; telecoms; utilities). Gold still makes sense. Gilts still make sense in a big way as inflationary pressure subsides and the likelihood of slashed interest rates builds. Taking the longer view, the ‘BRIC' countries - notwithstanding the likely hit to the global economy over the next few years - are still better positioned to deliver growth ; G7 economies will be close to exhaustion for some while yet. "The only thing we have to fear," says ‘The Onion's re-imagined 1933 US President in his inaugural address, "is a crippling, decade-long depression". By all means have the witch-hunt. But do the triage first.

 

www.thepriceofeverything.typepad.com 

The response to the bailout has been pretty much in line with my expectations. The Paulson comments yesterday showed what Congress was worried about. No direction. The longer all of this takes the less confidence there is in a near term solution. The timeframe for the turnaround continues to get stretched out. This leaves me as an investor less and less confident of any impact from the move by the government short term. The long term benefits will be nice as the order is restored to the financial markets, but in the short term it makes me want to be short versus long this market. In a July 24, 2008 article, Commodity Breakdowns Warrant Defensive Action, I wrote the following based on the ugly look of the chart of financial stocks (NYSE: XLF): I'm a bear with no hedge. I sold the last of my ProShares Double Short S&P 500 ETF (NYSE: SDS) when the market was just about flat this morning. I sold half my SDS at SPX 1150 and so this was the rest of it about SPX 986. The supply of sellers continues unabated, with buyers watching and waiting for the trend to change. Any upticks in the market are being met with renewed selling. How lopsided has the seller’s upper hand become? 1974 and 1987 – like.