February 14, 2008

Follow-Up Investment Advice Letter sent January 18, 2008


I have been asked several times if the worst is over and, if so, what actions to take and offer the following take on the market.

I hope that you all were able to lighten positions since my e-mail on November 12, 2007. The S&P 500 Index closed around 1,439 that day and today it is down to about 1,320 for a loss of around 9%. Most other broad market indices have suffered more damage – the NASDAQ composite is down over 10% and the Russell 2000 Index is down 14%. It’s not been very pretty. What’s done is done, though and several commentators are prodding people that it’s time to get back in the market now. I’d like to at least present a counter argument to that for you to consider before committing your hard-earned retirement and investment funds to this market.

Bear markets are insidious creatures – and the evidence is becoming clearer that a bear market is exactly what we are in right now. Bear markets “invite” investors back in by providing tantalizing bounces up – only to cut the investors off at the knees. Bear markets aren’t that easy for shorts to play, either. Those sharp bounces up can shake people out of their “shorts” really quick. Besides, it’s outside of the norm for most people to be short in the stock market so this is just a bad position for almost everyone to be in. So, one of the biggest danger in a market like this is to be too trusting when we do bounce. Many, if not most, market players are anxiously hoping that this very ugly recent action is just some sort of temporary blip that is going to be quickly forgotten as people realize that things really aren't that bad. The thinking is that with the Fed ready to make big rate cuts and Congress working with the president on fiscal stimulus, we should be right back on track very soon. While that is possible, it isn't the smart bet. This market is broken and we're now in a downtrend as almost EVERY indicator that I’ve looked at supports. Trends are stubborn things that don't come to an end easily. All you have to do is consider the move we made since the fall of 2006. Despite growing worries and concerns during that period, the market just kept on going straight up -- until this past fall. Despite a few blips along the way, the trend was steadily to the upside and was not derailed even by the first major subprime news back in August.

The stock market’s fall since around November 12, 2007 is historically unusual in its quickness and severity – but not as unusual when you look at how corrections have happened in the last couple of years. And that means we are likely to see some relief bounces -- especially as news of fiscal and monetary policy hits. It is very important to have a game plan in mind as to how you are going to deal with the action. Without a doubt, there are going to be those who will declare that the worst is over and that it is time to buy. They will be the most convinced right around the time the bounce starts to fade. Your No. 1 concern should be to avoid being sucked into that. Be ready to unload some longs (if you have not already done so) and to put on some shorts (if that is your style). In my e-mail, I presented a hypothesis about what will be one, if not the primary cause, of the market being so risky – the permeation of non-investment grade mortgage-securities into investment grade money market accounts and the resultant reclassification issues in 4th quarter corporate financial reporting, which will shock the market and depress corporate earnings. The most disconcerting thing to me at this point, is that I have heard nothing about this issue or how the market that trades those mortgage-security “bundles” is going to get re-started. At a certain point, all bad news, known or not known is factored into the market. The market has exhausted itself going down and all sellers have sold regardless of any more news to come out. I don’t think we are there yet and so news like that I alluded to in my November 12th e-mail can still shock this market down – down a lot.

One of the easiest things to do in a difficult market like this is let hope that things will improve, driving you to be too optimistic when we do have a bounce, especially a big one. Stay skeptical about the health of the market even if do enjoy a few good days. Those who were in the market during the bear market of 2001-2002 will recall how frustrating and dispiriting it can be to be hopeful every time we have some brief flurry of positive action. Those of you old enough to remember the bear market of the 70’s should really be in tune to what can happen.

I don't want, and I hate to sound too negative -- there will be good opportunities, in the future, to make money in this market -- but you have to be very careful to keep our emotions in check and not to be too positive until there is very good reason for it. If you do not have the luxury of having instant access to the stock market and business information, your best course of action is to continue to wait before you commit any additional money to this market. We are in a downtrend, and that needs to be respected. Don't start thinking that the worst is over. One of the things that really has been killing this market lately has been the incessant talk by government officials and Fed members. They all want to show how concerned they are and how ready they are to jump into action, but nothing happens. We end up with a lot of talk that is immediately discounted and renders the actions that they plan to make impotent. There is no real appreciation of the psychology that is at work. This is a market and economy that need reassurance, and that will only come when there is some real action – some extended POSITIVE action in the market.

The US stock market is a wonderful thing. Several companies and industries have stronger Balance Sheets than they’ve ever had, and have sufficient cash balances and capital structures to ride out any recession. Other countries still flock to the US markets in times of turmoil. There is still a decreasing supply of US stocks due to fewer IPOs, stock buy-backs and stock buy-outs. This market will always provide you opportunities to make money – provided you are patient in times like these and preserve your capital to take advantage of the better times to come.

I’d like to mention that several thoughts on this market that I’ve mentioned above are also espoused by James “RevShark” DePorre who has just published a book - Invest Like A Shark (How A Deaf Guy With No Job And Limited Capital Made A Fortune Investing In The Stock Market). I would highly recommend this book to anyone.

Best of luck to you all,


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