Insights & Advice

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A Shotgun Wedding

It is a good thing the markets were closed on Friday. I don’t think investors could have weathered another day of volatility even though the short week ended up 3% on the S&P and the Dow. We haven’t seen that for quite a while.

The week began on a down note. The collapse of Bear Sterns and its shotgun wedding to J.P.Morgan/Chase at $2/share engineered by the Federal Reserve last weekend sent the markets into a tizzy on Monday morning. Since then the stock has rebounded as hedge funds battle with bond and shareholders over whether the deal should go through. Meanwhile, J.P. Morgan’s Chairman Jamie Dimon is offering top executives money and stock options to stay on.

By Monday mid-day the S&P 500 hit an intra day low of 1256 (not good at all.) Then investors remembered the Fed was cutting rates again on Tuesday. As promised, the Fed did cut the Federal Funds rate by 75 basis points (financial speak for ¾ of one %). The markets soared Tuesday. The Dow Industrials gained 420 points, it’s largest one-day gain since 2002 while the S&P tacked on 54 points or 4.24% to 1330, well out of my danger zone of 1330-1270 (happy, happy).

On Wednesday half of that gain was taken back led by a free fall in commodities. For many investors, commodities were the last haven in an otherwise losing market. So what happened?

Some believe the Fed is finished cutting rates and rate cuts have fueled the rise in commodity prices over the past year. Traders say that was the reason the Federal Reserve did not deliver on a full point cut on Tuesday as expected while underscoring in their policy statement the ever-present danger of renewed inflation.

A second argument may be that we are entering a de-leveraging stage of this correction. For years, hedge funds and others have made a practice of borrowing money to buy securities, commodities and everything else financial. This is what the term”Yen-carry trade” is all about. Now, as the markets go lower, they are being forced to sell out commodities, reduce their borrowing and unwind that arbitrage.

The recent flood of statistics that point to a weakening economic picture have led some Perma-bears to contend that the economy is so weak that we are entering a deflationary period, the worst of all worlds for commodities. I’m not buying that argument.

A simpler explanation (and I like simple) is that commodities, as I argued last week, have had a big run up and should see a sharp, hopefully short but painful correction before continuing upward in their own bull market. How low? They could return to the price levels of last December when most commodity prices took off but that’s not a guarantee, just a guess.

Returning to the overall market, Thursday was quadruple witching hour day, a quaint term used to describe days in which contracts for stock index futures, stock index options, stock options and single stock futures all expire. Suffice it to say that witching hour days enhances volatility. It did but on the plus side. All three markets finished considerably higher chalking up over 2% on the day.

This was the market’s second successful test of the bottom. We first bounced off this level in January. I am encouraged by this action. Certainly the Federal Reserve is working overtime to solve the credit crisis and I do believe they are making headway. We could see as much as 5% additional upside from here before things get iffy again, barring any catastrophes. Catastrophes, however, in the form of problems with some hedge funds, might be just around the corner. So my advice: enjoy the ride but keep your eyes peeled for fast moving objects.

Posted in A Few Dollars More, At the Market