Insights & Advice

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So what happens next?

It’s been quite a week on Wall Street.  In fact, it’s been the worse week of downside since October, 2009.  But don’t fret; this is not the beginning of a second collapse, regardless of the claims of the hibernating Perma-Bears who are suddenly coming out of their caves.   Instead, I suggest you look at it as another buying opportunity.

Over the last few months, I have been warning readers that 1,150 on the S&P 500 Index would be an area where the markets would falter, at least over the short term, before resuming an upward trend toward 1,200. It appears that correction is now in progress.

“How low will the markets go?” asked a worried investor from Sheffield, who e-mailed me this week.

Since short-term forecasting is at best an art, I am guessing that we drop to 1,090 on the S&P before staging a comeback. To put that into perspective, Friday the index actually hit 1,090 intraday so I’m not talking about a lot more downside from here. That would put this dip at -5%, an average correction among several dips we’ve had since March, 2009.  That 1,090 level must hold. However, if it breaks that, we can expect a more serious decline in the vicinity of 7-10%. Our deepest pullback to date was about -7%.

I’ve already outlined the major reason for this decline. Investors bid up markets in anticipation of good fourth quarters earnings.  In a typical “sell on the news” maneuver, now that earnings results have come in as expected, investors are cashing in.

 However, Thursday, when President Obama launched another broadside against the financial community, the downside action in the markets gained momentum. The President threatened to prohibit proprietary trading by banks as well as limit their size.  It is easy to understand why the markets swooned. Most of this nine month rally has been led by the banking sector. The same banks that took our tax payer money (TARP funds, for example) but instead of lending it to us (which was the government’s intention); they speculated in the bond, stock, currency and commodity markets and they raked in huge gains.

 As a result, the lion’s share of bank’s profits emerging from the financial crisis has been generated by their proprietary trading departments. We’re talking about billions of dollars in profits.  It’s the reason, in case you were wondering, how the likes of Goldman Sachs could pay on average almost $500,000 in bonuses per employee.  The removal of this profit center leaves the large banks with a big hole in earnings. How can they fill that gap? God forbid that they have to go back to lending us money for things like cars, trucks, homes and education! Where’s the profit in that?

President Obama, in announcing these measures, is endeavoring to tap the outrage most of us feel toward the financial sector. That anger appears to be growing, fueled by the aforementioned bonuses that are now being doled out by the banks. It may also be why the confirmation of Federal Reserve Chairman Ben Bernanke to a second term is in trouble.

The U.S. Senate vote was supposed to take place on Friday but it was postponed to next week in an effort to garner more “yes” votes. Bernanke and the Fed have been criticized not only for being asleep at the switch as this financial crisis unfolded, but in ensuring that through government bail-out money, the banking sector would come back bigger and better than ever. The return of huge bonuses, say the chairman’s detractors, is the most visible indication of that collusion.

I suspect the rejection of Bernanke for a second term would not be taken lightly by the markets. It is one reason why I am advising a bit more caution than usual in this coming week and why holding that 1,090 level on the S&P will be crucial.  Be careful out there.

Posted in A Few Dollars More, At the Market