Wall Street's Trap

by John M. Curtis
(310) 204-8700

Copyright January 5, 2009
All Rights Reserved.                    

          Rising 1,300 points from it recent bottom hit Nov. 16, 2008, the Dow Jones Industrials rallied back Jan. 2 to just over 9,000.  But before investors get burned again, they should look carefully at the slew of economic data all pointing to more sideways movement.  Bear markets are notorious for rapid cycling, moving upward or downward over a thousand points.  Billionnaire investor Warren Buffet, whose stock portfolio has lost over 30%, admits to having no clue when predicting the market’s ups-and-downs.  With the U.S. still reeling from its recent once-in-a-century financial collapse, it’s premature for small investors to jump back in with both feet.  No one know for sure whether the government’s unprecedented spending, now estimated a nearly $10 trillion, will spare the economy further disaster.  President-elect Barack Obama warns that things could get worse before getting better.

            For well over a year, investors have been treated to a perpetual roller coaster, watching investments go up-and-down like a yoyo.  “There’s now an estimated $8.9 trillion sitting on the sidelines in cash and money markets,” said Stephen Leeb, president of New York-based Leeb Capital Management.  “High cash levels and low stock prices historically go hand in hand.  The current level as a percentage of stock market capitalization matches that at the market bottom in 1990,” implying that markets have no where to go but up.  Predictions like Leeb’s frequently result in private investors jumping the gun, hoping to profit from the recent downturn.  No one, including Buffet, can say whether the market has yet to test new lows based on real economic data, not investor speculation.  With the current stack of cards, it doesn’t take much to watch the Dow fall a thousand points.

            Private investors trolling for cheap stocks often get burned in both mutual funds and individual picks.  Few economists are willing to go out on a limb predicting market bottoms or peaks.  Recent market meltdowns have few precedents, watching the Dow plummet from its Oct. 1, 2007 record 14,000 high to its recent 7,700 low only 13 months later.  When the Dow hit its prior record of 11,750 in February 2000, it took three years to sink to 7,500 in July 2003.  Private investors should be forewarned that the same spectacular drop could occur again, though most analysts see present valuations as somewhat depressed.  Some analysts like Leeb see more liquidity coming into the market when financial institutions receive capital this month from the Federal Reserve.  With Obama taking over Jan. 20, they also see another stimulus package adding to positive market activity.

            Before the books were shut on 2008, nearly $10 trillion was lost in corporate and personal wealth.  Wall Street’s investment banking industry collapsed, leaving icons like Goldman Sachs restructuring to become depository institutions.  Insurance giant American International Group [AIG] went under, requiring a nearly $200 billion federal bailout.  Mortgage giants Freddie Mac and Fannie Mae collapsed.  Household names like Washington Mutual went broke.  Even solid banks like Wells Fargo Bank and Bank of America watched share prices plunge to records lows.  Given this backdrop, Wall Street’s biggest mutual and hedge funds continue to buy on dips and sell on peaks, leaving small investors scrambling.  Short-sellers, those institutions betting stocks will drop, continue the hammer long-term investors, turning otherwise stable investments into an endless roller coaster.

            Consumer spending, accounting for two-thirds of U.S. Gross Domestic Product, put a dark cloud over holiday spending.  A consumer cash-crunch, in part caused by rising mortgage defaults and foreclosures and dried up home equity lines, promises more layoffs in 2009, further eroding GDP.  Yet hedge and mutual funds continue to drive the market in irrational directions.  Buffet urges private investors to set long-term investment horizons, despite mutual funds buying-and-selling on a minute-to-minute, hour-to-hour, day-to-day basis.  Without gaining control over short-sellers, especially hedge funds, the prospects for long-term investing remain dim.  You can’t counsel private investors to stay in it for the long haul while major funds buy-and-sell on programs, designed for short-term gains.  Before small investors jump back in with both feet, the regulatory system must be fixed.

            When the Federal Reserve lowered it benchmark rate Dec. 16 to between zero and .25%, it should have signaled to small investors that the economy was in bad shape.  Wall Street used the rate cut to rally the market 1,000 points.  As former Fed Chairman Alan Greenspan liked to say, Wall Street displays “irrational exuberance” in light of real economic data.  All data point to a serious recession—possible depression—expecting lowered corporate profit growth, possible bankruptcies, into the foreseeable future.  Next week, the House Financial Services Committee will hold hearings on how billionaire hedge fund operator Bernard Madoff’s perpetrated the biggest fraud in Wall Street history.  With the Fed slashing the Federal Funds rate to nearly zero, no investor should be deluded.  Before hedge funds and short-sellers get regulated, small investors can only pray for better days.

John M. Curtis writes politically neutral commentary analyzing spin in national and global news.  He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

©1999-2012 Discobolos Consulting Services, Inc.
(310) 204-8300
All Rights Reserved.