Saturday, November 24, 2007

Brace Yourself !

After the stock market bloodbath which we have witnessed in the last few weeks, why shouldn't an enterprising investor stay away from the markets temporarily?
It appears investors have been spooked by recent colossal write downs reported by nearly all the major investment banks indicating that the turmoil in the credit markets is far from over. In fact some pundits warn that this is just the beginning and forecast that 2008 will be the year of reckoning.

You remember the controversial summer bailouts-when the major central banks around the world infused over a hundred billion dollars into the markets to ease the liquidity crunch? So much for the band aid solution which did not address the underlying weaknesses in the credit markets but instead sought to act as a temporary reprieve and serve as an artificial stimulus!

Deja-vu all over again? After a second run to past 14,000 a few weeks ago, the Dow has since lost over 1000 points, the NASDAQ and S&P are both down as well.
Outside of the financials, fundamentals seem to be sound as of now with some companies like HP who recently reported a 28% increase in profits in the last quarter. This holiday season is expected to be the slowest since 2002 with retail sales forecasted to increase only by 4% compared to last years 4.8%.

Personally, I don’t think that consumption will slow down. Yes, while it is true that foreclosures and delinquencies are at their highest level and home values have adjusted downwards, the American consumer is tenacious and will borrow to the hilt in an effort to maintain the lifestyle.

I managed to rollout of bed and join avid shoppers the queue at Best Buy at 4am on “Black Friday” not to shop, because I had already done so online, but to gauge consumer sentiment. My erudition yielded results that reinforced my opine-that shopping patterns haven’t changed and will not change much and consequently, we can expect retailers to report blow out earnings next quarter. My portfolio is long AAPL and GRMN because I believe their bottomline will benefit tremendously from this shopping season resulting in some nice capital gains when I exit.

However, I would advise investors with a short time horizon to refrain all together, go short or buy put options. Use ETF’s like QID, DOG, SDS, MZZ…etc which short indices. Avoid shorting individual stocks. Advanced investors should profit from the volatility using combination option strategies like straddles, which allow the holder to profit based on how much the price of the underlying security moves, regardless of the direction of price movement.

I foresee a continuing onslaught on the financials. Look for more surprises in the form of restated earnings and more write downs which have besmirched the balance sheets of otherwise profitable companies like Citi (C), Merril (MER) and Bear (BSC). These events will foreshadow overall good earnings results reported next quarter and hurt consumer and business confidence which will result in another sell off.

In an effort to mitigate risk and reduce exposure to consumer debt, banks will follow suit lowering credit lines thus dampening both consumer and business spending further; the tighter credit markets will result in a drag on the overall economy which will soon spread beyond housing into other sectors.

If the Fed vacillates like last time, the credit squeeze might spell doom for all and spiral us into a recession. Yes I said the R word.