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Stock Market Coughs Up A Lung

S&P 500 Index

Look at that chart. I haven’t seen anything like that since the October 1987 – which was 3X bigger – and it all happened in about 20 minutes. Whew.

The S&P 500 dropped all the way back to the January lows and recovered to the January highs – but still down 3.5% for the day. The most likely cause is computer trading that got out of hand. Floor traders in New York can’t move that fast – so it had to be a sell program kicking into high gear.

There are stories out there of sell orders entered wrong with billions of shares selling instead of millions of shares, but that can’t explain it all. Computer based trading kicks in to buy and sell based upon whatever parameters the investment manager desires. At 1:40pm, something happened to cause a cascade of selling for about 10 minutes that morphed into a cascade of buying for about 10 minutes. Logically, some program hit a buy signal that pushed the market down some, which triggered other sell programs. Finally, when the market hit the January lows, buy programs kicked in and pushed us up.

However, things are not good in Europe. The fear has hit that the problems in Greece – not just the financial problems but the social unrest – are set to spread to the other high debt European nations (Italy, Spain, Portugal, Ireland and the UK). Speculation is rampant that this is the beginning of the end for the Euro as the Germans and other fiscally prudent northern European nations will not want to subsidize the laid back lifestyle in southern Europe.

Unfortunately, all of these countries are interrelated in their borrowing and lending positions. Below is a graphic from the NY Times that shows you how interconnected all of these countries are – and you can then infer that if one of the dominoes is knocked over all of them will eventually fall.

Thanks to the Cara Community for this graph

Thanks to the Cara Community for this graph

This is a big story, but at least right now I don’t think this is enough to derail the world’s economic recovery. Greece is only 2.5% of Europe’s GDP and their entire debt problem is roughly equal to the AIG rescue. If Spain or Italy were to fall, that would be a much bigger issue, but at this point there is only speculation.

Given this, we used today’s plunge to put to work some of the cash we’ve generated in recent weeks. I’ve had the mid point of the January selloff as a buy point, so when we got there today in the panic fall (see the purple box on the chart below) we acted.

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We were able to pick up some great companies today, using a portion of the cash we have on hand: TROW, TIF, HSC, EWA, ABV, JPM, CMI, ITW, TD. We have plenty of cash available to buy these and others if the market pulls back more. Why are we buyers? Four Words: Don’t Fight The Fed. The Fed will inject liquidity into the system and keep rates low for as long as it takes to bring our economy around and drag the rest of the world with us. Those low rates and high liquidity will continue to drive stock prices up over time (all things being equal – i.e., no world wide debt crashes).

We will wait to see what tomorrow brings – there is the April jobs report coming up first thing tomorrow. Expectations are for a big gain that will drop the unemployment number from 9.7%. If that happens, look for the market to move higher at least initially on a relief rally. If that doesn’t happen, then you could likely see another move down, back toward the purple box buy zone where we will put additional cash to work.

Typically, we will want to see where the market is on trading day 3 after a day like today. So, Tuesday of next week will be the day where we want to do an assessment of how our buy zone trades worked today and whether its time to put some additional funds to work if we aren’t in the buy zone.

The big winner in all this? Gold. Look a the chart below:

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Gold is a hedge against uncertainty and against inflation. What you are seeing now is that gold is a hedge against uncertainty. There is talk that gold will be the alternative to the dollar that the Euro was to have been. That remains to be seen – let’s give the Euro nine months to determine whether it will live or die – but gold did make a new high in terms of the Euro today. It seems that all the middle east countries that wanted to trade oil in Euros instead of Dollars, and had accumulated a pile of Euros for that purpose, have been dumping them and buying gold.

Long live King Dollar? Eh… Its just the best of the worst at this point. Its day will come – just not now. The fiscal issues in the US are at least as bad as those in Greece, and Much Much Much bigger. Plus, we now have a dependent class much like the European dependency so their protests will mirror and surpass those in Athens. Just not now.

Eventually, the economies of Asia and Latin America (can you really believe we think this given our experience with the 70’s and 80’s?) as well as western economies that have sound economic fundamentals (Canada, Australia, Norway, South Korea) with their negligible to easily manageable debt to GDP ratios will far surpass those with high debt to GDP. Over time, all successful investment portfolios will mirror low debt to GDP economies.

For now? Invest what you see not the dogma you believe. The graphs above show us what to do – so we are doing it.

As things change, and developments occur, we will keep you informed. If we have another big plunge or big rally, I’ll let you know what’s up and how our strategy is impacted. Until then, relax and watch the following video that wraps up my Fall of Saigon discussions of the past month.


Click here for Marvin Gaye

Enjoy the night and there will no doubt be more excitement tomorrow.

Mark