Yesterday was a very bad day in the markets. A stunning chain of events over the weekend sent the S&P 500 index to its steepest one-day percentage drop since the 9/11 attacks in 2001. In a weekend of intense and almost non-stop meetings, the head of the Federal Reserve Bank, Ben Bernanke, Treasury Secretary Henry Paulson and New York Fed President Timothy Geithner were involved in meetings and conversations with key chief executives of the financial services industry. The purpose of those meetings was to fix the immediate problem with Lehman Brothers, Merrill Lynch and American International Group, and then to come up with a plan and new strategy to make sure we don’t go through this again.
The fundamental problem is laid out in an article at the Washington Post that takes a wide look at what has gone wrong. As noted in the article a big question is how much of a day-to-day role the government and regulators should be taking. The current hands-off approach is providing too much opportunity for greed to take over and benefit the few while taking advantage of the many. This imbalance in the risk-reward equation has been discussed many times and most recently are seeing that our financial systems tend to favor privatizing profits and socializing losses. By that I mean that when big profits are being made in the markets, individuals such as the shareholders, executives and board members benefit, but when the losses become so large that they could derail our economy those losses are passed on to the taxpayer in the form of government bailouts. We saw that back in the 80’s with Drexel Burnham, Long Term Capital and now we are seeing it again with Bear Stearns, Fannie Mae and Lehman Brothers.
As you know we have been bullish on the financial sector and in early May we began moving into a leveraged financial sector fund, Profunds Ultra Financial (FNPSX) in the Alpha portion of the portfolios. We had two more entry points into this fund in May and June. Based on the conditions at hand we saw opportunities within that sector to participate in a steady advance as that sector worked its way through the liquidity and credit issues that had been holding the economy back. We felt comfortable that we could weather the inevitable correction that was forthcoming in this sector. With the measured entry points we were looking at averaging into the position either on the way down or hopefully on the way back up. However, it now appears that we underestimated the depths that this sector would pull back to. With the insolvency of several large institutions this sector continues to struggle.
On July 15th the fund set a low of $11.05 and in the ensuing weeks rebounded very well to reach a high of $15.97 on September 8th. Today that fund fell back to $12.59. Suffice it to say that we are disappointed that this fund has not rebounded to our May/June purchase levels and the next week to ten days will be critical if it is to remain in the Alpha portfolio. Our markets are approximately one month past the 10 month average of historical corrections and while Consumer Confidence was up in August we have several critical reports coming out this week. In addition the Feds are meeting Tuesday and we will get some sense of their opinion Tuesday afternoon. However it will be the events of this past weekend that will drive the market this week and not necessarily the expected economic reports.
Despite the difficult circumstances the markets are currently in, it is often times a drastic capitulation that sets the stage for the next bull phase of the market. Based on the results of today’s market activity, we can only hope that this was the final capitulation.
Mark is also with NW Weath Advisors.