And the market’s red glare…

I have to admit, I’m quite amazed at how much the market has been dropping since the election. Sure, other things are happening as as well – major strikes across Spain, Portugal and Greece, an Israeli strike in Palestine killing a Hamas leader with Egypt pulling back their ambassador in retaliation, questions over the stance of new leadership in China. For the most part, however, the focus of stories is on the “fiscal cliff.”

Obama asked for $1.6 billion in tax cuts which is double what the republicans were arguing over during the summer, and the republicans haven’t made any move toward compromise on allowing tax rates to increase only for high incomes (though I don’t think they’ll stick on this issue, politically it makes more sense for them to use that as a bargaining chip for the final agreement and ultimately allow those taxes to rise). I’d be amazed at this point if taxes didn’t go up on capital gains and dividends as well, though not necessarily to the same rates as income taxes. It could very well be that the markets were anticipating a republican win leading to lower increases and the possible removal of the payroll taxes inherent in Obamacare. Keep in mind I’m not arguing the validity of these political issues – I’m just trying to digest why the stock markets have been dropping so violently in the last week. It’s very possible that they were simply due for a correction and the fiscal cliff issue merely served as the trigger … Valuations were on the high side given the worldwide economic conditions after all.

Last week I mentioned the easy way to find the stocks that would rebound first in cases of extreme selling such as that in October 2008 and again in March 2009. Keep in mind that unlike now, the outflows from stock related funds from individual investors in 401k’s toward bond bunds had been developing for a while. The basic idea though is to find what holdings are dropping due to forced selling. CHK was a classic example in October 2008 as the president bought massive amounts of shares on the margin and was forced in a margin call after the drop in natural gas prices hit the stock. It went down to $11 a share and was back in the $20’s within months. OTTR was another example, except this one had a high percentage of shares held by mutual funds faced with investor redemptions and forced to sell, hitting a low of $16.05 in October but rebounding well above $20 in November.

Finding these stocks unloaded due to forced sales may not seem easy, but remember to look for stable bellwether companies that will clearly survive a bit of economic turmoil that recently fell, and then look at “major holders” and see how much of the shares are held by mutual fund owners (example: BWP has 74% of its float held by mutual fund owners). Don’t expect this to be the case now unless you know a lot of people who are switching their 401-k’s to bonds … It takes a significant amount of time for average workers to get worried enough about their holdings to make this switch, and it doesn’t happen in the span of a week but over a period of months. Mutual funds also hold a significant amount of money in low-yielding cash-like assets (ex. Treasuries) which they can sell to cash out investors, and they have to exhaust this before a significant forced sale. For the answers on what to pick up for a quick gain you really have to know who is selling and why – and that it has nothing to do with the underlying value of the stock OR the markets. P/E contraction across the board due to prolonged political or economic uncertainty for example can be a perfectly valid reason for stocks to fall across the board without a quick bounce back in valuation.

I wish I had more definitive information for you on the drop, it’s causes, likely bottoms, etc, but all that is pure speculation at this point. If I had to guess on the bottom though I’d say mid to late December, as the republicans and democrats have yet to make a deal (which I’m guessing will be more or less last minute)… but I’m not putting money on that guess so don’t take it too seriously.

Good luck to you all and don’t panic. If you have any ideas that I’ve missed let me know (and I know about both EXC and SDR dropping like rocks, and I’m still holding them all the same).

John Taylor

About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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1 Response to And the market’s red glare…

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