Saturday, September 08, 2007

Is The Housing Crisis and Stock Market Decline Bad Enough Yet?

It is pretty bad... Home prices are dropping, jobs are declining, and the stock market continues to have big negative days. But it's not bad enough yet... A large number of people, including me, are still relatively confident the market will recover soon. Here's what may need to happen before returning to a consistently rising market:

More fear. Yes, that's right MORE fear. Overall, people are still relatively calm about the market issues. Many mortgages won't reset until next two years and the mortgagees believe there will be a government bailout. Not enough people believe that there may be further decline of stocks or that it may be an extended (e.g. one year) decline. Many folks are still cautiously buying on dips and dollar cost averaging. A number PF bloggers are still talking about the current market being a "buying opportunity." In addition, the Fed still doesn't think the economy is bad enough to telegraph a possible rate decrease.

Shortage of liquidity. There is still too much cash on the sidelines, which is being pumped in on the dips. This keeps the market from declining too far. However, once this money is gone, the market will experience larger and consistent declines.

Capitulation. Once there is sufficient fear and insufficient liquidity, people will want to get out of the market, no matter how low the price. There will be a massive sell off and general disgust with the investing, as there was in 2002.

Currently, many think they have the ability to stay in the market. I like to think I can too. But with losses of 20, 30 or 50% or more, it is often difficult maintain one's convictions. Can a decline of 50% happen today, especially to an index? One only has to go back to 2000 to 2002 to find a 78% NASDAQ decline from 5132 in March, 2000 to a low of 1135 in September, 2002 or the 49% S&P 500 decline from 1553 in March, 2000 to 794 in September, 2002. Some individual stocks even took a bigger hit. For example, Amazon declined 95% from a high of $113 in Dec 1999 to $5.67 in Sept 2001, on a split adjusted basis.

To note, I am not hoping for the market to get worse. I just know it will, because that is the nature of market cycles. Currently, I am considering only defensive stocks or international ETFs until the market has clearly turned upward. I will also begin to consider possibilities for shorting, should the the stock market turn significantly worse.

For more on Reflections and Musings , check back every Saturday for a new segment.

This is not financial or investing advice. Please consult a professional advisor.

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