The Only Market Cycle: Fear

It's often said that the only real market cycles are fear and greed. Since buying and selling are both done in panicked ways at points of market turns, we could say there's really only one market emotion: fear -- of having nothing, and fear of not having enough.

Wednesday, January 23rd showcased both varieties. The Dow opened in free fall, down 323 points, only to close up 299. Morning sellers were keen to get out of stocks at any cost, setting up the values that tempted buyers. A buying panic ensued, with traders worrying they would be left behind -- and short sellers rushing to buy back shares. The teachings of behavioral finance wrap these swings into jargon and theory, but it all boils down to human fear.

Have the financials bottomed? The broad market moved barely a jot all week, finishing only one percent higher than it started. But the financials were up 7% for the five days, according to Barron's. Citigroup, J.P. Morgan Chase, Bank of America, Wells Fargo and the other money center banks all rallied strongly from their lows. The emergency rate cut will assist lenders, who can take advantage of short-term rates to lower their cost of funds. The Fed action is probably most targeted at recapitalizing banks by allowing the yield curve to normalize. The cut in short rates could lead to an eventual inverse spike in long rates, as inflation fears persist. This would create the steepest yield curve in some time and provide a much needed gift to the banks. The wider spread will drop right to their bottom line.

If the financials have bottomed, this bear market will follow the pattern in 2000, where the locus of the speculative bubble (today it's leveraged lenders, home builders, and mortgage insurers; then it was internet, tech, and media) bottoms first, and then rallies, while the rest of the market continues downward.

When you consider the price-to-earnings ratios, you see the value prospect -- even if you adjust the earnings downwards to incorporate worst case scenarios: for example, Citi and Chase (both of which I own in the fund I manage) are trading at only nine times expected "recession-stressed" earnings potential. If we assume a deflationary spiral, with a further 50% drop in earnings from already pessimistic predictions, that would give Citi a p/e of 16, still 20% below its level in 1999. If we assume stagflation with a higher short-rate bias, Citi would probably have to cut its dividend another 40%, but that would still leave a 3% dividend yield. In many ways, Citi at $26 per share is the most attractive it's ever been: priced for disaster, but in better shape than during the recession of the early '90s. And forgotten is the fact that Citi has the best global banking franchise in the world, a growth story that's been forsaken by the media.

The credit cycle still has a long way to go to purge its excesses. Consumer defaults will grow. Write-offs, earnings shortfalls and charge-offs will continue. But the worst is already priced in. At some point, the market will look forward to normalized future earnings.

If you assume that our monetary system will cease to exist -- that we'll soon be bartering for wood and foraging for scraps -- then you should sell the financials and buy a machete. If you believe the more likely scenario, that the financial system will eventually recover, then buy shares instead.

Comments

[Sciguy]

"The only thing we have to fear is fear itself." (FDR) It's not just the market that runs on fear - everything we do runs on fear. Fear of invasion by terrorists, fear of losing a job, fear of losing a house, fear of not having enough money for retirement, fear of an afterlife, fear of NO afterlife, etc. ad infinitum.

I'm hedging my bets - I still have stocks, but I'm not giving up raising poultry any time soon. At least with my chickens, I know what I have and what I'll get - and I don't need to have a huge number of chickens to get eggs. With stocks, it really does take money to make money.

This may be a naive point of view, but if I've got 10 shares of something that hands me 25 cents per share as a dividend check, I get a whopping $2.50. If I've got 10,000 shares of that same stock, my dividend check will be for $2,500. If I'm fortunate enough to have 250,000 shares, then I'll be getting $62,500 - not bad for doing nothing but buy the stock to begin with.The rich get richer on their dividends from market bubbles, and the middle class gets enough trickled-down money from their dividends to buy bubble gum.

[sheila]

the best way to recession-proof your life is ENERGY INDEPENDENCE! fuel has created most of the problems we are facing, from global warming to wars, to insane price hikes, so why do we keep bowing down to the Big Oil/Big Utility model and subsidize them, when we WE THE PEOPLE should be selling them our clean solar power???

the "renewable power" industry as it's emerging now is a TOTAL SCAM, just another giveaway to rich, rapacious utilities who get to completely and permanently destroy hundreds of thousands of acres of OUR federal wilderness (yeah, real "green"), bottle OUR wind and sun, and sell it back to us at a profit, all on OUR tax dime. as usual, socializing the costs and privatizing the profits.

the only way we can break free of the nightmare of Enrons, Chevrons, 3 Mile Islands, dead coal miners, melting glaciers, wars in the middle east, unemployment, etc. is SANE ENERGY, ENVIRONMENTAL, AND ECONOMIC POLICY - put the stimulus package to work by getting out-of-work construction crews putting solar on every rooftop in america!!! use our tax subsidies to finance OUR renewable power plants on our own roofs!! we get our electric cars, and poof! half our financial and environmental problems are SOLVED, and WE profit.

this is so painfully obvious, people need to take some direct action NOW - contact your federal and state reps and demand change.

[realitytrumpsbull]

My question is, why doesn't the country ball up and go down in flames on weekends? Because the DOW doesn't really mean crap. Nor frankly does all the biz-porn that they sell, emerging markets and guaranteed returns and all that stuff. The Little Guy only stands to lose in the market, if you're not in possession of 10 million dollars already, you don't have enough to 'play' the market, but with folks like Bush in charge, and all that social security money just sitting there waiting to get harvested, well there's ALL the gramma's pension checks in one bushel basket...if the market goes seriously south, it'll hurt a lot of people, but the net effect of siphoning money away from so many people all at once is that no one really notices...until it's too late. I tried to pull the money out of my 'retirement' account, they still haven't gotten back to me...hmmm...

[peaceandfreedom]

Since the Market is gamed from start to finish, I believe that Fear is the only reasonable reaction to it. All of the happy econo-doublespeak notwithstanding, your graphs, charts, models, and computer projections are just more sand to throw in the eyes of the consumer. When the Market Makers want it to go up, it will go up. When they want to knock the pins out from beneath it, like now, they'll do that, too. If you happen to buy a few good stocks that can withstand the fluctuations and make a little money, sure, you come out ahead. But you can do that at the track--It's called gambling. Most of the time it suits the Players to have it all run more or less smoothly, and to reward or punish certain stocks or sectors as the need for bigger paydays arise. What we are seeing now, however, goes beyond even something as simplistic as this House odds mentality: we have crossed over into Economics as the ultimate WMD, and the American middle class is the target. Unwinding FDR is just a start. Be afraid? Yes. Be very afraid.

[knowhelpnow]

You are crazy only the rich can survive this sort of thinking. Our financial markets are going to go down, because we are already in a recession and heading for a depression. Our country is in debt up to it's eye brows and the workers are hanging on by a thread. You forget that our dollars are drowning in inflation and until this is over anyone in the stock market is going to lose.

[usna73]

I agree with your metrics, but still prefer to wait for banks to bottom in a trading tsunami. I don't yet see an signs of braod capitulation. They are only up on short covering. Patience my friend, patience. We're not there yet.

[January]

Thank you for confirming the familiar assertion that market investment is gambling, pure and simple. The sales pitch you offer for urging that stocks are a "good buy" immitates the gambler's message that blackjack is better than craps.

The only reply to the compulsive gambler is to stop. Since you make your living by selling market investments, that is a difficult option. You have grown comfortable with the fear that you cite.

It is difficult to manage in a capitalist economy without some form of investing. Now that real estate has been made into a gambler's paradise, that has made that investment much harder for those of us who don't want to gamble. So it is a game that one must play to try to keep up.

But in view of the consequences of unremitting incessant development for the health of the planet, it's just a matter of time before we will be forced to stop. Read "Collapse" and you will find a history of people who listened to the kind of advice as is found in this column.