It seems appropriate to make a comment on the market following the sharp downside volatility over the past few weeks. However, to be perfectly honest, I think predicting the short-term is pretty much impossible at this point. My gut feeling is that six or nine months from now we will look back on this period as a good buying opportunity and another of Wall Street’s periodic panics that have little relevancy to the broader economy. But compared to prior panics, this one has greater potential to lead to a recession. The fact that August, September, and October have been some of the worst months for the market over the years makes predicting the short-term that much more difficult.
I do think that the Fed did something very important on Friday by reducing the discount rate and issuing a new statement indicating that it had shifted from a primary occupation with preventing inflation to a focus on sustaining growth. This action clearly puts an interest rate cut or a series of interest rate cuts on the table. That increases the risk for bearish speculators to try to drive the market lower as they know that any statement or action by the Fed will trap them in positions with big losses. I think the Fed was probably growing concerned with all the rumors in the market last week and wanted to first and foremost calm things down. With this accomplished, the workout of the serious problems in mortgage financing and the trickle on effects on junk bonds, emerging markets, and merger and acquisition financing have been granted time to work themselves out. The Fed does not want to bail out speculators and hedge funds that made bad investments. On the other hand, protecting homeowners stuck in bad mortgages is important relative to the goal of maintaining strong and consistent economic growth. The Fed probably feels that by letting the market know it understands the problems it will buy time for all concerned….

Past panics where the Fed took action have shown a similar big positive short-term reaction such as the one we saw beginning with the Thursday turnaround last week. Past panics also show that selling often returns after the initial relief rally. What will be important to watch is how intense the selling is on the bad days over the next few weeks. Downside is to be expected. Less intense downside would indicate the worst has passed. My expectation is we will see less intense downside.
I have done very little in client accounts. I have not completed any sales. Since I think the risks are higher, I would like to take a little cash off the table but the quick and sharp declines in many stocks make this an inopportune time to sell, especially since my base case is that this panic will pass. For clients with higher cash balances I have been gradually spending cash since the first sharp downdrafts in late July. I continued to nibble as recently as last Thursday and Friday.
Developments are likely to rapidly emerge over the next few weeks. I’ll do my best to keep everyone informed of my latest thinking. A key thing to remember, however, is that Northlake Capital Management use a long-term investment strategy with virtually no influence from market timing. This means I’ll be more patient than many other investors, especially those you read about in the newspapers or magazines or hear on CNBC.
Please feel free to leave your comments below or contact me via phone or email if you want to discuss anything related to the current market conditions.