Saving the Market, or Postponing Doom

August 17, 2007, 11:37 am



Saving the Market, or Postponing Doom



Posted by David Gaffen


The Fed’s action this morning has its cheerleaders (like this guy) and those who view things with a bit more jaundiced eyes, and slowly, the market’s hysterical glee at the cut in the discount rate is giving way to, well, good-natured appreciation. By the end of the day, who knows what people will think.
The
Federal Reserve lowered the discount rate — the window at which the Fed
will lend to monetary institutions — to 5.75% from 6.25% in an effort to make sure liquidity remains readily available
(and some would argue, bail out investors with bad positions). This
move, along with an additional statement suggesting the Fed is now closer to cutting rates,
has buoyed various asset classes, as the impression among observers is
that this will save the market and put stocks on an upward path, cutting short the harsh correction endured in the past few weeks.
“We’re saved!” reads the opening sentence of Jim Cramer’s euphoric commentary, responding to the Fed’s answer to his exasperated plea for a cut in the discount rate two weeks ago. The former hedge-fund manager predicts, in a post on TheStreet.com, that the move “could have us up the most we have ever been.”



Optimism has faded a bit.


But others are skeptical, and the slow retreat from the opening bounce suggests skepticism is worming its way into the picture. The
fundamental concerns over credit haven’t been solved through a cut in
the little-used discount rate, and while we’ll leave the economic
discussion for another post, the interconnectivity of the economy and markets requires some mention of how the markets will view fundamentals now.
And in that sense, some believe not much has changed. “After the Pavlovian reaction, which will buoy short-term sentiment, the Fed move will be seen as nothing more than a temporary shot of adrenaline in a sea of credit-crunched bodies,”
says Doug Kass of Seabreeze Partners Management. “Once the immediate
reaction wears off the recognition of the severity of the credit crisis
and the concommitant unwind of debt will be seen with better clarity.”
Tony
Crescenzi, chief bond market strategist at Miller Tabak, applauds the
move, adding that he expects a rate cut at the September 18 Fed
meeting. He notes that only $187 million was borrowed from the discount
rate, on average, each day in the past year, a small amount. With more debt obligations tied to the federal-funds target, lowering that rate will become more important, he says.
But
others wonder whether the move represents panic. “It’s hard to imagine
that a 50 basis-point cut in the discount rate will cure what ails the
financial system. Yes, it may bring temporary relief. But it’s our belief, naive perhaps, that something more fundamental has upset the former rosy state of affairs,” writes James Picerno in the Capital Spectator blog.
What do you think the move means? Will the Fed lower rates? Is the correction over?

The Capital Spectator


Money, Oil, Economics & the Search for the Bottom Line









« ANOTHER DISCOURAGING REAL ESTATE REPORT |

Main



August 17, 2007



VOLATILE OPPORTUNITIES



These are the times that try investors' souls, pinch their wallets
and raise questions about what constitutes sound thinking on investment
strategy.

No, we don't have definitive answers, but we can at least take a
stab at dispensing some perspective, albeit informed by limited
information that afflicts the mortal senses. With that caveat out of
the way, perspective starts with the fact that volatility, as much as
it scares us, is a good thing for strategic-minded investors. And the
market has been nothing of late if not volatile.

The VIX index, a measure of S&P 500's price volatility, has
taken wing in recent weeks, effectively tripling from its close at the
end of last year, as the chart below illustrates. Dramatic as the new
trend is, the resurrection of risk isn't all that surprising.



This past January we asked: Is Volatility Set for a Comeback?
At the time, pondering a future of revived risk was widely dismissed as
misguided ramblings. The bulls, you may recall, were then basking in a
rare state of total control over asset classes. Everything had been
rising for five years or more, and in the process price volatility fell
sharply. The markets, in short, were priced for perfection, as they
say. The fact that the perfection came after five years of fun
suggested that it was time to prepare for something else. The timing
and catalyst that would usher in change were still mysteries in January
2007. But the future seemed clear for those who believed that risk
can't stumble and stay abnormally low forever.




Today, the cloud of unknowing has been withdrawn, leaving volatility
in an elevated state. Par for the course with dramatic market declines.
What does it mean? From a strategic standpoint, the lesson for us is
one of shifting the mindset from raising cash (which we've been
inclined to do, albeit slowly, for the last year or so) to looking for
opportunities to start nibbling at the major asset classes.

For the moment, the shift in sentiment is academic. Having made no
purchases in recent weeks, we're still all talk and no action. But one
shouldn't underestimate the importance of changing one's intentions
from that of a net buyer of liquidity to a net deployer. Buying on the
margins when markets are falling is as emotionally difficult as raising
cash on the margins when markets are rising. Contrarianism--even a
slow-moving, risk-averse variety such as ours--tends to be a thankless
task in the short run, particularly in roaring bull markets. Regardless
of the backdrop, it's emotionally difficult to alter one's strategic
thinking on a dime. Rethinking and revising one's big-picture portfolio
plans takes time because the process starts in the last great black box
in the universe: the control center of the central nervous system. But
the revision becomes essential at various moments over time for the
simple reason that buying low and selling high is still the only game
in town for the long run.

Alas, your editor is as clueless as everyone else about the precise
timing of bottoms and tops. The next best thing is adding a strategic
overlay of time diversification to asset diversification. Having
created a pile of cash, we now aim to use it, albeit methodically,
deliberately and in pieces. Ideally, the cash will be deployed at
moments of extreme stress in the coming weeks, months and years.

Of course, perhaps the selling will blow over. As we write, we read
that the Federal Reserve this morning has cut the discount rate by 50
basis points. S&P 500 futures responded with a dramatic 2% rise.
Perhaps the financial crisis has passed. Perhaps not. We don't know.
But from out perch, the crisis wasn't triggered because interest rates
were too high by 50 basis points. As such, it's hard to imagine that a
50 basis-point cut in the discount rate will cure what ails the
financial system. Yes, it may bring temporary relief. But it's our
belief, naive perhaps, that something more fundamental has upset the
former rosy state of affairs. Until and if that's addressed, one might
wonder if the recent turmoil still reflects deeper issues.

Even assuming that the bulls resume control, the inevitable
correction will be that much bigger. With that in mind, it's our guess
that many investors have not been raising cash these past months. For
those who are still fully invested, a market decline leaves no option
other than to sell. In contrast, those with cash will be willing and
able to help out for those on the other side of the trade...at a price.

This Rally's Part of Something Bigger



By Jim Cramer
RealMoney.com Columnist

8/17/2007 3:38 PM EDT

Click here for more stories by Jim Cramer




The Fed's gambit changed things up. Changed things big-time.