September Massacre

ppteam

Investors dump stocks around the world, as moves by the Federal Reserve and European Union fail to inspire confidence in the economy in the U.S. and abroad. Getting a chance to buy gold.
The big question before the opening session last week was: Could the brisk market rally last? Given the state of the global economy—pretty horrible and getting worse—our response was a resounding "No!" The big question as the week staggered to a close was a bit more urgent: Can the market survive? And our answer is a somewhat more equivocal: "We sure hope so."

A pounding that began Wednesday took on the dimensions of a massacre on Thursday. Obviously, the market doesn't know or plain forgot that massacres are supposed to occur only in October. On Thursday, our beloved old Dow fell as much as 527 points before finding some tenuous footing and finishing the session down 391 points, for a two-day drop of 675 points.

A combination of sellers' fatigue (in this age of high-frequency trading, even computers grow weary), short covering and, as a savvy friend points out, the institutional imperative of taking what profits they still have before the miserable quarter ends, stanched the bloodletting, momentarily at least.

In the frantic rush to unload, commodities, including oil and hitherto sacrosanct gold futures, as well as equities were dumped wholesale, providing a fantastic display of quantitative disinvestment. The ostensible trigger for the panic was that Ben Bernanke and cohorts on the Fed's Open Market Committee pulled a skunk instead of a rabbit from their bag of monetary tricks.

Operation Twist, which calls for the Fed to sell short-term securities (maturing in three years or less) from its capacious $1.7 trillion holdings of government debt and use the $400 billion thus raised to buy longer-term agency mortgage-backed securities maturing in six to 30 years, turned into Operation Tangle.

Designed to bring interest rates down further with an eye on goosing the moribund housing market, the plan was something less than a surprise, having been bruited about in the weeks leading up to the Fed's two-day confab. In the event, obviously, it struck investors as a pretty milquetoasty way to get the economy up to speed and create jobs.

It scarcely reassured the investing masses, moreover, that the Fed accompanied the announcement with a tepid, to put it mildly, assessment of the economy. Nor did it help that the European Union continued to futz around, holding meetings and issuing grandiose declarations signifying nothing, while some of its more vulnerable members (we'll spare you a full recitation of the now-familiar names) do a not-so-slow burn.

Possible defaults by the pallid peripherals—Greece, where the yield on 10-year government bonds shot up to an awesome 22%, is still the immediate risk, but Italy, for one, seems awfully shaky—could eat up hundreds of billons of precious bank capital, warned the International Monetary Fund, which seems to have a much better handle on the fragile state of the continent's economy than the European Central Bank.

When it comes to bad news, the hoary old adage that it never rains but it pours neatly defines the way things are in the world economy. The latest readings, released last week on the purchasing managers index of those supposed two bedrocks—Germany and China—both were disappointing, raising the specter and the odds of a global economic relapse.

Chinese stocks, for their part, have been lagging for quite a spell now, in part afflicted by fears that with Beijing tapping the monetary brakes, the Sino bubble might finally burst. The Shanghai market ended the week at its lowest point in 14 months, while Hong Kong had its worst week since October 2008.

And the much-heralded decoupling by emerging nations' markets, a notion that frankly never made much sense to us, was one of the prime casualties of the universal carnage. For inveterate stock lovers, pure and simple, as is always true when the big, bad bear is unshackled, there was no place to hide.

SO WHAT HAPPENS NEXT? Nosey, aren't you? We were afraid someone might ask us that question. The reason is that, though we pride ourselves on our forecasting acuity, by no means do we lay claim to being perfect. Indeed, in common with lots of other folks, we're compelled to own up to having trouble forecasting the future. But please don't be dismayed by this minor confession of fallibility; we vow to continue to prognosticate, encouraged by popular demand (that translates into three readers, only one of whom is a certified masochist).

Our view is that nothing has changed, except for the sharply reduced value of most equities. That's not to be blinked at, of course, but there's no immutable law of investing that says stocks can't get cheaper, even much cheaper. Trying to predict what the market does on any given day, or even a stretch of days, is akin to trying to foretell the outcome of a volley in a tennis match. Absolutely fruitless.

The market inarguably has taken a big hit, and investor confidence, at best only sporadically upbeat of late, has been badly shaken. We don't buy the analysis, engendered more by wishful thinking than tangible evidence, that the severe damage inflicted on portfolios will act as a kind of catharsis, leaching out wildly speculative impulses and yielding a more sober and solid investment approach by professionals and individuals alike.

For one thing, this was a nondiscriminating portfolio pasting that left well-heeled investors along with widows and orphans considerably poorer for the ordeal. Beset by dismal job prospects, housing foreclosures and lagging income, the overall populace has been in a defensive mood, manifest in a reluctance bordering on refusal to borrow even when credit is available—deleveraging is the fancy designation for such compulsory penny-pinching—and more risk-conscious than any time we can remember.

Contrary to what the Street shills say, it'll take more, much more, than a few good stock-market days to change that. Particularly with the economic climate getting noticeably less salubrious, the political climate more poisonous and Washington, like its counterparts abroad, apparently helpless to inject some vigor into the flagging recovery that seems more likely to grind to a halt than stage a revival.

Desperate bulls have latched on to the emphatic swing in sentiment to the downside. But sentiment has become quite fickle, and swelling of the bearish ranks might portend a bounce of sorts—but nothing sustainable. That won't come until we get a final climactic blowout in the market—and we're talking the real thing here, the sort of big breaks we had in '73-'74 and after the dot-com debacle. Or—and it's always at least conceivable—the economy's vital signs take a radical turn for the better. Just don't bet on it.

GOLD CONTINUED TO LOSE its luster, big time. On Friday, in case you somehow failed to notice, it really got whacked, shedding almost $100 an ounce and falling to $1,656, down comfortably (or uncomfortably if you happen to own a nugget or two) nearly 5%.

As we mentioned, the yellow metal, which at its peak was up more than 30% this year alone and has been on a tear for quite a spell now, powered by increasing distrust of paper money, and for good cause amid rampant threats of default and devaluation, had handsomely rewarded its true believers and Johnnies-come-lately alike. Prominent among the latter were any number of hedge funds.

And from all accounts, when the going suddenly got tough for equities, with the end of the third quarter fast approaching and portfolio managers anxious to put the best face possible on their performance (which, for the most part, wasn't setting any worlds on fire) before telling their investors how well or (gulp) poorly they fared, they naturally sold their biggest winners. So, for them, selling gold was a no brainer.

There have also been rumors, circulated, maybe even started for all we know, by the usual suspect heavy-breathing blogs that certain European banks (unnamed naturally) are fortifying their balance sheets via sales from their hoards of gold. What isn't in question is that there's some active large seller or sellers of the precious metal and the offerings keep coming.

Although some of our best friends are gold bugs, we're not of that persuasion. But we do think gold is worth keeping an eye on. At some point when the selling lightens—and that could happen in a matter of weeks—you could do worse than add a few ounces to your portfolio.

CHINESE DEMAND FOR VIRTUALLY anything traded by man has been a powerful spur to commodities of all kinds, from ordinary stuff like grains to relatively exotic items like rare earths. So it obviously figures that the slowing of China's growth has been accompanied by a retreat in the price of just about every commodity, including copper, which is reputedly an indicator of sorts for the economy as a whole (someone, perhaps it was our former colleague Jim Grant, once dubbed it the commodity with a Ph.D. in economics).

Even oil has shown signs of softening, although we must admit that pump prices have taken their own sweet time in reflecting the dip in crude. But we have a hunch that crude itself may be coming under renewed pressure. A story on Bloomberg noted that a newly built supertanker capable of carrying two million barrels of crude is slated to be mothballed at a natural harbor in Malaysia because a glut of ships has slashed rental rates to $1,000 a day, roughly a tenth of its running costs excluding fuel. It's the first time since the 1980s that has happened.

Besides a surplus of tankers, we can only infer that demand from petro producers isn't exactly gushing.