Is It Over Now?

Today brought a fitting end to one of the wildest weeks in stock market history. The Dow whipsawed up and down within a 1,000 point range, twice recovering from drops of 500 points or more and ending with a last-hour rally that made the 128 point closing loss look like a victory. The CBOE Volatility Index, widely followed as a sort of investor-fear gauge, spiked up to a record high as options traders paid enormous prices to be protected from loss.

Much of the day’s action hinged on an auction being held among derivatives dealers to settle contracts related to the now-defunct Lehman Brothers. There was fear that other banks might be forced into liquidation, but it appears all the firms involved were able to meet their obligations. Financials ended the day as the best-performing sector. Real estate and transportation stocks also got a bounce, while energy, utilities and health care added to their losses. The S&P 500 had its worst week since 1933 while markets around the world broke similar records.

Today’s slightly encouraging conclusion aside, the global financial problems are far from over. Inter-bank lending is still frozen and massive liquidity injections by central banks are not helping. In fact, they may be making things worse. Today we saw some anecdotal reports that cargo is piling up in seaports because ship-owners are unable to get the bank letters of credit that finance their shipments. This is a sign that the credit crunch is spreading into the broader economy.

President Bush’s reassuring public statement was widely covered by the media, but at this point it is unclear how many investors actually care what he has to say. This weekend the leaders of the G-7 industrial nations are meeting in Washington and are expected to issue some kind of joint statement about the credit crisis. Unless it is accompanied by some kind of miracle cure – and we can’t imagine what that would be – this statement is also unlikely to be helpful.

What will Monday bring? One glimmer of hope was today’s +4.7% gain in the Russell 2000 Small Cap Index. The Nasdaq Composite also made a fractional profit for the day. If small caps can gather some momentum, the Dow and S&P 500 may be able to follow soon. On the other hand, the fundamental economic conditions that got us in this mess haven’t changed. Housing prices, unemployment, consumer spending, and industrial activity all point to a deep global recession. Hence any rally from here is likely to be shallow and short-lived. Those with gray hair will recall that the 1987 Crash was followed by months of grinding, frustrating, and generally difficult market action. We won’t be surprised to see the same this time. Hopefully, there will be a few sector trends for us to trade.