Wildness Rules

If the geological evidence is to be believed, dinosaurs ruled the Earth for millions of years. Then one day, for reasons that remain unclear, they just went away.

In a similar manner, only two years ago Wall Street was ruled by five mighty beasts. Their names were legend: Lehman, Bear Stearns, Merrill Lynch, Morgan Stanley, and the mightiest of all – the T-Rex of Lower Manhattan – Goldman Sachs. Of the first two, only dust remains. For the third, its much-cherished independence is now just a dream. The last two were this week backed into a corner from which they struggled to survive. As of now, they still live, but they will either evolve or die out. A new financial age is dawning.

History may mark this as the week risk was socialized. Losses accrued by investors, borrowers, lenders, traders, and others are being transformed into obligations of the American taxpayer. That means you. As a society, we (or, more accurately, our leaders) have determined that it is better a large number of people to suffer a little pain than for a small number of people to suffer a lot of pain. Depending where you started, the net result of this process may be either good or bad for you. We can debate the wisdom and morality of it all, but the facts are what they are. Now we have to live with them.

Ironically, if you look only at weekly closing data (as many long-term investors do), this week will not look particularly eventful. The Dow slipped by -0.3%, the S&P 500 was almost flat at +0.3%, and the Russell 2000 had a decent gain of +4.6%. These figures mask the five-day roller-coaster ride that ended today. The Dow, for instance, had a loss of -4.4% on Monday, another -4.1% on Wednesday, and then a combined gain of +7.4% on Thursday and Friday. For some individual financial stocks, the volatility was simply breathtaking. Consider Wachovia Corp (WB). Here are the daily changes in WB shares this week:

9/15 -24.9%
9/16 +7.5%
9/17 -20.8%
9/18 +59.0%
9/19 +29.3%

Keep in mind, these are the daily changes for WB, and numerous other blue-chips had similar patterns. This sort of action is obviously unsustainable. If nothing else, markets will grind to a halt for lack of paramedics to treat all of the heart attacks among traders. Our relative strength rankings are showing extremely low values for numerous funds. As you know, RSM quantifies the intermediate-term trend on an annualized basis. An RSM value of 10, for instance, means that a fund which continues on its current trajectory will gain 10% in the next twelve months. Currently many sector, style and international funds are showing an RSM of -50, -80 or -100 and even less. That suggests these funds are headed for extinction in the near future. Given recent events anything is possible, but more likely such trends will correct themselves in the near future via a sharp short-term rally.

In hindsight, it appears that our decision on Monday to leave our strategies unchanged was the correct one. As of this writing we do not yet have Friday prices for the Fidelity or Rydex funds, but we can get a rough estimate by looking at similar indexes and ETFs. Rydex Small Cap Growth (RYWAX) should have had a good week while our health care and consumer-related funds were probably stable or off just slightly. For the moment, all our strategies still appear to be well-aligned with the intermediate-term strength. The only significant change this week was in our Equity Trader Strategy, in which Union Pacific (UNP) fell to our predetermined stop-loss point on Tuesday and was sold. Illumina (ILMN) and Datascope (DSCP) both had weekly gains, while Boots & Coots (WEL) pulled back but remains well above its stop-loss price.

Given that the last few weekends have brought significant news events, we will see how markets open on Monday before making any decisions for next week. AllStarInvestor.com subscribers will receive the usual Monday e-mail at mid-day.

For now, we suggest all investors find something relaxing to do this weekend. You definitely deserve it.

photo credit: cliff1066