Sam Collins

Follow the Money

by Sam Collins   10/13/08

As margin calls mounted on Friday, fear rose to record levels and so did the pressure on mutual funds and hedge funds to liquidate. The major stock markets plunged to new lows in one of the heaviest days of selling in the bear market of 2008.

It was the eighth day of losses, despite the efforts of the U.S. Treasury Department, the Federal Reserve System, and the G-7 Foreign Ministers now meeting in Washington.

However, the most important event in a week that finally saw stocks break the Dow (DJI) 8,000 mark for the first time since 2003 was a decision made on Wednesday by six central banks to cut interest rates.

The U.S. Federal Reserve cut the Fed funds and the discount rate by 50 basis points to 1.50% and 1.75% respectively, but it wasn't the only action taken by the Fed last week. Earlier, it doubled the outstanding balances of the Term Auction Facilities to $900 billion and announced a new Commercial Paper Funding Facility that will provide a backstop to U.S. issuers of commercial paper.

At one time on Friday, all 30 of the Dow Industrials were in the red, and at the close Alcoa (AA) was off 9.7%, Exxon Mobil (XOM) was down 8.3%, and Chevron (CVX) fell 9.64%.

But a late rally reversed many of the losses and Bank of America (BAC) closed higher by 6.32%, General Electric (GE) rose 13.10%, JPMorgan (JPM) was up 13.52%, and McDonald's (MCD)gained 2.44%.

Other blue chips saw some late buying with General Motors (GM) gaining 2.7% and MetLife (MET) up 8.04%. Some financials saw heavy buying, too, with XL Capital (XL) up 37% and Wachovia (WB) up 43.1%.

Virtually ignored were two positive economic reports: The Commerce Department said that the U.S. trade deficit narrowed in August and the Labor Department reported that import prices had declined in September.

At the close, the Dow Jones Industrial Average (DJI) closed at 8,451, down 128 points, the S&P 500 (SPX) fell 11 points to 899 and the Nasdaq (NASD) gained four points to close at 1,650.

Volume on both major exchanges was heavy with the New York Stock Exchange trading nearly 3 billion shares and Nasdaq trading 2 billion shares. Breadth on the NYSE was a negative 2-to-1, but on the Nasdaq there were more advancers than decliners by 8-to-7.

The week was one of the worst on record, with the Dow Industrials (DJI) down 18.2%, the S&P 500 (SPX) down 18.2% and the Nasdaq (NASD) off 15.2%. For the year the Dow, S&P 500, and Nasdaq are now down 36.3%, 38.8%, and 37.8% respectively.

On Friday, crude oil for November delivery fell $8.89 to $77.70 a barrel, and the Amex Energy SPDR (XLE) fell $1.85 to $43.40.

The December gold contract dropped to $859 an ounce, off $27.50, and the PHLX Gold/Silver Index (XAU) was down $13.92 to $100.56.

What the Markets Are Saying

With the markets in freefall and slicing through major support zones that took years to build, it is difficult to determine where or when a final bottom will occur. Emotion is high and with forced liquidations as the result of margin calls and pressures from other markets to liquidate to meet credit demands, some feel that the historical indicators may not be as valid as in 1987 or 2002.

But for someone like me, with more than four decades of observations, I find it unlikely that the tried-and-true measures of public fear and their resulting need to sell at any cost will not be as valuable a guide as in the past. I'm, of course, talking about the so-called sentiment indicators. They are now off the chart and therefore telling us that a bottom to the bear market of 2008 is at hand.

Here are some of those sentiment numbers: The CBOE Volatility Index's (VIX) prior high was 49.53, but on Friday it set a new intraday high at 76.94. The American Association of Individual Investors survey of bulls and bears had a prior bearish high of 54.8 and on Wednesday reached a new all-time high of 60.84.

There are others: On Wednesday, the 52-week lows on the NYSE as a percentage of issues traded spiked to an incredible 67.3%, also a new record.

And from Sam Stovall, as reported by Standard & Poor's: The percentage of S&P 500 (SPX) sub-industries on Wednesday with negative six-month returns had soared to 98%, the highest since Sept. 27, 2002 -- that's just about as bad as it can get. The CBOE put/call ratio hit 2.1 at 10 a.m. Eastern on Friday, another new high ... and on it goes.

Virtually every record of sentiment has been broken and the major indices closed on Friday into the heart of the chart support, marking the bottom of the last bear market, the triple bottom of 2002-2003.

And on Friday, with the market close to its low of the day at around 2 p.m. Eastern, a curious thing happened. The market reversed with huge block trading that centered on the technology and financial sectors. By 3:30, the key averages were in the black but some profit taking by traders appears to have capped the advance, closing stocks at a modest loss but ending a day in which the Dow (DJI) had a swing of almost 1,000 points from high to low, and back to high.

So, have we reached a bottom?

The sentiment numbers tell us that throughout last week, portfolios were thoroughly trashed with powerful and unprecedented breadth and volume. The chances, therefore, that we are now witnessing the final capitulation by holders of every class of investment asset and that the bottom is at hand, are very high.

In the past, the proof of a bottom after a selling climax has been the willingness of those with cash to invest. If indeed "past is prologue," then we will see an unprecedented rush to buy stocks because big buyers recognize value and are willing to take a small risk for large gains.

Today's Trading Landscape

Earnings to be reported include: Fastenal (FAST), KMG Chemicals (KMGB), POSCO (PKX) and Stanley Furniture (STLY).

No major economic indicators are scheduled for today.

Today, the Fed will begin providing unlimited dollar funding with three European central banks. Futures are predicting a higher opening following strong markets in Europe and Asia. The bond markets and banks are closed today in recognition of Columbus Day.

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Sam Collins can be reached directly at samailc@cox.net. You can also check out an archive of some of his most recent market outlooks by clicking here.