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Big falls but do we have anything to fear?

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by Peter Switzer

I know this looks like panic territory stuff with the Dow down more than 500 points this morning but we actually lived through days like this in 2010; we have just forgotten about it. As a CNBC super — those little strips that TV producers put on the screen under a talking head guest — reported, “Major averages have biggest one-day drops in more than a year.”

And in the past two financial years, investors have actually made around 10 per cent on shares if their portfolio did as well as the index, so we have to be careful about worrying too much on bad days like these. Of course, if you are a short-term investor and you didn’t see this coming then you have good reason to be upset today.

So let’s try and make sense of what happened today.

The underlying fear is about whether the US heads into a recession again. The majority of US economists have second-half growth at two to 2.5 per cent and that means they are saying no recession. However, they have cut their forecasts from a three to four per cent range and that would explain a less positive stock market but nothing like this.

So, what’s the key factor turning a sell-off to a big slide in the market? The answer is Europe.

The focus has swung to Europe and the picture is not looking good and the European Central Bank (ECB) is now in the spotlight and it needs to come up with a big play.

Art Cashin, who is the director of floor operations at UBS Financial Services on the New York Stock Exchange and who I interviewed last year when I was at Wall Street, pointed the finger at the Europeans. He thinks stocks could go down further unless some positive circuit breaker turns up.

“The internals of the market are heavily oversold,” Cashin noted. “It’s all about Europe in my view and not about any of the small incidental indicators.”

The European debt problems not only put fear into the equation over European banks but it does not help forecasts for global economic growth, especially when you throw in the likelihood that the US will grow slower than expected.

Cashin thinks the US selling could be Europeans who have cashed in US stocks to get liquidity that they can’t easily get in Europe.

Right now, so-called bond vigilantes are attacking Italian bonds driving down the prices and pushing up the yields and these guys are like short-sellers who sniff a bear market opportunity and go in for the kill. They need a ‘sheriff’ to come into town and make them pay.

I asked Dr Shane Oliver from AMP Capital Investors if these financial terrorists needed to be crushed and how could it happen before they precipitate a recession?

He said the ECB needed to act like the Fed and introduce the equivalent of QE2 — monetary stimulation — where they buy European Government bonds, which would drive up bond prices and bring the yields down.

Last week we were waiting on the nincompoops in Washington to get their act together and now the dopes at the ECB have to stand up to the plate and recognise that when you are trying to avoid a Great Depression, as we have so far, we are all Keynesians – that is, the policymakers spend to ensure prosperity returns and then when economies are growing you use taxes and smaller government to pay back the debt.

If you don’t like this solution, then you run with the market one, which will mean 20 per cent unemployment in countries like the US and probably 10 per cent here. It will mean businesses go broke and some people lose their fortunes but the problem is solved more quickly but with a hell of lot of pain.

My view remains that we will muddle through this and stocks will have a comeback as the year progresses. The current US corporate reporting season is better than expected and P/Es on stock markets — especially in Australia — look unbelievably attractive.

For those worried, you have my sympathy but long-term investors need to be reminded that they are in for the long haul. John Lennon once sung: “No one told me there’d be days like these.” Regular readers and clients know that I have warned that there would be days like these.

Before May, I argued the historical case for ‘sell in May and go away’ and I also pointed out that we were overdue for a correction on Wall Street, which comes every 160 days. I haven’t counted but I’d say that this one was over 140 days late!

From here, I think the Europeans will come up with a better plan. The Yanks will slow down but they will dodge the recession bullet. Our Reserve Bank will cut interest rates — at long last — and stocks will finish the year much more positively than they look like now. Finally, I bet, and I have actually done this with my investments, that for the financial year investors in stocks will do better than those in term deposits.

Francis Ford Coppola was once interviewed and he said how he was going through a rough patch and not feeling very positive about his future. This was months before he released a little film called The Godfather! Always be careful about short-term pain that makes you forget about the prospects of long-term gain.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Published on: Friday, August 05, 2011

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