Protect yourself

While the market sell-off has been sever and has left us oversold by many indications, there is still potential for more disastrous declines. The global sell-off today highlights this risk. The global markets appear to be more correlated than ever with the US markets. What really is happening is that the world is losing some faith in the US financial system.

Why is this? Well it started with the sub-prime mess. At the root. The entire wallstreet machine setup a fraudulent system to make money at the expense of homeowners and investors. The homeowners were the chumps who went into debt and the investors were the chumps who bought the debt. In between wallstreet made billions packaging these debts. They profited by selling them here and more importantly abroad. The reality is that much of the housing boom was funded with foreign money via the sales of securities abroad.

As investors abroad realize the losses they lose faith in anything wallstreet has to offer. This is because they were lied to by wallstreet and the rating agencies who rated otherwise crappy debt as AAA. If wallstreet is capable of lying on this scale about these mortgage securities are they not equally capable of doing this in the stock market. Since the modern stock market is held together mearly by faith in the system, any distrust is a serious issue.

They tell you owning a stock is owning a piece of a corporation. On the surface this seems like a great thing. But in practicality due to the nature of today's markets and due to the fact that most stocks pay little if any dividend, what you are buying is virtually worthless. The only reason you pay so much money is that there is a belief that it is worth something.

Now i know these statements are almost heretical, but let me explain. If i make an investment i need to get a return on that investment. The return i expect is regular cash payments that over time will return my entire principal and a profit. Many years ago this is what you would get, in the form of dividend payments, from the purchase of a stock. Based on this you actually could invest in a stock and the stock market. But since most stocks pay very little in the way of dividends what should i pay for them?

Now you are told "but they will appreciate over time?" Well the answer is maybe. No one knows for sure and "past performance is no garuntee of future profits." In some ways the current stock market is not an investment vehical but a speculation vehical. We must remember that an increase of sales, earnings, or anything else like eyeballs (from the late 90s) does not directly translate into a return to the investor. Since you cannot buy the whole corporation you cannot get at the benefit the increase sales or earnings brings. Dividends are the only direct payout to the investor (and yes i understand the theory behind buybacks).

The simple point is that we have another lapse of trust in wallstreet. It will take time for it to blow over. As the crisis spreads from subprime to alt-A to prime to credit cards to car loans to cable bills you will only see more of this. In each case the defaults will rise and unethical games in how the system works will be exposed. The distrust will continue.

At this time i have a few long positions i took because we are at support on the dow 30. But i may need to reverse this depending on the opening action on Tuesday. The big picture i see is that it is still all down for now, so any rally is a short entry point with the caveat that there could be a big, although temporary rally, on an intra meeting rate cut. That is why i have some small long positions right now.

But back to the main point. Protect yourself! The risk is just too great to be sitting there long hoping things don't get worse.

I do find it interesting how this is playing out. When i look at valuations on the S&P i don't see them as overvalued. As such it would seem ludicrous to think we could have a market crash. But the key is that the E part of the P/E is totally open. With 20% of the market financials and financials being the life blood of all other industries, any drop in the E estimates can suddenly make the undervalued market look very overvalued.
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