The End Of The Credit Crunch?

The End Of The Credit Crunch [¹]
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By David P. Van Knapp | 20 September 2007

I believe that the credit crisis of 2007 is over, at least insofar as it is likely to impact the stock market. To be frank, it ended somewhat sooner than I expected.

A few weeks ago, I published a thesis about the credit mess. In a nutshell:

1. The credit crunch, begun by sub-prime mortgage lending in the USA, had spread into all areas of the [international] credit markets. Ill-advised loans, over-reaching by unqualified borrowers, and over-leveraged purchases of "loan packages" had led to spreading defaults, the failure of some hedge funds [[and mortgage brokers and banks: normxxx]], and the tightening or withdrawal of credit availability not only in the USA but around the world.

2. Investor sentiment had been badly shaken and would continue to yo-yo. Investors would fret over the credit situation, possible effects on the economy, and the ability of the Fed and central banks around the world to contain damage. They would have hair-trigger reactions to any signs, positive or negative. Therefore, severe market volatility was inevitable. Up and down days would exceed 200-300 points repeatedly, with an overall downward trend until the situation clarified. At one point, stocks had dropped nearly 10% from their high on July 19.

3. The Fed and other national banks had responded by [repeatedly] injecting massive amounts of money into the financial systems to stave off panic, illiquidity, and total 'seizure' of the credit markets. It was not at all clear whether such moves would stave off a true economic crisis. However, the initial moves did suggest to all that the central banks recognized the gravity of the situation and would try to head off and/or mitigate grave damage.

4. Investors were likely, but not guaranteed, to recognize that in the overall scheme of things, the credit crisis was limited in size [[and scope?: normxxx]] and was unlikely to drag the economy into recession[!?!] Pullbacks from the market had driven many stocks down to attractive valuations, and investors were more likely than not to see these as entry points if they could regain confidence that the economy was not going down the tubes. While investor sentiment would swing wildly, on balance it would tilt positive, and the markets were likely to be higher than lower six months hence.

5. Therefore, I recommended that investors (a) look for excellent companies with strong balance sheets; (b) loosen or eliminate sell stops to allow for the likely market volatility over the next few weeks or months; but (c) limit their stock investments to 1/2 or 2/3 of available "stock money" as a hedge against the thesis being wrong.

That thesis has proved quite prophetic. The markets, while extremely volatile, did start to bottom out and trend upward again. It did become clearer that the credit crisis was unlikely to topple the economy into recession[!?!]

Now, with Tuesday's slashing of the federal funds rate by 0.5%, and an equal lowering of the discount rate (the amount the Fed charges banks for loans directly from the government), along with similar moves by central banks around the world, I believe we can declare that the credit panic of 2007 is over.

This does not mean that there won't be more bad news. Some over-leveraged hedge funds and investors may still go belly-up. More borrowers will default, especially as adjustable-rate mortgages reset. Credit will be harder to obtain generally (which is a good thing) [[but not for the economy: normxxx]].

But I now believe it is clear that the Fed and other central banks will contain the damage from the credit crisis. Stock investors can return to more "normal" strategies. Using appropriate caution, they can take advantage of good valuations to purchase shares in excellent companies. If they use sell-stops, they can return them to more normal levels. And they can become fully invested again. There is now a very high probability that the market will continue on an upward trend, and move toward more normal volatility ranges, over the next few months.

In his Kelly Letter, Jason Kelly Adds:

The Fed doesn't cut rates every day and the predictable pop after its doing so may not last, so I wouldn't get overly excited about missing that.

What I would understand as quickly as possible, however, is that the market is poised for a solid performance in the medium term. If you're still stuck on last month's headlines about sub-prime and shaky credit markets, you're looking in the wrong direction on your calendar. Flip forward, not back. It won't be long until this silly little correction isn't even talked about, and it won't rate anywhere near the top of the issues successfully faced down by the stock market.

Here at The Kelly Letter, we were never afraid of sub-prime. We never thought the "state of the market these days" was scary. We watched all of the action with amusement, and watched for bargain prices, but not for even a minute did we think systemic failure was imminent.

[ Normxxx Here:   That's strange; BB surely thought so, and a number of equally astute economic gurus too. Well, where angels fear to tread... ]

If you did, take this opportunity to look into yourself and ask if you have what it takes to be an investor. I'm not joking. What has happened over the summer is not unusual in the stock market. If it rattled you, this business may not be up your alley. If you pay attention to fear-mongering headlines in even the most august of publications, this business is definitely not for you. If your first reaction when hearing how bad things are is to think about what to sell when you should be thinking about what to buy, you need to hang it up while you still have some capital left.

[ Normxxx Here:   Or, you could use investment strategies that don't require you to play along the edges of the cliff... ]

Now, the market won't keep going higher at this pace, of course. Last week was great and this week is off to a heck of a start, but even in a strong medium-term environment, the market won't just rise.

[ Normxxx Here:   Indeed, I am looking for a substantial pullback this coming week. ]

You'll know you've reached a professional [[trader, not investor: normxxx]] stance when your approach to stocks is the same no matter what's in the newspaper [[that part is pretty much true: normxxx]]. When they say the world is ending, you look for bargains. When they say it's a new world economy and that stocks won't ever go down again, you still look for bargains [[I would look to get out, at that point: normxxx]]. The media is a sideshow, folks, and the sooner you realize that, the better.

I do not think it's too late to get in this market. The beauty of my permanent portfolios is that they're never too late, hence their name. What most really want to know, though, is whether they've missed the opportunity to get money in for the end-of-year run-up I wrote about.

Obviously, some of the performance has been missed, but not all. The end of the year is quite a ways out there still, and the people who think the market is scary will take more convincing to realize that it's not— and will pile on just about the time the bargains are all gone. That will send prices higher, so there's still upside in this market.

As ever, be smart. Don't put your money in at the highs following the Fed's rate cut. Wait for another scary headline and a price drop. It'll happen along the path higher, which is still intact.

  M O R E. . .

Normxxx    
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