Other than the week of September 11, 2001, last week was the most memorable of my career.
By the time the closing bell rang on Friday, investors were exhausted after an astonishing week of crazy activity, as the stock market swung from enormous losses, due to the fallout of the Lehman Brothers bankruptcy and AIG mess, to equally remarkable rallies amid talk of a massive government bailout plan.
Like many others, I knew I’d need the weekend to digest and make sense of everything that happened. The only reprieve I got was taking my 7-year old son to his first baseball game. He even got a ball from Florida Marlins manager Fredi Gonzalez, which made the night as unforgettable as the week.
By Saturday morning, though, it was back to the news – and unfortunately not the sports section. After reading countless reports, columns and opinions, here are my two cents (euro cents, by the way, since they’re worth more than US cents – and will continue to be for some time)…
A big bailout and A ban
So the US government is set to give Wall Street a bailout to the tune of $700 billion. Additionally, the Securities and Exchange Commission (SEC) issued a ban on the short selling of 799 stocks until October 2.
My immediate reaction to both decisions was outright anger. I don’t like government interfering with free markets. And in this case, I felt that those who took on too much risk would not feel the full impact of their actions if “Big Brother” came riding to the rescue. Not to mention the chance of others making similar mistakes in the future if they think taxpayers will bail them out if they get into hot water.
With regard to short sellers, they actually play an important role in the market. Here are just two…
• Hedge funds and institutions short stocks in order to offset their long positions and cut risk. But with no short selling allowed, they must find other ways of doing this – which could include selling their long positions altogether.
• When markets are at a bottom, shorts provide demand by buying shares to offset or close out short positions. If not, there’s a chance that the market could see very low volume as fears rise.
But as I learned more about what was going on, I think Treasury Secretary Henry Paulson had no choice. Here’s why…
Imperative intervention
We were (and still could be) facing a complete meltdown of our financial system. If this issue was just about stocks, I’d say let ’em crash. I’m a firm believer that equities should be allowed to find their own level without any artificial interference.
But this is about much more than the stock market. We had a major money market fund that plummeted to less than $1. Remember… these kinds of funds are supposed to be safe investments, where people park their cash.
So when word got out that the fund was under a buck, a run on the fund began, just like the run on the banks during the Great Depression. Had this situation been allowed to continue unfettered, the ripple effect throughout the system would have been devastating.
At one point, three-month Treasuries were trading at a negative yield. This means investors were so panicked that they would lose so much of their capital, they were willing to invest in Treasury bills, where they were guaranteed to only lose a little bit.
Think about what that says – and about how close to the precipice we were. So what now?
They’ve got the “short” end of the stick… but they’re some of the smartest guys in town
I have a lot of issues with the way the bailout will be handled, but again, I sincerely believe we were looking at a collapse of the system. Something had to be done.
What we didn’t need, however, was the ban on shorting financial stocks. Blaming the short sellers for the latest problems reminds me of when the perma-bulls cried about day traders during the dot com collapse. Investors have just as much a right to short a stock as they do to buy it.
And think about this: Short sellers are very often the ones who expose bad companies masquerading as good ones. For example, how much more money would have been pumped into Enron if it weren’t for people like Jim Chanos, a famous short seller who unearthed the problems at the company?
And what if investors had listened to David Einhorn of Greenlight Capital, who was shorting Lehman Brothers over a year ago?
Because they go so strongly against the grain, shorts tend to conduct very thorough research. And like it or not, they’re a hugely valuable part of the system. In fact, whenever I research a stock, I always take the shorts’ arguments into account.
So I’m glad the Feds did something. They had to. However, it’s not without consequences. The $700 billion necessary for this rescue package isn’t exactly sitting around in the basement of the US Treasury, just waiting to be spent.
No… the government will have to issue yet more debt to cover the cost of this program – something that will make the US dollar even less valuable, and will eventually drive up interest rates.
Stocks prepare to hit the bear trail
Higher interest rates and lower confidence in the market means one thing for stocks: Bear mode.
However, over the long haul, I suspect we will eventually enjoy a bull market again. Be prepared, though… I believe that day may be a few years away.
So what should you do? Withdraw all your money and stash it under the mattress? Take shelter in an underground bunker until the dust settles?
Absolutely not. Despite the doom and gloom we’re hearing, you can get some respite…
The best medicine for the economy’s ills
Next time you hear someone on television ramble on about what a mess the US economy and stock market is in, I want you to ask yourself this question: “Okay… but that doesn’t mean the whole country is going down the toilet. So what sectors can still enjoy success, despite the economic sickness?”
The clue is in the question with the word “sickness.”
No matter what happens in the economy, people will still need to go to the doctor, take their medicines, and have life-saving procedures.
So while the economy may be sick, people will unfortunately still get sick, too – whether it’s a virus, broken bone, cancer, heart disease, diabetes, or a myriad of other ailments.
And whether they’re spending their own money, their insurer’s, or the government’s, they’ll buy therapies to treat their conditions, no matter what the S&P 500 is doing.
It’s just one of the reasons why I’m so optimistic about the healthcare sector – and why I expect it to outperform – especially in this market.
The thing is, good research and science will continue to be funded, as there’s always big money to be made from blockbuster drugs (unless, of course, the government nationalizes our healthcare system, too).
And as our resident healthcare expert, a difficult economic climate could actually make my job easier, as some companies will have a harder time raising capital. That’s why it’s worth repeating that companies with sound science should be able get the funds they need to conduct their research. On the other hand, those firms whose science is a bit more speculative may not.
Don’t get me wrong… there are few slam-dunks in the healthcare sector. You really need to know what you’re doing when you invest in it, and I actually pass on more than 90% of the companies that I research.
But think about it… if the field is whittled down a bit, that should mean I’ll have to sift through fewer losers to find my potential winners.
Hoping your longs go up and your shorts go down (the latter of which I admit might be difficult, given the government’s ban on short selling!)
• This article was written by by Marc Lichtenfeld for the Smart Profits Report