Fear and Loathing on Wall Street

To date, yesterday was the maximum point of fear and loathing for investors in this latest market meltdown. Billions of dollars fled securities markets all over the globe, if only to seek respite from the damage that has occurred. Sure TARP may make it better than it could have been, but the view from these folks is clear: “I am willing to miss the next potential leg up in asset prices to avoid further pain on the downside.”

Unfortunately we are living in a time where fundamentals are no longer active. Psychology rules the day and as a result, fear is propelling investors to retrench and go to cash. Maybe you are one of those people who just can’t take it anymore. My advice is that if you can’t sleep, then by all means, make a change. But if you can take a longer view, you may be rewarded for your courage—and courage these days may in fact be the simple action of remaining in your diversified portfolio. (Hopefully you came into September with your money allocated among different asset classes, which has shielded you from the worst of the sell-off.)

Many are wondering how it got so bad so quickly—the answer is clear: the pressures have been building in the credit system for fourteen months and they are now evident for all to see. There has been a growing reluctance among financial institutions to offer basic loans that are the lifeblood of the economic system. Banks don’t want to lend to beleaguered consumers, but worse, they don’t want to lend to another institution if they suspect even the tiniest hint of problems with the counter-party’s balance sheet.

The evidence of this trend can be seen in the Fed’s recent data, which indicated that lenders reduced short-term loans to companies by a record $94.9 billion, bringing the total decline to $208B over the past three weeks. Commercial paper outstanding is down 14% from a year earlier, which is one of the reasons that GE, arguably one of the best companies in the world that continues to operate in the black, could not raise money and had to basically give a piece of the company to Warren Buffett to raise sufficient capital.

As anxiety intensified, so too did fear -- the Chicago Board Options Exchange Volatility Index or VIX, jumped almost 25% percent to a record high of 57.55, before slightly paring gains to trade at 52.05. To put that number in perspective, the last time the VIX was even close to this level was at the height of earlier economic or financial market dislocations, including the 1997 Asian crisis, 1998 Russian financial market crisis, 9-11 terrorist attacks and the economic crisis involving several South American countries in mid-2002. The elevated VIX is just one sign that investors do not trust any asset. Of course the other sign is the stock market, which tumbled to fresh lows on the year.

At its lowest point, the Dow was off 800 points yesterday afternoon, its biggest intraday drop on record. It regained ground at the end of the session to close down 369.88 points, or 3.6%, at 9955.50. The Dow closed below the 10,000 mark for the first time since Oct. 26, 2004. The S&P 500 fell 42 points, or 3.9%, to end at 1,056 and the Nasdaq lost 84 points, or 3.8%, to finish at 1,862. In a bright spot for consumers, crude-oil futures closed at $87.81, down $6.07, or 6.5%, while treasury bonds rallied along with gold as investors sought safe havens from market volatility.

In the end, you can’t be self-delusional about what’s going on – it’s pretty bad out there as investors absorb the structural, sentimental, technical and real economic worries that are plaguing markets and credit investors. Those hurdles aren’t likely to disappear any time soon, and the lack of liquidity clearly isn’t helping. However, by many measures, it appears that we have hit extremes, from sentiment, to performance, to valuation. We are likely to slowly transition away from the fear, loathing and systemic panic that has gripped markets and hopefully emerge with nerves frayed, but the future more secure.