It Ain’t Over…

The action of the past two days is more evidence that extreme volatility remains in play for investors. Unfortunately, we have no idea when the fat lady will sing to mark the end of it. In times like these, it is advisable that you try not to make too many big decisions and instead patiently await the return of sanity to infuse the markets.

So what happened over the course of two days? On Wednesday, investors realized that the financial crisis is not the end of the process. People turned their attention to the fundamental economy and the news was a bit spooky, even for October. Evidence is mounting that the downturn could be more significant than the 2001 or 1990-1991 recessions. While we all knew this was coming, it was confirmed by the release of September Retail Sales, which dropped 1.2%--the worst reading in two years. Considering that 70% of the US economy is powered by consumers, a retrenchment in their consumption is going to have a dramatic effect on the economy. Additionally, a more esoteric report underscored the pull-back in global growth. The Baltic Dry Index, which measures the cost of shipping bulk commodities, tumbled to its lowest level in almost six years as recession fears intensified. The index has fallen 49.8% since the end of September and has fallen 86% from May’s all-time high amid weakening demand.

These recession fears were exacerbated in the last hour of trading on Wednesday. Some said it was mutual fund liquidations or hedge fund puking after margin calls. In the end, there were just more sellers than buyers and US stocks saw their worst percentage loss since the crash of October, 1987. The Dow tumbled 733.08 points or 7.9% to close at 8577.91; the NASDAQ dropped 8.5% to 1628.33; and the S&P 500 was down 9% to 907.84. The damage amounted to approximately $1.1 trillion in value in ONE DAY.

Then something neat happened yesterday: investors realized that maybe the world was not ending just yet. The readings on inflation demonstrated that indeed prices are falling—crude oil traded below $70 a barrel for the first time in over a year; interbank lending rates improved; the VIX broke through an intraday record above 80, but finished down 3.2% at 67.06; and stocks partially recovered from Wednesday’s debacle. The Dow swung in an 816-point range, finishing in the black by 401.35 points higher, up 4.7%, at 8979.26, a more than 50% retracement of the previous session's damage.

So what have we learned from the two-day roller coaster? There is now a consensus that we are in a recession on top of significant financial market stresses that have wreaked havoc over the past month. What is less clear is how bad it’s going to get. The best way to think about the massive swings is to translate them into a conversation. On Wednesday, Mr. Market said: “this is going to be a really bad recession and it’s going to last a very long time—maybe forever!” Then yesterday, Mr. Market said: “this is going to be a bad recession, but there are still companies that will make money and maybe they are worth owning.” This will likely be a conversation that continues for some time, so be prepared for more of these wild gyrations.