Market Update

"Wall Street took it on the chin, Monday." Any Simpsons aficionados know whether Kent Brockman ever said that on an episode? It seems like something he would say. I'm just trying to have a little fun and despite the graphic in the picture it is not time to panic.

Several times over the last couple of years after a nice little pop I commented along the lines that if you were freaked out and bargaining with yourself at SPX 700 or SPX 800 that you should take advantage of the (then) recent lift to sell some stock.

The idea back then was to envision, or better yet remember, your psychology from a past fast decline in order to avoid in a future fast decline like we are having now. I recently commented that at 1500 everyone knows the market goes down every now and then and everyone can tolerate the volatility. It becomes a different story a couple of hundred points lower but I would say it does not have to be if you have the right asset allocation.

We have current news about serious problems in Europe, with US banks, with a legacy airline and with an almost obsolete company (Kodak). What is your exposure there? Fortunately we have no ground zero exposure. We own things that are down a lot of course. Stock are arguably well along the road of pricing in a recession which means industrial and energy companies get hit hard.

I had a conversation over the weekend with someone who has a large position in a very cyclical stock and of course that stock is down a lot like many very cyclical stocks. I know a little something about the stock and made the observation that it seems to go down more than the market on the way down and then go up more than the market on the way up which was his observation too.

This is an important concept. The person knows ahead of time that if the market drops a lot, then this one name is very likely to go down more. I expect the very same thing with all of the cyclical stocks we own. I expect the defensive names will go down less and then go up less. Generally this is how it works and it is foreseeable. This is not about predicting what the stock market will do it is about understanding what your portfolio is likely to do if the market goes down or if it goes up.

When the above is combined with a little time spent figuring out what to avoid, financials and Europe may turn out to be the easiest avoids of our lifetimes, then you should be in position to endure this reasonably well. I've disclosed many time before that we own Nike (NKE). The company appears to be doing very well but the stock is still down. If a company is executing well even if the market is down then there is probably no reason to worry about it as a going concern.

I disclosed selling Caterpillar (CAT) earlier this year in the belief that we were headed into a recession and that heavy cyclicals get crushed during recessions. If this is a recession and bear market then I would expect CAT to bottom out with a about a 50% decline from its peak for the simple reason that this is what it has done time after time.

It is great when you can trade around that sort of decline but if you don't then you can take solace that most companies will come back and go on to new highs. CAT will go to $130 at some point even if it gets there by way of $60. This is not "permanent impairment of capital" although some of these financial stocks might be.

One last point to reiterate is that if you took defensive action along the way (we made several sales earlier on that I disclosed here) then you are probably thinking you should have taken more on a day like yesterday and if we close the week at SPX 1200 you will think you took too much defensive action. No one will trade this perfectly, but I would say if you can smooth it out some then you were successful. SPX 1200 by Friday might seem crazy but with the recent volatility it is not impossible. That is not a prediction and it would not be a sign of health either.