In my post this morning, I speculated that the correction was not over yet and that the bottom was yet to come. Chicken Little is running full tilt this afternoon, but the market is what it is, and I for one doubt there is reason yet to conclude the bear is here.

Well, the correction is clearly not over yet, with the DJIA losing 387 points today (2.8%). But for me, that’s in the so-what category, since I simply think the correction continues to progress.

The sub-prime mortgage mess just gets worse all the time, as I have been predicting all along, because I have thought since at least February that it is far worse than most all financial commenters believe it to be. In an earlier post I noted that all true stock bubble markets are really asset bubbles, and at bottom, credit bubbles. Now the subprime crisis is making its way up the food chain. As long as the damage was mostly confined to hedge funds and subprime lenders, no one got too concerned; the Fed Open Market Committee seemingly least of all. The FOMC remains far more concerned about core inflation. Now major European central banks are finding it necessary to inject huge amounts of liquidity into the financial markets. Here is a great quote:

“Subprime problems have now gone global,” said Kathy Lien, chief strategist of DailyFX.com. The damage “is no longer limited to just small banks and mortgage lenders, but is now hitting Tier 1 banks around the world.” This is the asset (credit) bubble stretching at the seams before bursting open.

I have always thought the puncturing of the asset bubble would eventually undo the bull market, and it will. You hear a lot about the yen carry trade (borrowing in low-interest yen to take advantage of higher interest opportunities elsewhere). Well a lot of the yen carry loans went into - you guessed it - the asset bubble. The problem is gargantuan, and it’s global.

There are many bulls out there, including some (like Gerald Appel, the MACD inventor) whose opinion I deeply respect. And I think the bulls are right to say that this great market is not over yet. They point to corporate earnings holding up well so far and similar encouraging factors. But the fractures are obvious from so many signs. And when earnings start to tank, so will the market. Consumer spending drives corporate earnings, and since Americans don’t save and spending the last few years was driven by cash obtained from hone equity withdrawals (a tap mostly now shut), where will the spending come from? In fact, the market may start to tank well in advance of lousy earnings, since it tends to lead economic swings by months.

I hope this correction underlines for readers why I harp so much on confining covered call writing to the best companies. Yes, 25 of the 30 DOW stocks were down today, but that means 5 weren’t. When the market starts digging out of this correction, the best stocks will come back the most, and fastest. And when the bear comes, the best large-cap stocks will hold up the best and the longest.

I won’t repeat in detail here my many exhortations for covered call writers to take advantage of volatility swings in the market or to consider the purchase of multi-month puts. But are you rolling the calls down and writing ITM calls as the stocks drop? This captures some of the drop and puts it into your pocket.

Like the corner man says to the boxer, protect yourself.

This entry was posted on Thursday, August 9th, 2007 at 3:42 pm and is filed under Covered Calls. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.