Your faithful scribe has been out of town for a week, relaxing a bit. The DOW closed at a low of 12,455 while I was gone, down 1,666 from the 14,121 high (11.8%). You don’t have to be religious for those three sixes to bother you. The DOW closed today at 13,121, almost exactly 1,000 points from the high. The SPX is down a like amount. The question we’re all asking, like kids in the back seat on vacation, is “are we there yet?” Can we breathe safe in the assumption that this substantial pullback is merely a correction?

Another view was called to my attention today. In recent history, there were two previous credit crises: 1990 and 1998. In both of them, “the late August peak in the S&P 500 and the near-term low in the VIX occurred on the 23rd trading day from the 52-week high of the S&P 500 set that July. Both times, the market had already sold off more than 9% and then rallied at least 1.5% by the close on the 23rd trading day; yet, by the end of August, the S&P 500 was down an additional 9% to 12%. Today, Monday, August 20, 2007, is the 23rd trading day since the S&P 500 set a high on July 19, 2007. So, if history repeats itself, today is the day to short the market.” - EarningsWhispers.com.

Interesting, since the market has popped up more than 2.5% from the bottom last week. The current credit crisis is not identical to the two earlier ones (in particular, the Fed has acted much more quickly), but IS eerily similar in some ways - particularly how the VIX, a measure of investor fear, behaved both then and now.

The Fed cut the discount rate (not the fed funds rate) as a sop to the market, and - this is a biggie - has revised its earlier stance that the subprime issue is not expected to have major effects on the broader economy. The correction may not have bottomed, and revisiting the lows from last Thursday or even going lower is a distinct possibility as bad news piles upon more bad news. The market is very jittery now, and many are pulling the trigger whenever the bushes twitch. It doesn’t take much to send the market spiraling down.

I still think the sounder view is that the market is correcting. The puncturing of the credit bubble may not yet have progressed far enough to end the bull market; it’s impossible to tell. But the sight of central banks injecting nearly $300 billion into the world’s monetary supply is NOT an encouraging sign.

Yet I still think the bull has legs, primarily because corporate earnings remain strong, and I think that weakening earnings ultimately will be what sends the bull over the cliff. Remember, the market came back from the debacle in 1998 to new highs before the final crash in 2000. So I think there is reason for encouragement. Yes, I think we’re in the end game for the bull market, but the bull has further to run. But there may be rough water ahead in coming weeks, if history is any guide. If this crisis takes the same course as the two last ones, we could have a lot further to fall.

If the market appears to be taking a dive again, consider buying multi-month ATM puts to protect open covered call positions, assuming you have not already done so. If the dip is short-lived, you can sell the puts and recoup your cash, perhaps at a profit. If there is an additional sell-off, you can sell the puts for a very nice gain and hold the stock, or simply exercise the puts and sell the stock. The puts place you in the driver’s seat. It is late in the day to buy puts, considering how far the market has fallen, but ’tis better than simply watching them go down.

I would be loath to dump good stocks that are down, particularly large caps, since they will come back when, and if, the correction resolves itself. Buying puts is a way to delay having to decide whether to take a loss or hold the stock and takes the pressure off.

This entry was posted on Monday, August 20th, 2007 at 9:47 pm and is filed under Markets/Economy. 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.