To Catch a Dropping Knife

Two dramatic days in the stock market have been driven by renewed investor confidence.

Yesterday’s 200+ point advance was triggered by a $7.5 billion investment in one of our largest financial institutions, Citigroup. The source of this investment, the Abu Dhabi Investment Authority, generates questions from many philosophical, political and financial fronts, and at the same time encourages investors in both the debt and equity markets that the fundamental value of the US financial sector is still very real regardless of uncertainties in the near term. It also provides confidence that the Fed is not the only white knight out there with deep pockets.

Today’s 300+ point gain in the U.S. stock market was helped by comments made by Vice Chairman of the Federal Reserve Donald Kohn. He told the Council on Foreign Relations “uncertainties” in the markets “require flexible and pragmatic policymaking”. Wall Street interpreted these remarks to mean the Fed will cut rates again at their next meeting.

This is also reflected in the price action of the Fed Funds futures contracts which have long been an indicator of institutional investor sentiment on where short-term interest rates are going. That measure is currently predicting an approximately 80% chance of a Fed easing at the next meeting.

All this positive action in the face of a week of negative economic news:

1) 90% of companies in the S&P 500 have reported earnings and those earnings have shown an 8.5% decline in earnings versus the 3^rd quarter of 2006 in which there was an 11.6% year over year gain. The worst year over year comparison since the 4^th quarter 2001. Yes…2001.

2) The Fed’s Beige Book report out today showed slowing economic growth in October.

3) Orders for durable goods such as cars, computers and appliances fell .5% in October following a revised 1.4% decline for September. This, however, was in line with economic forecasts.

So, now what? The fact is that all those negative numbers are a snapshot in the rearview mirror. The near term future will likely bring more negative news as the Credit Crunch brought about by the Sub-prime debacle plays itself out over the next 12-24 months and individual investors will, as they always have, watch the “big money” to give them direction as to the next move up in the economic cycle. Granted, the best and brightest are a little more tarnished than in the past, but for better or worse they still run the game.

The $7.5 Billion investment in Citigroup by foreign investors is not their effort to “play the stock market.” They are not trying to take an educated risk on the direction of the stock market in the next 6 months. Additionally, these folks are certainly not “day traders”. But, they do know a bargain. An investment in Citigroup is an asset play that spans stocks, bonds and real estate. It may get a little uglier but even they cannot pick a bottom. There's a saying in the investment industry... picking a market bottom "is like catching a dropping knife." Who needs that? One thing is for sure, they would rather be in the game than standing on the sidelines. Can’t make money there… can you?

By: Ron Ojeda, Capital Development, Blue Moon Capital, LLC